Mayo Clinic, (DC MN 8/6/2019) 124 AFTR 2d ¶2019-5122
A district court has held that Reg. § 1.170A-9(c)(1), defining “educational organization” for Code Sec. 170 charitable contribution purposes, is invalid, i.e., that the IRS exceeded its authority when it added requirements in the reg that aren’t in the Code.
Background. A taxpayer is allowed a deduction, subject to a 50% limit, for charitable contributions to various organizations, including:
- 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. (Code Sec. 170(b)(1)(A)(ii)); and
- an organization that, among other things, the principal purpose or functions of which are the providing of medical or hospital care or medical education or medical research. (Code Sec. 170(b)(1)(A)(iii), emphasis added)
Educational organizations under Code Sec. 170(b)(1)(A)(ii) are exempt from paying tax on certain unrelated business income (UBI). (Code Sec. 514(c)(9)(C))
An organization cannot qualify as an “educational organization” under Code Sec. 170(b)(1)(A)(ii) unless, among other things, its primary function is the presentation of formal instruction. An educational organization does not include organizations engaged in both educational and noneducational activities unless the latter are merely incidental to the educational activities. (Reg. § 1.170A-9(c)(1), emphasis added)
The Supreme Court set out a two-step analysis to determine if a reg is valid: (1) if the intent of Congress is clear, IRS and the courts must give effect to the unambiguously expressed intent of Congress; (2) if the statute is silent or ambiguous as to a specific issue, the question for a court is whether the agency’s answer is based on a permissible construction of the statute. (Chevron U.S.A. Inc. v. Natural Res. Def. Council, Inc., (S Ct 1984) 467 U.S. 837) This analysis is often referred to as Chevron deference.
Facts. The Mayo Clinic (Mayo) is the parent organization of several hospitals, clinics, and the Mayo Clinic College of Medicine and Science.
Mayo brought a case to obtain $11,501,621 in refunds due to taxes it had paid on certain UBI that it did not have to because it was an educational organization.
Mayo and the IRS agreed that Mayo qualified for the tax refunds if, during the tax years in question, it met the requirements of Code Sec. 170(b)(1)(A)(ii).
The IRS conceded that, during the tax years at issue, 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.” But the IRS said Mayo is nonetheless not an “educational organization” since it did not pass the “primary function” and “merely incidental” tests of Reg. § 1.170A-9(c)(1). The IRS argued that Mayo’s primary function was health care, not education, and even if that were not so, that Mayo’s health-care activities were not merely incidental to its educational activities.
Decision. The district court held that the reg does more than the law allows because it adds requirements, i.e., the primary-function and merely-incidental tests, that Congress did not, and did not intend to, include in the statute. In other words, the court concluded that the IRS exceeded the bounds of its statutory authority when it promulgated the primary-function requirement and merely-incidental test in Reg. § 1.170A-9(c)(1). The court therefore held for Mayo and found the reg to be invalid.
Applying the Chevron deference test, the court found that Congress’s intent was clear when it did not include the primary-function requirement and merely-incidental test language in Code Sec. 170(b)(1)(A)(ii). The court pointed out that Congress did include the primary-function requirement in Code Sec. 170(b)(1)(A)(iii) when it mentioned “principal purpose or function.” While the wording in Code Sec. 170(b)(1)(A)(iii) and Reg. § 1.170A-9(c)(1) is different—Code Sec. 170(b)(1)(A)(iii) refers to “principal” and Reg. § 1.170A-9(c)(1) refers to “primary”—the court held that those words are interchangeable.
The court then concluded that, if Congress puts specific language in one part of a Code section (here Code Sec. 170(b)(1)(A)(iii)), but not another (here Code Sec. 170(b)(1)(A)(ii)), then there is clear intent that Congress did not want the specific language in the other part. It is a deliberate and unambiguous omission.
And, the court said that the primary function test and the merely-incidental test are effectively one test. The merely-incidental test is just the flip side to the primary-function requirement; if an organization’s primary function is education, then necessarily all other activities it engages in will be incidental. Since the court already concluded that the IRS was wrong to include the primary-function requirement in the reg, it was also wrong to include the merely-incidental test.
References: For discussion of Reg. § 1.170A-9(c)(1), see FTC 2d/FIN ¶K-3724; United States Tax Reporter ¶1704.07.
