Federal Taxation - Michael H. Plowgian, Svetoslav S. Minkov, and Mark S. Davis

• Publication year: 2008

Federal Taxationby Michael H. Plowgian^* Svetoslav S. Minkov^** and Mark S. Davis^***

I. Introduction

The courts in the Eleventh Circuit heard a number of relatively prominent tax related cases in 2007. In United States v. Mount Sinai Medical Center of Florida, Inc.,¹ the Eleventh Circuit held that medical residents are potentially eligible for the student exemption from social security taxes, with their eligibility being determined on a case-by-case basis.² In Estate of Jelke v. Commissioner,³ the Eleventh Circuit vacated the United States Tax Court's valuation methodology in computing, for estate tax purposes, the net asset value of a holding company in which the decedent held a minority interest.⁴ The Eleventh Circuit held that the decedent's estate should be allowed a full dollar-for-dollar discount for the tax liability associated with the built-in gain in the holding company's assets.⁵ In addition, in Womack v. Commissioner,⁶ the Eleventh Circuit joined the list of federal courts of appeals that have consistently held that the proceeds from the sale of rights to future installment payments of state lottery winnings are taxed as ordinary income, rather than as capital gains.⁷ In a long and very fact-intensive opinion in Estate of Kanter v. Commissioner,⁸ the Tax Court, on remand from the Eleventh Circuit,⁹ upheld its earlier finding that Claude M. Ballard and others had fraudulently failed to report income from a kickback scheme.¹⁰ In United States v. Coastal Utilities, Inc.,¹¹ the United States District Court for the Southern District of Georgia granted the government's motion for summary judgment and held that universal support payments received by a telephone company from the federal government and access funds received from Georgia were income to a telephone company, not contributions to capital not subject to tax.¹² Finally, in Brandon Ridge Partners v. United States,¹³ the United States District Court for the Middle District of Florida denied a partnership's motion for summary judgment and held that the extended six-year statute of limitations applied to allow an adjustment of partnership items related to a tax shelter transaction.¹⁴

II. Eleventh Circuit Cases

A. Eligibility of Medical Residents for Student Exemption from Social Security Taxes Must Be Determined on a Case-By-Case Basis

In United States v. Mount Sinai Medical Center of Florida, Inc. (Mount Sinai II),¹⁵ the United States Court of Appeals for the Eleventh Circuit, reversing a district court decision, held that medical residents are potentially eligible for the student exemption from social security taxes under the Federal Insurance Contributions Act ("FICA").¹⁶

Under FICA, both employers and employees are taxed on wages that employers pay to their employees as remuneration for "employment."¹⁷ These taxes are used to fund the federal social security program.¹⁸ The term "employment" is defined, for FICA purposes, as "any service, of whatever nature, performed . . . by an employee for the person employing him."¹⁹ A number of relationships are excluded from the definition of employment.²⁰ Among these exclusions is the "student exemption," which covers any "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."²¹

In 2002 the United States brought a complaint against Mount Sinai Medical Center of Florida, Inc. ("Mount Sinai"), claiming that the Internal Revenue Service (the "Service") had issued to Mount Sinai an erroneous refund in the amount of $2,450,177 in 2000 and 2001. This amount was attributable to FICA taxes paid and withheld by Mount Sinai for payments made to medical residents in Mount Sinai's graduate medical education program for the tax years of 1996 through 1999.²² The medical residents who enrolled in the program did not pay tuition or fees, but rather received either uniform salaries or stipends from Mount Sinai to perform medical functions in the medical center. The medical residents also participated in an educational program that included numerous conferences, core curriculum classes, graded examinations, and textbook readings.²³ Based on the educational aspects of the medical residency program, Mount Sinai contended that the refund was proper because the underlying payments to its medical residents fell under the student exemption from FICA taxation.²⁴

In 2005 the United States District Court for the Southern District of Florida determined that the student exemption to FICA does not cover wages paid to medical residents.²⁵ The court first noted that the terms "employment" and "wages" should be construed broadly in this context to promote broad coverage under social security.²⁶ Quoting the United States Supreme Court, the district court explained that "'federal social security legislation is an attack on recognized evils in our national economy, [and thus] a constricted interpretation of the phrasing by the courts would not comport with its purpose.'"²⁷

The court next turned to the legislative history of the student exemption and the related exemptions that have, at different times, applied to doctors.²⁸ In particular, the court focused on the since-repealed medical intern exception to FICA tax, which exempted payments for "'[s]ervice performed as an interne in the employ of a hospital by an individual who has completed a four years' course in a medical school chartered or approved pursuant to [s]tate law.'"²⁹ The medical intern exception was added to the Internal Revenue Code in 1939.³⁰ According to the district court's opinion, the House Report accompanying the 1939 amendments "made clear that the [medical] intern exception did not apply to [medical] residents,"³¹ but instead applied only to medical interns, who are generally defined as individuals in the first year of a medical residency program.³² A similar exception covered self-employed physicians.³³ As a result, between 1939 and 1965, many medical residents were subject to FICA tax even though they were exempt from FICA prior to becoming medical residents and would likely be exempt again once they became practicing physicians.³⁴ In St. Luke's Hospital Ass'n v. United States,³⁵ the United States Court of Appeals for the Sixth Circuit acknowledged the seeming inequity of this regime as applied to medical residents.³⁶ Nonetheless, the court held that medical residents were subject to FICA tax while medical interns and self-employed physicians were not.³⁷ Rather than expanding the exceptions to include medical residents, however, Congress responded to St. Luke's in 1965 by repealing the medical intern and self-employed physician exceptions.³⁸

The district court in Mount Sinai I determined that based on the legislative history of the 1965 amendments, Congress repealed the medical intern exception in order to include medical interns within the social security program, not, as Mount Sinai had posited, because the student exemption already covered medical interns.³⁹ Based on Congress's intent to narrow the exceptions to FICA, as well as Congress's knowledge of the Sixth Circuit's decision in St. Luke's, the district court determined that Congress did not intend to exempt medical residents from FICA taxation and found in favor of the government.⁴⁰

On appeal, the Eleventh Circuit reversed and remanded the case to the district court, holding that the lower court's reliance on legislative history was improper.⁴¹ The Eleventh Circuit criticized the district court's failure to analyze whether the language of the student exemption was ambiguous before turning to the legislative history of the statute for guidance.⁴² Performing its own analysis of the language of the student exemption, the court of appeals concluded that the statute's language was not ambiguous and therefore did not, as a matter of law, preclude Mount Sinai "from attempting to prove that its residents' services qualify for the student exemption."⁴³ Instead, the court determined that the statute prompted a factual inquiry into whether a medical resident in Mount Sinai's residency program is a "'student'" and whether he or she is employed by a "'school, college, or university.'"⁴⁴ Such a factual inquiry is not contrary to the FICA statutory scheme, the court reasoned, because medical residents are not excluded from the student exemption by the exemption's language, and no separate provision mandates FICA taxation of payments to medical residents.⁴⁵ The Eleventh Circuit disagreed with the government's assertion that the court should adopt a bright-line rule that medical residents can never be covered by the student exemption.⁴⁶ The court held that a "case-by-case analysis" was necessary to determine whether the exemption applies to medical residents.⁴⁷

Despite the Eleventh Circuit's determination that the legislative history of the student exemption was not controlling in this case, the court analyzed the legislative history relied upon by the district court and found it unpersuasive.⁴⁸ The court was not persuaded by the decision in St. Luke's because the Sixth Circuit opinion only analyzed whether the medical intern exception, not the student exemption, applied to medical residents.⁴⁹ Consequently, "[t]he fact that Congress repealed the entirely separate [medical] intern exemption in 1965," in the wake of St. Luke's, "is irrelevant to the question of whether [medical] residents may qualify for the student exemption under the plain language of the statute."⁵⁰ The Eleventh Circuit likewise dismissed the district court's determination that the Eleventh Circuit's reading of the student exemption would have rendered the medical intern exemption superfluous if it applied to medical residents.⁵¹ According to the court of appeals, the medical intern exception would have been superfluous only if one assumed that a medical intern was always a "'student'" and that...