Americas Weblog: NYU Changes Course (and So Do We)
2 June 2005
Tags:
FICA, New York University, NIH, NRSA, Postdocs
NYU Changes Course (and So Do We)
We reported last month that IRS regulations and guidance issued in February seemed to require universities to begin withholding FICA (social security tax) and FUTA (unemployment tax) from the paychecks of all postdoctoral fellows—including National Institutes of Health National Research Service Award (NRSA) recipients—starting 1 April. This conclusion was based on our own reading of the new rules and on conversations with deans and other administrators in the biomedical sciences community.
Anthony Mazzaschi, associate vice president for research at the Association of American Medical Colleges (AAMC) in Washington, D.C., was the first to bring the issue to our attention, via an AAMC newsletter. "This is really going to be an institutional decision, I believe," Mazzaschi said in a subsequent interview with Next Wave correspondent Beryl Benderly. "I think postdocs need to talk to their graduate deans and their graduate adviser to see how their school is handling it." The University of Pennsylvania, we soon learned, was considering whether to start withholding. Trevor Penning, associate dean for postdoctoral research and training at the Penn School of Medicine, put it this way: "Every tax office and controller's office at every university is going to have to make the decision [on what to do] for their university."
Joel Oppenheim, senior associate dean for biomedical sciences at the New York University School of Medicine, made his call early, on the advice of NYU's legal staff. "It's been open to question in the past, so I think this removes all question," Oppenheim told Next Wave in mid-March. The new IRS language, he noted "doesn't say that NRSAs are exempt." At least a few other universities were considering making a change, including—as recently as last week—the University of Iowa.
But soon after our article appeared on 1 April, we were contacted by Bertrand Harding, a noted tax attorney who numbers several universities among his clients. In interviews and several e-mails, Harding maintained that we, NYU, and anyone else who said that NRSA fellows owed FICA—or even that they might—had it wrong. The issue was simple, he maintained, and the IRS case law is clear: people on NRSA fellowships are not employees, so they don't owe FICA or FUTA.
Later, after weeks of trying, I finally managed to contact the right person at the Internal Revenue Service, and he agreed with Harding. John Richards of the Office of the Assistant Chief Counsel (Exempt Organizations/Employment Tax/Government Entities) said, in a phone interview, "Our position with respect to NRSA fellows is clear: those people are not subject to [FICA and FUTA] taxation."
So what about those new regulations? "I wouldn't think there's anything in [the new rules that] would make people change their treatment of NRSA fellows," said Richards.
In late May, NYU reached the same conclusion. At a 24 May meeting involving senior deans, other administrators, and "internal and external counsel," NYU changed course. "We are not going to withhold FICA on NRSA [postdocs]," Oppenheim said in an interview following the meeting. "We are going to review 'NRSA-like' fellowships case by case. For all other fellowships, we will continue to withhold."
So what about those new rules issued by IRS in February that, to us and to the people at NYU, seemed to require institutions to withhold FICA and FUTA from the paychecks of postdoctoral fellows? Those rules, says Richards, were intended to determine if employees also qualify as students. The IRS has found repeatedly, he observed, that NRSA fellowship recipients are fellowship recipients and are not to be treated as employees.
The First Test
According to both Richards and Harding, a fellowship recipient could be exempt from FICA and FUTA taxation in two ways. The first is if the fellowship qualifies, according to the tax code, as a grant instead of a wage. That's a harder test to meet than you might think; IRS has complex regulations for determining whether a fellowship payment is compensatory—a wage—or non-compensatory—a grant. Decisions are made case by case, but generally, in order to be found to be non-compensatory, a payment must not have a direct service requirement. Unlike most other fellowships, says Harding, tax courts have consistently found NRSA fellowships to be non-compensatory—despite the fact that NRSA fellowships do, indeed, have a service requirement.
So why are NRSA fellows singled out for special treatment? Harding addressed this question in his book, The Tax Law of Colleges and Universities, Second Edition (John Wiley and Sons, New York). In 1977, Harding wrote, the IRS held that NRSA fellowships are indeed compensatory, implying that FICA/FUTA tax is owed by all NRSA fellows. There were two reasons for the IRS decision: NRSA fellows were required to do biomedical research within 2 years of the fellowship's end; furthermore, NIH retained the right to make royalty-free use of copyrighted material produced during the fellowship period. Both of these conditions make an NRSA fellowship a fee for service—a wage—and not free money—a grant.
Members of Congress, however, disagreed with IRS's decision, and the following year Congress included in its revenue act a provision that suspended the IRS ruling until 1983. In 1981, the NRSA program was modified slightly; then, in 1983, IRS announced that those 1981 changes had rendered their 1977 ruling "obsolete," and declared NRSA fellowships FICA-exempt, a position IRS has maintained ever since.
IRS didn't specify what specific changes made in 1981 made their earlier decision obsolete. The NRSA service requirement was reduced by one year in 1981, but it was not eliminated. Furthermore, the right to make royalty-free use of copyrighted materials wasn't changed. So as a logical proposition, it's not obvious that the 1981 changes should have voided IRS's 1977 decision and rendered NRSA fellowships FICA-exempt. More than likely, IRS exempted NRSAs—and continues to exempt them—because of Congress's special interest in the NRSA program.
So what about other postdoctoral fellowships? Other fellowships must meet the same tests that those NRSAs were given a pass on. As a practical matter, other fellowships are evaluated for FICA and FUTA withholding on the basis of how closely they resemble NRSA fellowships; the closer the resemblance, the more likely that a fellowship will be exempt from FICA and FUTA taxation.
The Second Test
If a payment is found to be compensatory—a wage and not a grant—it may still be exempt from FICA/FUTA taxation under the student FICA exemption. The new IRS guidance—which (mis)led us to claim that NRSA fellowships were FICA-taxable—applies to payments made to students who have also been determined to be employees. Ordinarily this student exemption is restricted to people who are enrolled in degree-granting programs at educational institutions, but under some circumstances other groups—including, perhaps, postdocs, medical interns, and medical residents—could be found to be students. This is why IRS, in the new guidelines issued in February, confusingly refers to "employees who are postdoctoral students, postdoctoral fellows, medical interns, or medical residents" in order to exclude them from the "safe-harbor" provisions that would exempt them from FICA/FUTA taxation. As a consequence, says Harding, postdoctoral fellows who have already failed the first test—those whose fellowships have been determined to be compensatory—will almost certainly fail to qualify for the student FICA exemption. This is why many postdoctoral fellowships are FICA taxable, while NRSAs are not.
The Bottom Line
So what does it all mean for postdoctoral fellows and their host institutions? With the caveat that we are not tax attorneys and cannot offer tax advice, here is our current understanding of the issue:
* Institutions need not withhold FICA or FUTA from NIH NRSA fellowships.
* If a fellowship closely resembles an NRSA, it should be measured against the NRSA, and the relevant tax-court law should be consulted. Holders of "NRSA-like" postdoc fellowships may owe FICA and FUTA, or they may not.
* The FICA-taxability of other postdoctoral fellowships should be determined case-by-case. But many fellowships are likely to fail IRS's requirement that there be no quid pro quo, that no service be required in exchange for payment. So most postdoctoral fellowships are likely to be found FICA and FUTA taxable.
- posted by Jim
