IRS Regulations

IRS Regulations

March 31, 2011

IRS Regulations will be harder to challenge after a US Supreme Court decision in January.

The Mayo Clinic did not pay Social Security taxes on “stipends” paid to young doctors who work three to five years as residents after graduating from medical school as further training in specialty areas of medical practice. The residents are paid $41,000 to $56,000 a year. They work as much as 80 hours a week, but are also expected to do assigned reading, attend weekly lectures and take written exams.

Social Security taxes do not have to be paid on wages that a school, college or university pays students who work for the school while regularly attending classes. The IRS said in regulations issued in 1951 that the exemption applies only where the student works “as an incident” to attending classes. In 2004, it amended the regulations to clarify that it does not consider the work a student does as merely “incident” to attending classes if the work is the “predominant . . . aspect of the relationship” the student has with the school.

The change had the effect of requiring taxes be paid on the residents’ stipends.

The Mayo Clinic and the IRS ended up in court. The clinic argued that the IRS regulations were invalid.

The Supreme Court sided with the IRS. It said Congress did not address the issue unambiguously in the tax code. Congress gave the IRS broad discretion in section 7805 of the US tax code to “prescribe all needful rules and regulations for the enforcement” of the tax laws. The IRS gave notice to the public of its position and allowed a period for comment. The position is not unreasonable.

In the past, courts have distinguished between “legislative” regulations that the IRS issues under a section of the tax code in which Congress specifically asked the agency to fill in details and other regulations. Legislative regulations have been afforded more deference.

The Supreme Court declined to distinguish between the two.

The case is Mayo Foundation for Medical Education and Research v. United States. The Supreme Court released its decision on January 11.

The bottom line is that taxpayers will have a hard time challenging IRS positions taken in final regulations in the future. They would do better to argue that Congress was clear about what it intended. Once a court decides that there is room for interpretation, if there are several possible approaches any one of which is reasonable, the IRS gets to choose. It is not clear to what extent the decision applies to other forms of IRS guidance, most of which are issued without first proposing an approach and then letting the public comment.

Keith Martin