Mayo Clinic v. United States of America: Opening Brief

We have followed Mayo Clinic's efforts to avoid an $11 million tax on debt-financed income for nearly 5 years now.  Starting here and continuing here, here, here and here. Last Friday, DOJ filed its initial brief in Mayo Clinic v. United States.  The Government seeks to overturn a district court's ruling on remand that Mayo qualifies for an exception because it is an educational organization under IRC 170(b)(1)(A)(ii).  The Eighth Circuit ruled earlier that the regulation's insistence on formal instruction was invalid and remanded to the district court to determined whether Mayo's "primary purpose" was education.  The district court split the baby, ruling that Mayo has two substantial purposes, health care and education, and thus qualifies for the exception set forth in IRC 514(c)(9)(C)(i).  The United States appealed.  The brief makes the dictionary observation that "substantial" is not a synonym for "primary," among other substantial and primary points.  Here is the Statement of the Case: 

STATEMENT OF THE CASE 

A.  Procedural Overview 

Mayo is the parent company of an extensive healthcare system that is generally exempt from income tax under §501(c)(3). As an organization described in §501(c)(3), however, Mayo is subject to tax on its “unrelated business income.” §511. (This tax is commonly called UBIT.) This case concerns a specific exception from UBIT. That exception is limited to educational organizations that employ faculty to instruct students through a curriculum (described in §170(b)(1)(A)(ii)). See §514(c)(9)(C)(i) (cross-referencing §170(b)(1)(A)(ii)). For over 60 years, the courts and the Treasury Department have interpreted “educational organization” under §170(b)(1)(A)(ii) and similar statutes to mean an organization primarily serving an educational purpose and only incidentally serving a noneducational purpose. E.g., Better Bus.Bureau, 326 U.S. 279; Reg. §1.170A-9(c)(1); Reg. §1.501(c)(3)-1(c)(1). 

Claiming to be an educational organization within the meaning of §170(b)(1)(A)(ii), Mayo filed multimillion-dollar refund claims for the tax it paid on its debt-financed real-property income. The IRS denied those claims, and Mayo filed this refund suit. The parties cross-moved for summary judgment. The District Court denied the Government’s motion, rejecting its interpretation of §170(b)(1)(A)(ii) and invalidating Reg. §1.170A-9(c)(1). The court also rejected Mayo’s interpretation of the statute but nevertheless granted it summary judgment. The Government appealed.

This Court reversed and remanded. It validated most of the regulation and directed the District Court to determine “whether Mayo’s overall purpose and operations establish that it is ‘organized and operated exclusively’ for educational rather than other purposes.” Mayo, 997 F.3d at 802. After holding a trial, the District Court found that Mayo was organized and operated for a substantial patient-care purpose and a substantial educational purpose. Based on those findings, the court held that Mayo qualified for §514(c)(9)(C)(i)’s exception as an educational organization. The Government has appealed.

The 8th Circuit validated only "most" of the regulation because it invalidated the part that limited the exception to organizations engaged in classroom instruction.  Lloyd speculated earlier that the Government might not appeal the district court's remand decision because it was a factual determination and the Government would have to meet a "clearly erroneous" standard of review. But the brief tries to avoid characterizing the case as a factual one, arguing instead that the case involves a legal dispute allowing the court to undertake a de novo review.  It almost sounds like DOJ is implicitly asking the 8th Circuit to revisit the legal conclusion regarding the validity of the "formal instruction requirement" more than it is challenging factual findings.  Pretty clever and I love witnessing good lawyering.  We should know who wins by the Court's decision on that procedural issue, likely in the first few paragraphs when the opinion finally arrives.  Because procedure is substance.  Below the fold there are a few snippets from the argument.

darryll k. jones

 

As discussed in more detail below, of the nine categories of organizations listed in §170(b)(1)(A), only educational organizations described in §170(b)(1)(A)(ii) qualify for this limited exception to the debt-financed-real-property rules. §514(c)(9)(C)(i)-(iv). In particular, Congress did not extend the exception to teaching hospitals, medical research organizations, or academic medical centers described in §170(b)(1)(A)(iii). These organizations, along with the others listed in §170(b)(1)(A), must pay tax on income from debt-financed real property.

. . . 

Educational organizations described in §170(b)(1)(A)(ii) are a subset of educational organizations that qualify for exemption from the income tax under §501(c)(3) and do “not include all organizations that engage in tax exempt educational activities.” Mayo, 997 F.3d at 794. Section 170(b)(1)(A)(ii) describes “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.” In contrast, any organization that provides some form of instruction on subjects useful and beneficial to the community can qualify as an “educational organization” exempt from tax under §501(c)(3); the instruction need not involve faculty, curriculum, and enrolled students. Reg. §1.501(c)(3)-1(d)(3)(ii), Ex. 4. Such organizations include museums, zoos, and symphony orchestras. Id. But educational organizations that provide instruction through faculty and a curriculum for enrolled students — the subset of educational organizations described in §170(b)(1)(A)(ii) — have received additional tax benefits (like the exception in §514(c)(9)(C)(i)) over the years. 

. . . 

The District Court disregarded this Court’s directive by refusing to separately evaluate Mayo’s “educational” and “other” purposes in order to determine whether Mayo’s noneducational purposes were substantial and therefore disqualifying. Its conclusion (App. 232; R.Doc. 331/Op., at 88; Add. 88) that an activity that “furthers both educational and noneducational purposes” is nevertheless “exclusively” educational — even if the noneducational purpose is “substantial” — conflicts with Better Business Bureau, Reg. §1.170A-9(c)(1), and this Court’s prior ruling. 

. . . 

In sum, the fact that Mayo — like other academic medical centers— integrated its clinical practice with its educational and research activities does not mean that it was organized and operated exclusively for educational purposes. Rather, it only means that those various endeavors operated as a single activity. But, as noted above, a single activity can serve dual purposes, and it is the presence of the second, noneducational purpose that disqualifies Mayo from being an educational organization because that second purpose (medical care) was “substantial,” Better Bus. Bureau, 326 U.S. at 283, not “merely incidental,” Reg. §1.170A-9(c)(1). Although the medical-care and educational purposes were intertwined, they were nevertheless distinct purposes, only one of which qualifies under §170(b)(1)(A)(ii).  

. . . 

Ignoring Reg. §1.170A-9(c)(1)’s merely-incidental limitation on noneducational activities, the District Court relied (App. 220; R.Doc. 331/Op., at 76; Add. 76) on Reg. §1.501(c)(3)-1(d)(3)(ii), Ex. 4 to support its holding that primary means substantial. The court’s reliance is misplaced. That regulation lists “[m]useums, zoos, planetariums, symphony orchestras, and other similar organizations” as examples of “educational organizations,” if “they otherwise meet the requirements of this section.” Reg. §1.501(c)(3)-1(d)(3)(ii). The court incorrectly assumed that such organizations do not have education as their “most important” purpose because they can be entertaining. (App. 220; R.Doc. 331/Op., at 76; Add. 76.) As the regulatory requirements make clear, museums and like organizations only qualify as “exclusively” educational organizations if (among other things) their noneducational purposes — including any “entertainment” purpose (id.) — is merely “insubstantial.” Reg. §1.501(c)(3)-1(c)(1); see Rev. Rul. 77-366, 1977-2 C.B. 192 (holding that an organization that engaged in activities that served both educational and entertainment purposes (educational tours) was not organized and operated exclusively for educational purposes).