Mayo Clinic v. United States

          Mark P. Rotatori, Jones Day, Chicago, IL; and Annamarie A. Daley, Caroline Heicklen, and Andrew Leiendecker, Jones Day, Minneapolis, MN, for Plaintiff Mayo Clinic.

          Curtis J. Weidler, Samuel P. Robins, and Eric M. Aberg, U.S. Department of Justice Tax Division, Washington, DC, for Defendant the United States of America.

          OPINION AND ORDER

          Eric C. Tostrud United States District Judge

         Mayo Clinic brought this case to obtain $11, 501, 621 in tax refunds. Mayo qualifies for the tax refunds it seeks if, during the tax years in question, it was:

an educational organization which normally maintains a regular faculty and curriculum and normally has a regularly enrolled body of pupils or students in attendance at the place where its educational activities are regularly carried on.

26 U.S.C. § 170(b)(1)(A)(ii). The Government concedes that, during the tax years at issue and today, Mayo “normally maintains a regular faculty and curriculum and normally has a regularly enrolled body of pupils or students in attendance at the place where its educational activities are regularly carried on.” The Government says Mayo is nonetheless not an “educational organization.” To support this position, the Government argues that the term “educational organization” as used in § 170(b)(1)(A)(ii) unambiguously requires education to be an organization's “primary purpose.” The Government also relies on a Treasury Department regulation interpreting § 170(b)(1)(A)(ii). That regulation, 26 C.F.R. § 1.170A-9(c)(1), provides that an organization cannot qualify as an “educational organization” under § 170(b)(1)(A)(ii) unless education is the organization's “primary function” and its noneducational activities are “merely incidental” to its educational activities. These requirements do not appear explicitly in the statute.

         The Government and Mayo have filed cross-motions for summary judgment. The Government argues that Mayo's primary function is health care, not education, and even if that were not so, that Mayo's health-care activities are not merely incidental to its educational activities. Mayo disagrees with the Government's interpretation of the law at every step and disputes the Government's characterization of the facts. Mayo describes its educational and patient-care activities as essential to each other and inextricable.

         Resolving the Parties' summary-judgment motions requires analyzing § 170(b)(1)(A)(ii) and its accompanying regulation under Chevron U.S.A., Inc. v. Natural Resources Defense Council, Inc., 467 U.S. 837 (1984). This analysis shows that the regulation does more than the law allows because it adds requirements-the primary-function and merely-incidental tests-Congress intended not to include in the statute. Because the Government's position is based entirely on these impermissible requirements, Mayo is entitled to the sued-for refunds. Mayo's summary-judgment motion will be granted, and the Government's motion will be denied.

         I

         Mayo is a Minnesota nonprofit corporation and tax-exempt organization under 26 U.S.C. § 501(c)(3).^[1] Mayo SOF ¶ 4 [ECF No. 185]. For this case, it helps as background to know that Mayo is the parent organization of several hospitals, clinics, and the Mayo Clinic College of Medicine and Science. Id. ¶ 34. The College is comprised of five distinct medical schools that offer M.D., Ph.D., and other degrees, as well as residencies, fellowships, and continuing medical education: (1) Mayo Clinic Graduate School of Biomedical Sciences; (2) Mayo Clinic School of Graduate Medical Education; (3) Mayo Clinic Alix School of Medicine; (4) Mayo Clinic School of Health Sciences; and (5) Mayo Clinic School of Continuing Professional Development. Id. ¶ 35.

         After conducting an audit, the Internal Revenue Service in 2009 issued a Notice of Proposed Adjustment asserting that Mayo owed tax on certain income that it received from partnerships. Id. ¶ 7. The IRS concluded Mayo was not entitled to a tax exemption with respect to this partnership income because, in its view, Mayo was not an “educational organization.” Id. In 2013, the IRS issued a Technical Advice Memorandum confirming its position that Mayo did not qualify as an “educational organization.” Applying a test from a Treasury Department regulation, the IRS concluded Mayo's “primary function” was not “formal instruction.” Id. ¶¶ 8-9; see Mayo SOF Ex. 10 [ECF No. 186-1 at 371].

         Mayo paid the disputed taxes and, in 2016, filed this lawsuit seeking a refund. Mayo SOF ¶ 10; see Compl. [ECF No. 1]. Mayo is the proper party to seek all tax refunds at issue in this case. Id. ¶ 6. The Parties have stipulated that the value of the refund at issue is $11, 501, 621, together with interest as provided by law, and breaks down as follows for each tax year for which Mayo seeks a refund:

Taxable Year	Refund Requested
2003	$31, 365
2005	$837, 111
2006	$9, 390, 781
2007	$439, 193
2010	$51, 395
2011	$597, 235
2012	$154, 541

Id. ¶ 11. The Parties also have stipulated that Mayo's refund claims are timely. See Compl. ¶ 18 (discussing tolling of statute of limitations).

         There is subject-matter jurisdiction over this case pursuant to 28 U.S.C. § 1346(a)(1). See 28 U.S.C. § 1346(a)(1) (providing jurisdiction for “[a]ny civil action against the United States for the recovery of any internal-revenue tax alleged to have been erroneously or illegally assessed or collected”); see also 26 U.S.C. § 7422 (containing pre-suit requirement that plaintiff in tax-recovery lawsuit must first file “a claim for refund or credit . . . with the Secretary” of the Treasury) and Compl. ¶ 9 and Answer ¶ 9 [ECF No. 23] (establishing Mayo's compliance with this requirement).

         II

         The statutory system governing unrelated business income (“UBI”) and the related tax (“UBIT”) seem complex and contain multiple exceptions to the rule and exceptions to the exceptions. For this case, the precise framework of the UBIT (26 U.S.C. § 514) is less significant than the statute concerning “educational organizations” that the UBIT statute incorporates by reference (26 U.S.C. § 170(b)(1)(A)(ii)). Regardless, some background information on UBIT helps to understanding this case. As the United States explains it, tax-exempt charitable organizations under § 501 are permitted to exclude from their UBI “certain types of passive income-such as income from dividends, interest, and real-property rents.” USA Mem. in Supp. at 4-5 [ECF No. 177]. “This passive-income exclusion is generally what allows a tax-exempt organization to avoid incurring UBIT on the dividends and interest that it earns on its endowment.” Id. at 5. But there is an exception to this exclusion: “If the passive income is earned using leverage-that is, borrowed money-then the amount that is excluded from UBI is reduced.” Id. And this exception, too, has an exception: “[W]hen the passive income comes from debt-financed real property, the income can be excluded from UBI if the organization is a ‘qualified organization' under 26 U.S.C. § 514(c)(9)(C).” Id. Included among the qualified organizations is “an organization described in section 170(b)(1)(A)(ii), ” which is the educational-organization statute at issue in this case.

         Section 170(b)(1)(A)(ii) is one subsection of a statute that lists nine types of charitable contributions by individuals that are eligible for tax deductions. As relevant here, the statute provides:

(A) General rule. Any charitable contribution to- (i) a church or a convention or association of churches, (ii) an educational organization which normally maintains a regular faculty and curriculum and normally has a regularly enrolled body of pupils or students in attendance at the place where its educational activities are regularly carried on,

(iii) an organization the principal purpose or functions of which are the providing of medical or hospital care or medical education or medical research, if the organization is a hospital . . .

. . .

shall be allowed to the extent that the aggregate of such contributions does not exceed 50 percent of the taxpayer's contribution base for the taxable year.

26 U.S.C. § 170(b)(1)(A).

         In addition to this statute, there is a regulation promulgated by the Treasury Department interpreting § 170(b)(1)(A)(ii), 26 C.F.R. § 1.170A-9. The regulation is entitled “Definition of section 170(b)(1)(A) organization.” The regulation essentially repeats the statute in some respects, parroting the “faculty-curriculum-student-place” requirements of the statute. It also includes two requirements that do not appear explicitly in the statute-what will be referred to as the “primary-function requirement” and the ...