August 2, 2010
In Mayo Foundation, et al. v. United States, No. 09-837, the Supreme Court will consider whether medical residents are exempt from FICA taxation, with the decision likely to turn on the level of deference the Court is willing to accord to a recent regulatory change. Although the issue may seem obscure, there are 8,000 residency programs in the United States, and the government estimates that $700 million in taxes per year is at stake, with $2.1 billion in refund claims pending.
The issue involves the meaning of the “student exemption” to FICA, which excludes from the definition of “employment” “service performed in the employ of a school” by a “student who is enrolled and regularly attending classes at such school.” I.R.C. § 3121(b)(10). The regulations implementing that statute long provided that “student” status depends on the relationship between the employee and the institution and that when the services are performed “incident to and for the purpose of pursuing a course of study,” the employee can qualify for the student exemption. Beginning in the late 1990s, there have been several cases addressing whether this exception applies to medical residents, who work more than full-time and earn a $40,000-$60,000 stipend, but perform their duties as part of an educational process in which they also attend classes.
In 2003, a federal district court in Minnesota ruled that the Mayo Clinic’s residents qualified for the student exception under the statute and existing regulations. The government responded by amending the regulations, effective April 1, 2005, to provide a bright-line rule that does not allow full-time employees to qualify for the exception. Thereafter, four other courts of appeals ruled against the government, stating that the residents fell within the terms of the statutory exception. All four of those cases, however, involved pre-2005 periods, and therefore the courts did not directly consider the impact of the amended regulation. In this case, the first to address the new regulation, the Eighth Circuit held that it owed Chevron deference to the new regulation as a reasonable interpretation of an ambiguous statute. Thus, contrary to the other four circuits, it sided with the government and held that the residents are subject to FICA taxation.
Most tax cases reach the Supreme Court on the strength of a request for further review by the government, but in this case the Court granted a petition filed by the taxpayers over the government’s opposition. The taxpayers predictably argued that the circuit conflict, and dollars at stake, necessitated Supreme Court review. In situations like this, the government often acquiesces in certiorari, because the IRS likes to get circuit conflicts resolved to promote its own institutional interest in uniformity. In this case, however, the government sought to avoid taking its chances in the Supreme Court by arguing that there was no genuine circuit conflict, because the other four circuits had not considered the new regulation. Evidently, the government hoped that it could build on this decision and use it to get the other circuits to retreat from their prior decisions and adopt a rule going forward under the new regulation that would subject medical residents to FICA taxation. The Court, however, was apparently persuaded by the taxpayers that the new regulation is unlikely to lead to a different result in those circuits – because they had already indicated a view that medical residents qualify for the exception under the unambiguous statutory language, which would leave no room for Chevron deference to the new regulation.
A decision by the Court will, of course, resolve the question of FICA taxation of medical residents — unless Congress steps in. But the decision could have a much broader impact because it implicates the general topic of deference to IRS regulations, particularly the question whether Chevron deference principles have superseded the more specialized analysis developed over the years in tax cases dating back to National Muffler Dealers Ass’n v. United States, 440 U.S. 472 (1979). In recent years, courts of appeals have begun to trend towards applying standard Chevron analysis in tax cases, but the Tax Court has resisted. See, e.g., Swallows Holding Ltd. v. Commissioner, 126 T.C. 96 (2006), rev’d, 515 F.3d 162 (3d Cir. 2008). The Supreme Court has not specifically addressed the issue.
There is not a huge difference in the two deference approaches, and, in most cases, choosing between them is not likely to affect the outcome. Like Swallows Holding, however, this case could be an exception. Among the factors listed in Muffler Dealers for determining deference that have been oft-applied in later cases are whether the regulation is contemporaneous with the statute and “the consistency of the Commissioner’s interpretation.” 440 U.S. at 477; see also, e.g., United States v. Cleveland Indians Baseball Co., 532 U.S. 200, 220 (2001); Cottage Savings Ass’n v. Commissioner, 499 U.S. 554, 561 (1991). In this case, those factors support the taxpayers’ rejection of the regulation, as the government is arguing for reliance on a new regulatory approach that departs from a 65-year old regulation. Contemporaneity and consistency, however, play no role in the Chevron analysis, which does not penalize the agency for inconsistency or for promulgating new regulations designed to overturn adverse court decisions. Indeed, the Court has specifically ruled that prior contrary judicial constructions of a statute do not foreclose owing Chevron deference to a subsequent regulation, unless the court decision had determined that the statute is unambiguous. National Cable & Telecommunications Ass’n v. Brand X Internet Services, 545 U.S. 967, 982-86 (2005).
The parties did not tee up this potential issue in the briefs filed at the certiorari stage. The court of appeals’ opinion straddled the fence, purporting to apply Chevron but also stating that the Muffler Dealers factors were “instructive” on the second part of the Chevron inquiry – whether the regulation is a reasonable interpretation of the statute. The certiorari petition focused mostly on the circuit conflict. To the extent it discussed the merits of the case, it argued that the Eighth Circuit’s decision was inconsistent with Chevron and and did not cite the Muffler Dealers line of cases. (The petition argued that the Eighth Circuit had “effectively eliminate[d]” the first step of Chevron analysis in tax cases when it stated that, when common words are found in “a provision of the Internal Revenue Code, a Treasury Regulation interpreting the words is nearly always appropriate.”) The government’s brief was happy to embrace the notion that Chevron governs the deference inquiry. It will be interesting to see whether the taxpayers try to get more mileage out of Muffler Dealers and its progeny at the merits stage.
The parties will be briefing the case over the summer, with the taxpayers’ opening brief currently due on August 6, 2010. Oral argument is expected to be scheduled for November or December. One important note is that this is one of the cases in which Elena Kagan has stated her intent to recuse because she participated in the case as Solicitor General. That means the case will be decided by an eight-Justice Court, with the possibility of a 4-4 split. If that occurs, the Court would issue a one-line order affirming the Eighth Circuit’s decision by an equally divided court. The government’s victory in this case would stand, but the decision would have no precedential value, and the issue would remain in play outside the Eighth Circuit.
The opinion of the Eighth Circuit and the parties’ briefs at the certiorari stage are linked below. We will provide the briefs on the merits after they are filed.