New guidelines released Jan. 16 by the Internal Revenue Service clear up a provision in the federal tax code that authorizes a tax exemption for students who regularly attend classes at the college or university where they are employed.
The long-awaited clarification in federal law means students enrolled at least half time and employed by GW no longer will need to pay Social Security and Medicare taxes.
The Federal Insurance Contribution Act, commonly referred to as FICA, requires a 15.3 percent “contributory” tax on wages to fund the Medicare and Social Security programs. One half of the tax is withheld from a student employee’s earnings, the other half is paid by the University.
The FICA tax exemption applies only to students employed in on-campus jobs since universities are tax-exempt organizations.
Previously, only undergraduate students enrolled in at least 12 credit hours, or otherwise classified as “full time” by their institution – and who worked no more than 20 hours a week – received an exemption from the IRS for FICA taxes. Graduate students were subject to slightly different benchmarks, but the IRS still required more or less full-time enrollment for tax exemption.
But many universities, including several large state schools like the University of Michigan and Indiana University, challenged the agency’s so-called “12/20 rule,” referring to 12 credit and 20 work hours, calling for a more liberal definition of a “student.”
“The previous guideline was a very restrictive test,” said Bertrand M. Harding Jr., a Washington lawyer who specializes in federal income tax law. “If you applied the 12/20 rule, it severely limited the number of students eligible for exemption.”
Harding represented a group of about 30 colleges and universities which has lobbied the IRS since 1994 to relax its 12/20 rule to expand the definition of a student to almost anyone who works while taking classes.
The new standard exempts any university employee enrolled as a student at least half time – a definition that applies to anyone at GW who takes between six and 11 credit hours. And, unlike the previous provision, the new standard includes no limits on the number of hours an employee can work.
“This ruling means that the typical student will not be subject to FICA withholding,” said Jim McGovern, a former IRS assistant commissioner for tax-exempt organizations who now works for the accounting firm KPMG Peat Marwick.
“The coalition that Bert Harding represented basically went to the IRS and said, `We don’t think your definition of a student is a meaningful definition,’ ” he added.
Harding and McGovern said the IRS’s previous position applied the tax exemption only to student employees who were “students first.”
The tax guide distributed to students at GW’s Career Center, published in November 1996, notes that “regulations require that the student’s primary activity be that of a student rather than that of an employee who is also taking classes.”
McGovern said the IRS promised Congress in the early 1990s that the agency would do a thorough audit of universities and other large tax-exempt organizations. During the audit, it found that the existing standards – which were originally added to the Internal Revenue Code in 1935 – were no longer applicable in an era when higher education is common across the nation.
“When the IRS started zeroing in on this issue, they realized the standard was dated,” McGovern said.
“This is significant in these days of IRS-bashing,” McGovern added. “(The new guideline) sends a very positive signal to the nation’s colleges and universities that the IRS is willing to work with them to establish administerable standards.”
Though the new guidelines allow a larger group of student employees to claim tax-exempt status, limits still are built into the tax code.
The exemption does not apply to students who work during breaks that are longer than five weeks unless they are enrolled in classes at the same time. For instance, a student who worked in a university office during the summer could not claim exemption unless s/he also was taking classes in summer school, Harding said.
The new standards also do not apply to post-doctoral students, fellows, medical residents or medical interns, McGovern said.