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Senate Majority Leader Harry Reid (D-NV) expects the Senate Finance and Health, Education, Labor, and Pensions committees to mark up their healthcare reform bills by the end of this month. The goal is for Senate floor action to take place prior to the August deadline set by both the House and Senate for healthcare reform legislation. The House of Representatives is also expected to advance legislation this summer

Last month, the Finance Committee issued a paper that outlined several options for financing healthcare reform. One of the largest revenue-generating options put forward was a capping of the exclusion from taxes of employer-provided healthcare benefits. The Obama administration has indicated a willingness to consider that option. Other proposals set forth in the Finance Committee paper include:

  • modification of the tax status of nonprofit hospitals
  • elimination or modification of employer-provided flexible spending accounts
  • modification of health savings accounts
  • extension of Medicare tax to employees of state and local governments
  • scaling back of the itemized deduction for medical expenses
  • narrowing of the student FICA exception (see details below)
  • increase tax on alcoholic beverages
  • new excise tax on sugar/high fructose corn syrup-sweetened beverages

Background on Student FICA Exception. Since 1939, the Internal Revenue Code has included an exemption from FICA tax for wages paid to students who are enrolled at a college or university and also employed by that institution. This helps student-employees keep more of their income, and in addition, the institution-employer experiences a tax savings. The IRS has long taken the position that the student FICA exemption is not available to all students who are employed by the school, but only those who are "primarily" students. The IRS issued safe harbor standards in final regulations published in 2004.

Medical Resident Issue on Hold. The final rules clarified eligibility issues related to the student FICA exemption except for whether medical residents may qualify for it. In 1998, the 8th Circuit held that medical residents at the University of Minnesota were eligible for the student FICA exemption, and this case has spawned hundreds of FICA tax refund claims filed over the past 10 years. Some estimate that these refund claims (plus interest) total billions of dollars today. The IRS has staunchly fought this position in the courts, with little success. While there's a chance that IRS could eventually prevail with respect to its position that medical residents are ineligible for the student FICA exemption, those chances diminish with each new adverse court decision and it becomes more likely that the government will have to issue billions of dollars in tax refunds.

SFC Options. The Senate Finance Committee report includes a provision removing medical residents from eligibility for the student FICA tax exemption. This would avert what appears to be the inevitable IRS defeat in the medical resident area. The report, entitled "Financing Comprehensive Health Care Reform: Proposed Health System Savings and Revenue Options," explains the controversy over the medical resident issue, and that the government has not fared well in court. The option to remove medical residents from eligibility for the student FICA exemption may be appealing to lawmakers seeking to finance a $1 trillion healthcare reform package and save the Treasury billions of dollars in refund claims (if enacted retroactively).

Another policy option outlined in the paper is a limitation on the student FICA exemption covering all student-employees so that it would only apply "to an individual for a year only if the individual's earnings from the school, college, or university are less than the amount needed to receive a quarter of FICA coverage for the year ($1,090 for 2009). Therefore, if an individual's earnings exceed the limit, all of the individual's earnings are subject to FICA, regardless of whether the individual otherwise meets the requirements for the student exception." Adoption of that proposal would effectively eliminate the tax benefit for most student workers. It is unclear how much congressional support, if any, there would be for this option.

What You Can Do. NACUBO is interested in learning what the impact of not only the FICA-related provisions would be on your institution, but also how modifications to the employer exclusion for healthcare benefits and elimination of flexible plans would affect your campus from a financial and benefits design perspective. Share with us which provisions you see as the most harmful to your institution and why. Please send your responses to Mary Bachinger at We will be closely following these issues and will keep you posted via Advocacy Alert on any required action on Capitol Hill.


Mary Bachinger

Director, Tax Policy


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