8th Circuit Remands Mayo Back to District Court

In a case deep in the weeds of tax-exempt law, the United States Eighth Circuit Court of Appeals remanded Mayo Clinic v. United States, No. 19-3189 back to the District Court. Though deep in the weeds, the case has some potential big importance to tax exempt law. 

Though it is technically about whether Mayo owes the unrelated business income tax associated with debt financed income, it has big importance because a loss here would potentially open up a simple way for charitable organizations to establish that they have a favored status of being a public charity rather than a private foundation by being an educational organization.

In order to be allowed an exemption under section 514 of the Code from the UBIT, Mayo claimed that it is a qualified organization under section 514(c)(9)(C)(i) because it is an "educational organization under section 170(b)(1)(A)(ii). That statute states: 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." Note that without the "primary test" a charity could normally maintain faculty and curriculum and normally have a regularly enrolled body or pupils, as something less than a primary part of the organization's activity. 

The IRS determined that Mayo was not such an educational organization based on its regulation interpreting the above language. The regulation Treas. Reg. 1.170A-9(c)(1) provides an organization is an educational organization "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."

Obviously Treasury and the IRS added the "primary function" test to what is provided for in the statute. The District Court held for Mayo on the basis that the primary function was not a part of the test Congress implemented. Mayo Clinic v. United States, 412 F. Supp. 3d 1038 1042 (D. Minn. 2019).

After applying the Chevron Two Step, the Appeals Court upheld the Treasury Regulation, but only in part, it says. It first finds that the District Court was right that the primary test added by Treasury was not reasonable. They find that the history and prior case law did not support this language. But then it suggests that the primary test should indeed apply but as to the idea of educational generally. Thus, the court determines that the test to apply is as follows: "The analysis normally unravels in three parts: (1) whether the taxpayer is “organized and operated exclusively” for one or more exempt purposes; (2) whether
the taxpayer is “organized and operated exclusively” for educational purposes; and (3) whether the taxpayer meets the statutory criteria of faculty, curriculum, students, and place."

One part of the history of charitable organizations that the Eighth Circuit fails to trace is the development of the idea of a publich charity under section 509 of the Code. There an organization is generally determined to be a private foundation unless it meets one of the requirements under (a)(1)-(4). Section 509(a)(1) includes these same educational organizations. 

I think what this all means is that there is an easier end run around obtaining public charity status for "educational organizations." A well funded advocacy organization by one individual that mainly educates the world about their point of view in order to influence political choices need only hire some faculty, have them establish curriculum, and then regularly educate some pupils. This would meet the above test and would circumvent the private foundation rules. I doubt this was intended by Congress, but that I think is the practical result of the Courts ruling. 

The Eighth Circuit remanded the case for further proceedings. It seems likely to me that Mayo will again win at the District Court. I would be surprised if the IRS appealed it further as they have lost the main issue on this one. Additionally, given the way they lost, I don't think the IRS can fix the regulation. The only way for the IRS to fight this one again would be to try to win in another Circuit. Given the trend of federal court cases going resoundingly against the IRS on interpretation issues like these lately, including most recently CIC Services at the Supreme Court, I suspect the only way to solve this mess is for Congress to take action. 

Philip Hackney

May 19, 2021