EXECUTIVE SUMMARY: The U.S. District Court for the District of Minnesota ruled in favor of the Mayo Clinic and held that in determining whether an organization meets the definition of an educational organization under Code §170(b)(1)(A)(ii), the primary function test imposed by regulation is invalid.
FACTS: The Mayo Clinic sought to exclude debt-financed passive income from unrelated business income by qualifying as an organization described in Code §170(b)(1)(A)(ii). That provision describes an organization that is:
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.
The Government acknowledged that the Mayo Clinic “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.” However, the Government argued that the Mayo Clinic was not an “educational organization” within the meaning of the statute since the Clinic did not meet the primary function and incidental activities requirements of Treas. Regs. §1.170A-9(c)(1). This regulation provides:
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 District Court ruled that the primary function and incidental activities requirements imposed by the regulation were not a valid exercise of regulatory authority and were thus not valid requirements in determining what organizations are described in Code § 170(b)(1)(A)(ii).
Before overriding the regulation, the District Court first had to determine that it had authority to do so under the Chevron deference doctrine arising under Chevron U.S.A., Inc. v. Natural Resources Defense Council, Inc., 467 U.S. 837 (1984). The Court noted that the framing of the Chevron deference issue is critical to the result, and framed the issue as whether Code §170(b)(1)(A)(ii) is silent or ambiguous with respect to the primary-function and merely incidental requirements in the regulation. With that framing, the Court determined that the Government’s regulation was not entitled to Chevron deference, and thus opened the door to an exaination whether the primary function and merely incidental requirements were a proper interpretation of the statute without giving substantial deference and advantage to the Government’s purported interpetation.
The Court determined the Government’s interpretation under the regulation as improper for various reasons. Principal among them is that Congress knew how to impose a primary function test if it wanted, as evidenced by Code § 170(b)(1)(A)(iii) which expressly imposed a principal purpose test for certain medical organizations seeking to be described therein. The Court noted that “principal” and “primary” were essentially the same for these requirements. By not writing such a requirement into the statute, the Court determined that Congress intended that no such requirement applied.
COMMENTS:
The “why” of the rejection of the primary function and merely incidental requirements is less important than the rejection itself. This rejection of the regulatory requirement will assist many organizations in meeting the requirements of Code §170(b)(1)(A)(ii). This will have relevance in determining the deductibility of contributions to such organizations, exclusion of debt-financed income from UBI, and the application of numerous other provisions of the Internal Revenue Code that involve organizations described in Code §170(b)(1)(A)(ii) (such as the exclusion of tuition payments to such educational organizations from taxable gifts under Code §2503).
Of course, the determination is that only of a District Court, and not a Circuit Court of Appeals or the U.S. Supreme Court. Thus, its precedential authority is limited, and may be overturned on appeal (or sustained, of course). Nonetheless, it may presently support reporting positions and litigation positions of taxpayers that are limited by the regulatory requirements invalidated by the Court.
Tax practitioners often deal with regulations which in their opinion exceed statutory authority or are unreasonable. In determining whether to challenge a regulation, Chevron deference is a major obstacle, and typically kills the challenge in its cradle. Any case that acknowledges Chevron deference as something that in the real world can be overcome under the right circumstances is always welcome in my book.
Mayo Clinic v. U.S., 124 AFTR 2d 2019-XXXX (DC MN) (8/6/2019)
No comments:
Post a Comment