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Federal Circuit Reverses Lower Court; Supports Hospital's Bid for FICA Reimbursement

(Parker Tax Publishing February 2018)

The Federal Circuit reversed the Federal Claims Court's dismissal of a hospital's reimbursement claim against the federal government for a $6.6 million settlement it paid to medical residents for Federal Insurance Contributions Act (FICA) taxes it incorrectly withheld. The Federal Circuit found that the phrase "shall be indemnified" in Code Sec. 3102(b) is not merely an immunity provision but mandates a right of recovery in damages from the government. New York and Presbyterian Hospital v. U.S., 2018 PTC 19 (Fed. Cir. 2018).

The Federal Insurance Contributions Act (FICA) requires employers to withhold and pay taxes on wages paid to employees. Under Code Sec. 3102(b), employers that are required to withhold are liable for any unpaid FICA taxes, and are indemnified against claims of any person for the withholding taxes they pay.

One exception to FICA withholding applies to students employed by universities. Medical residents were initially determined to be ineligible for the student exception, but the issue became the subject of litigation. While the lawsuits were pending, the IRS allowed either employers or medical residents to file protective refund claims to preserve their claims for a refund of the FICA taxes withheld.

A 2004 regulation excluded medical residents from the student exception and required withholding on their wages beginning after April 1, 2005. However, the IRS determined that medical residents qualified for the student exception on wages paid before that date, and hospitals and medical residents who had filed protective refund claims would be entitled to refunds.

In 2013, former medical residents sued New York and Presbyterian Hospital, alleging that the hospital had not filed protective refund claims between 1995 and 2001 and asserting various claims including fraud and breach of fiduciary duty. The hospital eventually settled with the residents for approximately $6.6 million. The settlement agreement provided that the award could be characterized as a refund for the amount of FICA taxes previously withheld by the hospital.

The hospital sued the federal government in the Court of Federal Claims for reimbursement of the settlement award on the basis that it was indemnified under Code Sec. 3102(b). The Court of Federal Claims dismissed for lack of jurisdiction, finding that Code Sec. 3102(b) is merely an immunity provision and does not entitle an employer to seek damages against the government. The hospital appealed to the Federal Circuit.

The Federal Claims Court has jurisdiction over a damages claim against the government only if a substantive law creates a right to money damages (money mandating). A law is money mandating if it can be fairly interpreted as requiring compensation from the government. This standard is met if the statute in question is reasonably amenable to the reading that it mandates a recovery in money damages.

On appeal, the hospital argued that Code Sec. 3102(b) is money mandating because the phrase "shall be indemnified" can be fairly interpreted to require the government to pay monetary compensation. The government, on the other hand, argued that the primary dictionary definition of indemnification at the time Code Sec. 3102(b) was enacted was immunity from liability and not a right to reimbursement. The government also reasoned that the statute would not make sense if employers who have withheld and paid FICA taxes could, at their own whim, pay the claims of their employees and then be entitled to full reimbursement from the government.

The Federal Circuit reversed the Federal Claims Court's dismissal and remanded the case. It held that the Court of Federal Claims did have jurisdiction because Code Sec. 3102(b) can be fairly interpreted as mandating recovery from the government.

The court rejected the government's argument that the primary meaning of indemnification is immunity for three reasons. First, the court found that reimbursement did not need to be the first definition of indemnify; the court had only to find that the statute was reasonably amenable to that interpretation. Second, the court found that the order of the definitions in dictionaries did not necessarily reflect the most widely accepting meaning of the terms as understood at the time. To the contrary, at least one dictionary stated that the first definition was the earliest usage of the term. Third, the court found that even if the meaning of "indemnify" was limited to the first definitions, those definitions still contemplated monetary compensation. The Federal Circuit went on to find that the definition of "indemnification" contemplated reimbursement because three contemporaneous dictionaries included "to compensate" in their definitions of the term, and two specifically discussed reimbursement.

The Federal Circuit also did not agree that Code Sec. 3102(b) would be internally inconsistent if it gave employers a right to reimbursement. The court reasoned that it had to defer to the statute's plain language as an expression of Congressional intent, and that the plain language was reasonably amenable to an interpretation that mandated reimbursement. The court concluded that even if it agreed with the hospital's position, it was for Congress, not the court, to rewrite the law.

The Federal Circuit also found that other Code provisions supported its interpretation. Code Sec. 3202(b), which applies to railroad employers, and Code Sec. 3403, which concerns the withholding of taxes by an employer, provide that an employer "shall not be liable" to any person for the amount of any payment for taxes deducted. The fact that these similar provisions explicitly state that employers are not liable, rather than that they are indemnified, shows that Congress understood these terms to have different meanings. Code Sec. 7422 provides that taxpayers cannot sue for any wrongfully collected tax without first filing a refund claim. This provision, which gives employers immunity from employee claims for wrongfully collected taxes, showed to the court that Congress knew how to craft an immunity provision when it wanted to do so.

Finally, the Federal Circuit found that the legislative history also supported its conclusion. A House Report contained language that Code Sec. 3202(b) was intended to protect employers by indemnifying them up to the "correct amount." This showed that Congress understood indemnification to contemplate the payment of money.

Observation: In a dissenting opinion, one judge contended that the majority's conclusion conflicted with the refund procedure under Code Sec. 7422. The dissenting judge reasoned that taxpayers seeking refunds must first file a refund claim with the IRS before filing suit against the government (and only the government) for the taxes paid. It was implausible to the dissenter that Congress meant to give employers a reimbursement right when it explicitly excluded them from the procedure for claiming a refund.

For a discussion of FICA withholding, see Parker Tax ¶213,101.

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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