Friday, May 13, 2011

Fellowship Payments Subject to FICA Tax Other than Payments Made under National Research Service Awards Grants

The IRS Office of Chief Counsel has reaffirmed its conclusion in Chief Counsel Advice 200944027, that amounts paid by a university to post-doctoral fellows and funded through grants other than National Research Service Awards (NRSA) are subject to FICA taxes [Chief Counsel Advice 201117026].

Background. Fellowship grants are subject to FICA tax if classified as wages under Code Sec. 3121(a). Whether there is an employment relationship between an institution that disburses funds from a grant and a researcher who receives payment in connection with performing research depends on the facts and circumstances.

Under Code Sec. 117(a), gross income doesn't include any amount received as a qualified scholarship by an individual who is a candidate for a degree at an educational organization. Code Sec. 117(c) provides that this exclusion doesn't apply to any amount which represents payment for teaching, research, or other services by the student required as a condition for receiving the qualified scholarship or fellowship.

The facts. A state university (the university) applied for grants from public and private sources to fund research. The research was performed by faculty members and by post-doctoral fellows and graduate students, undergraduate students, and other individuals hired to work on research projects. The university offered post-doctoral fellowship positions to individuals who had received their doctorate degree.

Individuals with doctorate degrees could also become post-doctoral fellows with the university by applying for an NRSA grant directly to the U.S. Department of Health and Human Services (HHS). The HHS made NRSA grant payments to the institution that hosted the post-doctoral fellow, and the institution, in turn, made these payments to the applicant.

The 2009 Chief Counsel Advice. In Chief Counsel Advice 200944027, the IRS compared the NRSA and non-NRSA grant programs and found them similar in many respects: the research performed was similar, the educational credentials of the recipients were similar, and the supervisors of both types of fellows could incorporate training into the supervision. The IRS concluded that payments under the NRSA grants weren't subject to FICA tax. It noted that the NRSA grant recipient's performance was evaluated by his sponsor in terms of the research training, rather than substantive achievements. Progress reports and sponsor comments consistently and primarily focused on the quality and quantity of research training opportunities that the recipients had pursued. Recipients could continue to receive NRSA grant payments despite not meeting the substantive goals that their supervisors set.

In contrast, the IRS concluded that the payments to the non-NRSA fellows were subject to FICA tax, because the payments were for the performance of specific services determined by the university through the faculty sponsor, rather than to support training and development. Although non-NRSA fellows inevitably received training as a result of performing research tasks that were new to them and working with an experienced supervisor, the clear quid pro quo for the payments was the research work. This conclusion was supported by the grant's terms and conditions.

The protest. The university now argued that payments to certain non-NRSA fellows were excludible from FICA tax. The university said that the primary purpose of these payments was to defray the fellows' cost of living while they prepare for a career in scientific research. In addition, the university maintained that it administered its sponsored research program in accordance with standards established for NRSA fellows by the National Institute of Health (NIH). The university claimed that it did not differentiate between fellows receiving NRSA training grants and fellows receiving non-NRSA research grants.

The new ruling. The IRS said that the university's contention that it did not distinguish between NRSA fellows and non-NRSA fellows was “simply untrue.” The IRS noted that Office of Management and Budget (OMB) Circular A-21 mandates that the two programs be treated differently. In addition, the university's assertion that the non-NRSA fellows did not receive compensation for employment services was at odds with the documentation and certifications that the university was required to provide under OMB Circular A-21 with respect to payments it makes to non-NRSA fellows. The IRS also pointed out that the university's own employment policies distinguished between fellows whom it classified as “employee fellows” (including non-NRSA fellows), and fellows whom it classified as “non-employee fellows,” such as NRSA fellows. These policies authorized the university to provide non-NRSA (but not NRSA) fellows with remuneration packages that were consistent with the existence of an employer-employee relationship.

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