Mayo Foundation for Medical Educ. and Res. v. U.S.

568 F.3d 675

MAYO FOUNDATION FOR MEDICAL EDUCATION AND RESEARCH; Mayo Clinic, Plaintiffs-Appellees, v. UNITED STATES of America, Defendant-Appellant.

Regents of the University of Minnesota, Plaintiff-Appellee, v. United States of America, Defendant-Appellant.

No. 07-3242.

No. 08-2193.

United States Court of Appeals, Eighth Circuit.

Submitted: October 16, 2008.

Filed: June 12, 2009.

Teresa E. McLaughlin, argued, Bridget M. Rowan, on the brief, Dept. of Justice, Washington DC, for appellant.

Thomas Tinkham, argued, John W. Windhorst Jr., William R. Goetz, Christopher R. Duggan, on the brief, Minneapolis, MN, for appellee.

Before LOKEN, Chief Judge, BYE and SMITH, Circuit Judges.

LOKEN, Chief Judge.

"Residents" participating in accredited graduate medical education programs receive substantial payments (called stipends) from the Mayo Foundation for Medical Education and Research ("Mayo") and the University of Minnesota (the "University") for medical and patient care services provided by the residents at affiliated and unaffiliated hospitals and clinics. The difficult issue in these cases is whether these payments qualify for the student exception to Federal Insurance Contributions Act ("FICA") taxes imposed on employers and employees. See 26 U.S.C. § 3121(b)(10). The district court answered this question affirmatively, declaring invalid recently promulgated Treasury Regulations to the contrary and awarding Mayo and the University refunds of substantial FICA taxes paid during the second quarter of 2005. Mayo Found. for Med. Educ. & Research v. United States, 503 F.Supp.2d 1164 (D.Minn.2007); Regents of the Univ. of Minn. v. United States, 2008 WL 906799 (D.Minn. Apr.1, 2008). The United States appeals. We review the district court's invalidation of Treasury Regulations de novo. Walshire v. United States, 288 F.3d 342, 345 (8th Cir.2002). Concluding that we must defer to the regulation limiting this exception to students who are not full-time employees because it is a permissible interpretation of the statute, we reverse.

I.

FICA taxes, which support the Social Security system, are imposed on both employers and employees based upon wages paid. 26 U.S.C. §§ 3101, 3111. The term "wages" is broadly defined in § 3121(a) as "all remuneration for employment." "Employment" is also broadly defined in § 3121(b) as "any service, of whatever nature, performed ... by an employee," but there are twenty-one specific statutory exceptions. At issue here is the exception for "service performed in the employ of ... a school, college, or university ... if such service is performed by a student who is enrolled and regularly attending classes at such school, college, or university." 26 U.S.C. § 3121(b)(10).

A student exception has been part of the FICA and Social Security statutes since 1939. Although litigation regarding its application to medical school stipends paid to enrolled residents arose only recently, it has now exploded across the country. The avalanche began when Minnesota sued the Commissioner of Social Security to recover assessments for stipends paid to the University's medical residents under a "Section 218 Agreement," the mechanism by which States such as Minnesota then obtained Social Security coverage for designated employees. The district court ruled for the State on two alternative grounds, and we affirmed. Minnesota v. Chater, 1997 WL 33352908 (D.Minn. May 21, 1997), aff'd, Minnesota v. Apfel, 151 F.3d 742 (8th Cir.1998). The first ground, that the State did not intend to designate medical residents under the Agreement, is of no relevance here. But the alternative ground, that medical resident services fell within the student exception in the Social Security Act, 42 U.S.C. §§ 410(a)(7)(A), 418(c)(5), prompted the filing of more than 7,000 claims with the IRS, as medical schools sought refunds of FICA taxes on medical resident "wages," based on the student exception in 26 U.S.C. § 3121(b)(10).¹

One refund claim was filed by Mayo. The IRS paid the refund, sued to recover it, and Mayo counterclaimed for refunds in other years. At that time, as one familiar with federal tax law would expect, there was a lengthy Treasury Regulation interpreting the student exception statute, which provided in relevant part:

(b) For purposes of this exception, the amount of remuneration for services performed ... the type of services performed ... and the place where the services are performed are immaterial. The statutory tests are

(1) the character of the organization ... as a school, college, or university ... and (2) the status of the employee as a student enrolled and regularly attending classes at the school, college, or university by which he is employed....

(c) ... An employee who performs services in the employ of a school, college, or university, as an incident to and for the purpose of pursuing a course of study at such school, college, or university has the status of a student in the performance of such services....

(d) The term "school, college, or university" ... is to be taken in its commonly or generally accepted sense.

Treas. Reg. (26 C.F.R.) § 31.3121(b)(10)-2(b)-(d) (2004) (emphasis added).

After a bench trial, the district court granted judgment in favor of Mayo. Relying on our decision in Apfel that the Social Security Act regulations required a fact-specific, "case-by-case examination," 151 F.3d at 748, and applying the above quoted portions of the Treasury Regulations, the court found that Mayo was the employer of its medical residents; that Mayo is a school, college, or university; that the residents were "students" enrolled in a residency program and regularly attending classes; and that "the patient care services provided by residents in the [Mayo] residency programs were incidental to and for the purpose of pursuing a course of study in postgraduate medical education." United States v. Mayo Found. for Med. Educ. & Research, 282 F.Supp.2d 997, 1011-18 (D.Minn.2003) (Mayo I).

The government appealed this decision but then dismissed the appeal and published notice of proposed regulations amending Treas. Reg. § 31.3121(b)(10)-2. 69 Fed.Reg. 8604 (Feb. 25, 2004). After extensive public comments and a hearing, the IRS promulgated final amended regulations, effective April 1, 2005. T.D. 9167, 2005-1 C.B. 261, 69 Fed.Reg. 76404 (Dec. 21, 2004). As relevant here, the amended regulations provide, with the amendments at issue highlighted:

(b) ... The statutory tests are:

(1) The character of the organization ... as a school, college, or university within the meaning of paragraph (c) of this section ... and

(2) The status of the employee as a student enrolled and regularly attending classes within the meaning of paragraph (d) ....

(c) ... An organization is a school, college, or university within the meaning of section 3121(b)(10) if its primary function is the presentation of formal instruction.... See section 170(b)(1)(A)(ii) and the regulations thereunder.

(d) ... In order to have the status of a student ... the employee's services must be incident to and for the purpose of pursuing a course of study within the meaning of paragraph (d)(3) of this section ....

[(d)(3)](iii) ... The services of a full-time employee are not incident to and for the purpose of pursuing a course of study.... [R]egardless of the employer's classification of the employee, an employee whose normal work schedule is 40 hours or more per week is considered a full-time employee.... The determination of an employee's normal work schedule is not affected by the fact that the services performed by the employee may have an educational, instructional, or training aspect.

Though the amended regulations cover a broader range of issues, the "Need for Regulations" section of the notice of proposed rulemaking expressly focused on medical residents and the decisions in Apfel and Mayo I. See 69 Fed.Reg. at 8605. The final regulations include as an example of services not excepted under 26 U.S.C. § 3121(b)(10) a person employed by a university to provide patient care services at an affiliated teaching hospital if the employee works at least forty hours per week, even if the services have an educational or training aspect. Such services are not excluded, the regulations explain, because the person is a full time employee and therefore his services "are not incident to and for the purpose of pursuing a course of study." Treas. Reg. § 31.3121(b)(10)-2(e), Example 4.

The amended regulations apply to the calendar quarters here at issue, but the district court held them invalid. In Mayo's case, decided first, the court concluded:

(i) the "primary function" test in Treas. Reg. 31.3121(b)(10)-2(c) "is inconsistent with the plain meaning of [the term `school, college, or university' in] the statute and is invalid."

(ii) "the full-time employee exception [in Treas. Reg. 31.3121(b)(10)-2(d)(3)] is invalid because it is inconsistent with the plain meaning of the statute and is arbitrary, capricious, and unreasonable" because the term student, like the term school, college, or university, "is not ambiguous."

503 F.Supp.2d at 1171-77. Eight months later, the court granted summary judgment in favor of the University. The court adopted its ruling in Mayo's case that the amended regulations are invalid, applied the prior regulations, and concluded that the University's medical residents (i) are employed by the University, not by the independent hospitals where they provide patient care services, (ii) are "enrolled" and "regularly attending classes" in a residency program, and (iii) provide patient care services that are "incident to and for the purpose of pursuing a course of study."

The government appeals both decisions, arguing that the amended regulations are valid and challenging the grant of summary judgment to the University on the employer issue. We assigned both appeals to the same panel, which heard oral arguments the same day. We...