Procedure & Administration
The Supreme Court’s decision in Mayo Foundation for Medical Education and Research, S. Ct. Dkt. No. 09-837 (U.S. 1/11/2011), clarified much of the existing uncertainty regarding the level of deference courts should grant to Treasury regulations interpreting the tax law.
The Mayo Case
In the Mayo decision, the Supreme Court determined the level of deference owed to an interpretive Treasury regulation, Regs. Sec. 31.3121(b)(10)-2(d)(3)(iii), under which persons who work 40 hours or more per week are treated as employees rather than students for purposes of the Federal Insurance Contributions Act (FICA). FICA imposes a tax on both employees and employers for wages earned performing services, with certain exceptions like the student exemption under Sec. 3121(b)(10) for services performed in the employ of a school, college, university, or similar organization, “if such service is performed by a student who is enrolled and regularly attending classes at such school, college, or university.”
The Mayo Foundation sought a refund of FICA taxes paid on behalf of doctors who have graduated from medical school and attend Mayo’s residency programs for additional instruction in their chosen specialty. The residents receive annual “stipends” of over $40,000, are required to take written examinations, and spend roughly 50–80 hours a week in a “clinical setting, where they learn by caring for patients in a medical specialty under the supervision of a faculty member.”
Mayo argued that the term “student” for purposes of the statutory exemption plainly encompasses medical residents and that, in any event, the categorical exclusion in the regulation of employees working more than 40 hours a week without regard to the educational component of the work is an unreasonable interpretation of the law.
Background
Certain regulations issued by Treasury are based on specific grants of authority in the Internal Revenue Code; one example is Sec. 1502, which authorizes the Treasury secretary to issue consolidated return regulations. More common than such legislative regulations, however, are interpretive regulations promulgated under the Sec. 7805(a) grant of general authority to the Treasury secretary to “prescribe all needful rules and regulations for enforcement” of the Code. Courts generally attach great weight, and thus often defer, to Treasury’s interpretation of the Code, but both the Supreme Court and the Tax Court have stated that an interpretive regulation under the general grant of authority in Sec. 7805(a) is not entitled to the high degree of deference accorded a legislative regulation. See, e.g., Rowan Companies, 452 U.S. 247, 253 (1981); Swallows Holding, Ltd., 126 T.C. 96, 129–30 (2006).
Judicial Deference to IRS Regulations Prior to Mayo
Prior to Mayo, judicial deference depended on whether the regulation was legislative or interpretive. The Supreme Court developed two principal standards for judicial review of agency regulations:
- In National Muffler Dealers Ass’n, Inc., 440 U.S. 472 (1979), the Court established a lesser standard of deference for interpretive regulations, holding that courts should defer to such regulations if they implement a congressional mandate in a proper manner and “harmonize with the plain language of the statute, its origin, and purpose” (440 U.S. at 477), taking into account several factors, including whether the regulation was contemporaneous with the statute’s enactment and whether the IRS’s interpretation has been consistent.
- In Chevron, U.S.A., Inc. v. Natural Res. Def. Council, 467 U.S. 837 (1984), which was not decided in the context of a tax regulation but became the most-cited case for giving broad deference to legislative Treasury regulations, the Court laid down a two-part analysis, stating that in a first step, “[i]f the intent of Congress is clear, that is the end of the matter, for the Court, as well as the agency, must give effect to the unambiguously expressed intent of Congress” (467 U.S. at 843). Second, “if the statute is silent or ambiguous with respect to the specific issue, the question for the Court is whether the agency’s answer is based on a permissible construction of the statute” (id.).
After Chevron, it was unclear whether the less deferential National Muffler standard still applied to interpretive Treasury regulations.
The Supreme Court’s Opinion in Mayo
In Mayo, the Supreme Court clearly rejected the less deferential National Muffler standard of review and did not see “any justification for applying a less deferential standard of review to Treasury Department regulations than we apply to the rules of any other agency” (slip op. at 9). Noting that the “administrative landscape has changed significantly” since National Muffler, the Court concluded that “[t]he principles underlying our decision in Chevron apply with full force in the tax context” (slip op. at 10).
The Court applied the two-step Chevron analysis, establishing in a first step that Congress had not provided a clear definition of “student” for purposes of Sec. 3121(b)(10), and further held that the regulation “easily satisfies the second step of Chevron, which asks whether the Department’s rule is a ‘reasonable interpretation’ of the enacted text.” The Court went on to state that “the Treasury Department reasonably sought a way to distinguish between workers who study and students who work. Focusing on the hours an individual works and the hours he spends in studies is a perfectly sensible way of accomplishing that goal” (slip op. at 13, citation omitted).
Thus, in a unanimous decision, the Supreme Court upheld the regulation under the broad deference standard of Chevron. Medical residents were held to be validly excluded from the student FICA exemption in Sec. 3121(b)(10) under the regulation’s interpretation classifying them as employees whose wages are subject to the FICA tax.
Implications and Open Questions
The most immediate impact of the Supreme Court’s decision in Mayo is that hospitals, medical schools, and medical residents will need to consider FICA taxes in financial planning and tax compliance. The FICA tax obligation upheld by the Court applies to wages paid to medical residents on or after April 1, 2005, the date the regulations under Sec. 3121 went into effect. (The IRS has stated that it will process medical residents’ refund claims for periods before that date (IR-2010-25).)
The National Muffler standard of deference for interpretive regulations was in general rendered obsolete and replaced by the broader deference standard of Chevron, which was held to be uniformly applicable to regulations of all administrative agencies, regardless of any distinction between legislative and interpretive regulations in the context of the Code’s grant of authority to Treasury to promulgate regulations enforcing the tax law. However, the National Muffler standard or something like it may still apply in cases where tax regulations are not issued under “full notice and comment procedures.”
The opinion in Mayo mentions that the IRS issued the regulation in a question following notice-and-comment procedures, which is seen as a “significant sign that the rule merits Chevron deference.” The Court did not explain, however, whether full notice-and-comment procedures outside the Administrative Procedure Act (APA) could warrant such deference. Temporary regulations are also required to be issued as proposed regulations under Sec. 7805(e), which allows for notice and comment, but only after the temporary regulation has become effective. In other contexts, courts have held that such post-promulgation notice-and-comment procedures do not satisfy the APA’s standards for notice and comment. Further litigation may be necessary to determine whether the National Muffler standard may still apply to such regulations.
EditorNotes
Kevin Anderson is a partner, National Tax Services, with BDO USA, LLP, in Bethesda, MD.
For additional information about these items, contact Mr. Anderson at (301) 634-0222 or kdanderson@bdo.com.
