Utah Supreme Court Denies Charitable Use Tax Exemption to Sports Drug Testing Organization

The Utah Supreme Court decided an interesting case last week.  The Sports Medicine Research and Testing Laboratory is a 501(c)(3) sports research and testing laboratory.  Guidestar shows it had a $76 million net asset balance and $20 million in revenues.  The lion's share of those revenues came from "market rate" fees charged to the NFL, Major League Baseball, and the United States Anti-Doping Agency to administer those organizations' separate drug testing programs, according to the  Supreme Court.    Market rate testing constitutes 50% of Sports Medicine's testing activity.  Below or no cost testing for government agencies and charities make up the other 50%:  

In support of its claim [for charitable use tax exemption], Sports Medicine notes that each year it tests tens of thousands of blood and urine samples for government agencies and charitable organizations and that it provides those tests either for free or at a significant discount from market rates. In opposition to that claim, the respondents point out that Sports Medicine performs a similar number of tests for professional sports leagues and that the market rates Sports Medicine charges for those tests net it a significant profit.

Sports Medicine used much of the market rate revenues to fund research concerning the performance enhancing drugs. The issue came down to whether the market rate testing was (1) an unrelated activity and, assuming the activity is unrelated, (2) whether it was more than a de minimis part of Sport Medicine's activities.  It is interesting to note how the court uses a slightly different language from the language used under federal tax exemption law to articulate the tax rule that a substantial non-exempt use will preclude tax exemption.  Indeed, Sports Medicine argued that the Court should refer to and be guided by federal law regarding unrelated business activity.  The Court's only reason for rejecting that approach was that it thought the federal approach is not strict enough for Utah standards. 

The Court found that the market rate testing was not a related activity because its only purpose was to generate a profit, even if the profits were legally committed to the organization's charitable purposes.  This, of course, is a state application of the feeder rule, precluding tax exemption on the sole basis that profits from an activity are devoted to charitable use.  Sports Medicine argued that the market rate testing was related to the charitable research mission because  that testing allowed it to gather data otherwise unattainable from the smaller populations tested for governments and other nonprofits. That argument might win if the IRS sought to impose the unrelated business income tax on the market rate testing,  The Court acknowledged the necessity for data to accomplish the charitable research goal but stated that the need did not explain why Sports Medicine charged market rates to those professional leagues.  This is the most curious aspect of the case.  The Court seemed to insist that the professional leagues should have been charged discounted or below market fees.  But if Sports Medicine charged below market rates to those professional leagues, it might have been operating for private benefit.  That seems like a catch -22 the Court did not recognize.  

Once the Court determined that the market rate testing was an unrelated activity, it was easy to conclude that Sports Medicine had a substantial non-exempt activity.  Therefore it did not qualify for exemption.  The outcome seems about right to me based on my own smell test.  But the reasoning with regard to whether the market rate testing is related or unrelated could use some polishing up.  It certainly conflicts with the federal rule that allows exempt hospitals to charge market rate fees to the majority of their patients.  Still, I think Sports Medicine should have some legitimate worries concerning its tax exemption or whether it should be paying unrelated business income tax.

darryll k. jones