by Theresa E. Corona

The Internal Revenue Service issued final regulations related to the exception for student services from employment taxes, on December 21, 2004. The final regulations differ in several significant respects from the proposed rules issued last February and are in many ways less restrictive than the proposed regulations.

The regulations generally provide an exception from the definition of "employment" for which wages are subject to FICA taxation for: "services performed in the employ of a school, college or university…if the services are performed by a student…who is enrolled and is regularly attending classes at the school, college or university" or, services performed by a student in the employ of an organization that benefit the student’s school, college or university, and which meet several other requirements.

Whether an individual may be categorized by an institution as a student depends on the individual’s relationship to the organization. A facts and circumstances test is applied under the final regulations to determine whether an individual's employment is "incident to and for the purpose of pursuing a course of study" and therefore falls within the intended scope of the term "student." Under the regulations, if an individual is properly characterized as a "student," the amount of remuneration received by the individual, the type of services, and the place where services are performed are not material in determining whether the wages will be subject to FICA taxation.

The individual's status as a student must be determined with respect to each academic term, and may, under certain facts and circumstances, be required to be re-evaluated during an academic term based on a change in the individual’s employment obligations. An individual who is categorized by an institution as a full-time employee, or who performs 40 or more hours of service per week, cannot be considered a student under the final regulations under any circumstances. Unforeseen changes in workload and services performed during academic breaks are not considered in this determination. Also, it is apparent that the individual’s work schedule as compared to his or her academic course load is of particular relevance to the facts and circumstances determination of whether an individual is properly treated as a student for FICA tax purposes.

The final regulations include several examples illustrating the application of the standards set forth in the regulations. One example addresses a controversial issue in the courts and states that a medical resident is not considered a student and therefore is not eligible for the FICA tax exception; another example sets forth a factual situation typical of most graduate teaching assistants at a university and concludes ultimately that the individual should be treated as a student and therefore is eligible for the FICA tax exception.

The final regulations incorporate many of the comments received by the Internal Revenue Service regarding the proposed regulations. Several other key differences between the proposed regulations and the final regulations include: an individual may be considered to be enrolled in a class if such class is led by a qualified individual hired by the institution, including a teaching assistant, visiting faculty member, etc.; an individual who might be classified as a "professional employee" may still be eligible for the FICA tax exception even though he or she is required to possess knowledge of an advanced type in a field of science or learning, consistently exercise judgment and discretion, and perform services that are intellectual and varied in character; the fact that an employee is required to be licensed to perform his or her job is not by itself determinative as to whether the individual is a student; and, finally, an individual’s eligibility for benefits is also not dispositive of the individual’s status as a student.

All schools, colleges, and universities, as well as supporting organizations that employ students of such entities, should review their current withholding and reporting systems to ensure that job classifications are appropriately coded to withhold FICA taxes in the correct situations, and to make certain that an individual’s status as FICA-exempt or -non-exempt is being evaluated as of each academic term, or more frequently as may be necessary.