IRS sues hospitals to get FICA refunds back

Medical residents are considered employees, not students.

By Myrle Croasdale, AMNews staff. Aug. 22/29, 2005.

The Internal Revenue Service appears to be going after teaching hospitals to reclaim social security tax refunds it made in recent years. If the courts find in favor of the IRS, the impact on the individual hospitals involved could be significant, legal experts said.

The University Hospital in Cincinnati is facing the possibility of having to repay, with interest, $5 million in Federal Insurance Contributions Act tax refunds it was awarded in 2003. With an annual budget of $450 million, that won't be easy, said Gail Myers, vice president of public relations and marketing for Health Alliance, which represents five hospitals, including University Hospital.

"Paying back the tax refund would have a significant impact," Myers said. "We're a not-for-profit, and money is put straight back into teaching and technology."

It's unclear how many schools or hospitals may be sued, but the IRS confirmed that it has filed complaints against three hospitals so far. The amounts it is seeking range from $2.5 million to $16 million.

The debate over whether medical residents are employees or students has gone on for at least 40 years. The Social Security Act was signed into law in 1935, and by 1939, students, medical interns and self-employed physicians were exempt from the tax. Residents were not. In 1964, when this distinction between interns and residents was challenged, Congress responded by expanding Social Security to include interns and self-employed physicians.

Then came Minnesota v. Apfel in 1998. Because employees of the state of Minnesota were exempt from paying Social Security taxes, the University of Minnesota had not been paying FICA for its medical residents. When the Social Security Administration decided that the University of Minnesota's medical residents should be taxed, the university sued and won in the 8th U.S. Circuit Court of Appeals.