Minnesota Federal District Court Invalidates Treas. Reg. 1.170A-9(c)(1) (defining "educational organization") based on Chevron Analysis

In a surprising opinion, Mayo Clinic v. United States, a federal district court in Minnesota held yesterday that Treas. Reg. 1.170A-9(c)(1) is invalid to the extent that it limits the term "educational organization" to organizations whose "primary function" is education and which do not engage in "noneducational activities" in greater than "incidental" amounts.  The Court applied a Chevron analysis.  The regulation states:

An educational organization is described in section 170(b)(1)(A)(ii) if its primary function is the presentation of formal instruction and it 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 term includes institutions such as primary, secondary, preparatory, or high schools, and colleges and universities. It includes Federal, State, and other public-supported schools which otherwise come within the definition. It does not include organizations engaged in both educational and noneducational activities unless the latter are merely incidental to the educational activities. A recognized university which incidentally operates a museum or sponsors concerts is an educational organization within the meaning of section 170(b)(1)(A)(ii). However, the operation of a school by a museum does not necessarily qualify the museum as an educational organization within the meaning of this subparagraph.

 [emphasis added].  The regulation was important to Mayo Clinic because it determined whether Mayo would be subject to tax on unrelated debt financed income under IRC 514.  By convincing the Court to invalidate the regulation, Mayo saved about $11.5 in unrelated debt financed income tax.  Here is the penultimate conclusion to the 31 page opinion:

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.” See USA Mem. in Supp. at 5–6. The Government’s position that Mayo is not entitled to the refunds it seeks is premised entirely on Mayo’s alleged inability to satisfy the primary-function and merely-incidental requirements in 26 C.F.R. § 1.170A-9(c)(1). Because those requirements exceed the bounds of authority given by 26 U.S.C. § 170(b)(1)(A)(ii), they are unlawful. Thus, there is no genuine issue of material fact that Mayo qualifies as an “educational organization” under § 170(b)(1)(A)(ii) and is entitled to summary judgment on its refund claims.

The regulations under 501(c)(3) (regarding exemption for "educational organizations"), by the way, do not include the "primary function" or "merely incidental" requirements.  

 

Darryll K. Jones