Student Blog: Extra Requirements for Tax Exempt Status of Educational Organizations?
by Ainsley Tucker, RBFL Student Editor
Tax law often requires interpreting words that seem clear until the right controversy comes along—and interpretation can be costly. When tax law and administrative law collide, agency deference adds yet another layer to the puzzle. The District Court for the District of Minnesota recently heard a case examining the interplay between the U.S. Tax Code and the Treasury Department’s interpretive regulations in assessing tax liability for sophisticated tax-exempt organizations.
At stake in Mayo Clinic v. United States (2019): an $11.5 million tax refund. At issue: the meaning of “educational organization” under U.S. tax law. The controversy over interpretation arose because both the Internal Revenue Code (“the Code”) and the Treasury Department present tests for defining “education organization”—and the Treasury Department’s interpretive regulation (“the Regulation”) requires additional factors. Treasury regulations establish proper statutory interpretation of the Code.[1]Tax-exempt organizations rely on both the Code itself and the clarifying regulations in determining tax liability. Thus, the question before the Court: which definition controls?
Mayo Clinic needs to worry about paying taxes, despite being “tax-exempt,” because tax-exempt organizations generally owe federal taxes for income substantially unrelated to their charitable missions (“UBIT”) unless they are “qualified organizations.” Qualified organizations, which include “educational organizations,” are exempt from certain forms of UBIT. Mayo Clinic contends it is an education organization because it operates numerous teaching hospitals, grants medical degrees, and its official charitable mission is to “provide the best care to every patient through integrated clinical practice, research, and education.”[2]
The Code presents a four-part test for defining education organizations, the “faculty-curriculum-student-place” test.[3]The Regulation adds two mandatory requirements to the Code’s definition: 1) education is the organization’s primary function, and 2) any non-educational activities are merely incidentalto the educational activities.[4]Employing a Chevron analysis, the Court concluded that the Regulation overstepped its agency authority by including the two additional factors.[5]As a matter of statutory construction, Congress had “spoken clearly” by omitting the Regulation’s two additional factors from the Statute but including them in subsequent sections.[6]Therefore, the District Court invalidated the Regulation and held that Mayo Clinic was an “educational organization” entitled to its tax refund.
The United States has appealed the decision to the Eighth Circuit, where the case will continue to raise questions of the relative ease with which tax-exempt organizations, particularly academic medical centers like Mayo Clinic, may be able to call themselves “educational organizations” in the future, how much deference courts may give to U.S. Treasury Department regulations, and the importance of a tax-exempt organizations’ self-identification for tax purposes. At stake: millions of tax dollars. Stay tuned.
Sources:
[1]IRM 32.1.1.2 (Aug. 2, 2018) (from Part 32: Published Guidance and other Guidance to Taxpayers, Ch. 1 § 1), at https://www.irs.gov/irm/part32/irm_32-001-001.
[2]Mayo Clinic, Form-990 (2008)
[3]26 U.S.C. §170(b)(1)(A)(ii)
[4]Treas. Reg. § 1.70A-9(c)(1) (1973) (26 C.F.R. § 1.170A-9(c)(1))
[5]Mayo Clinic v. United States, No. 16-cv-03113, slip op. at 6-7 (D. Minn Aug. 8, 2019).
[6]Id.