Mayo Case Raises Issues on Meaning of Educational Organization: Part II

Federal District Invalidates Regulation Requiring Education as Primary Purpose

In Part I of this series, we discussed the background of Mayo Clinic v. U.S. and the meaning of an educational organization. In the federal district court case, the government conceded that during the tax years at issue and today, 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,” thereby meeting the statutory definition of an educational organization under Section 170(b)(1)(A)(ii). Thus, as the government put it, “the United States does not dispute that Mayo Clinic, by virtue of its schools, satisfies the requirements relating to faculty, curriculum, students, and place.”

The government nonetheless argued that Mayo is not an educational organization because it does not meet the primary function and merely incidental requirements of Regulation 1.170A-9(c)(1). In this regard, the government argued that Mayo’s primary function is health care, not education, and even if that were not so, that Mayo’s health-care activities are not merely incidental to its educational activities. The court noted in this context that the IRS had issued a technical advice memorandum confirming its position that Mayo did not qualify as an educational organization. Mayo described its educational and patient-care activities as essential to each other and inextricable and asserted that the Department of the Treasury exceeded the bounds of its statutory authority when it promulgated Regulation 1.170A-9(c)(1).

In determining that it would not simply defer to the Treasury regulation in interpreting the meaning of an educational organization, the federal district court, citing Supreme Court precedent, stated that Congress unambiguously chose not to include a primary function and merely incident requirement in Section 170(b)(1)(A)(ii). As such, the court stated that the statute must be interpreted in the light of their surrounding provisions.

Here, the court noted that Section 170(b)(1)(A)(ii) “contains no explicit primary-function requirement, but the equivalent of that very requirement appears in the very next subsection of the statute, §170(b)(1)(A)(iii). In this situation—that is, when Congress imposes a particular requirement in one subsection of a statute but not in another—settled rules of statutory construction say that the absence of the requirement is generally to be considered a deliberate omission that must be respected.” The court noted that Section 170(b)(1)(A)(iii) contains the words “principal” and “purpose” but stated that the statutory and regulatory framework suggest that the words “primary” and “principal,” as well as “function” and “purpose,” are interchangeable. Accordingly, the district court held that the Department of the Treasury exceeded the bounds of its statutory authority when it promulgated the primary function requirement in Regulation 1.170A-9(c)(1). With respect to the merely incidental requirement, the court stated that the “corollary of determining that Congress unambiguously did not include a primary-function requirement in §170(b)(1)(A)(ii) is that Congress also must be understood to have decided not to include a merely incidental test in this statute, at least as that test is described in the corresponding regulation.”

Thus, under the district court’s holding, an organization that engages in activities that meet the statutory requirements under Section 170(b)(1)(A)(ii) relating to faculty, curriculum, students, and place can qualify as an educational organization even though such activities may not constitute the primary function of the organization and other activities are not merely incidental to the educational activities. Because the government’s position that Mayo was not entitled to the refunds it sought was premised on Mayo’s inability to meet the primary function and merely incidental requirements contained in Regulation 1.170A-9(c)(1), a regulation the court found to be invalid, and the government conceded that 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, the court held that “there is no genuine issue of material fact that Mayo qualifies as an ‘educational organization’ under IRC § 170(b)(1)(A)(ii) and is entitled to summary judgment on its refund claims.”

Eighth Circuit Reverses District Court, But Holds That Presentation of Formal Instruction Need Not be Primary Function

After an extensive review of the history of expressed congressional intent as it relates to the definition of a charitable organization, the U.S. Court of Appeals for the Eighth Circuit, in reversing the federal district court, found that the terms “primary function” and “merely incidental” have a valid role in interpreting the meaning of an educational organization under Section 170(b)(1)(A)(ii). Thus, the court concludes that an “educational organization” in Section 170(b)(1)(A)(ii) unambiguously means an organization whose primary purpose is broadly educational and whose noneducational activities are merely incidental to that primary purpose.

The Eighth Circuit, however, agreed with the federal district court that Regulation 1.170A-9(c)(i) adds an unreasonable condition to the statutory requirements under Section 170(b)(1)(A)(ii) by requiring an educational organization’s “primary function [must be] the presentation of formal instruction,” which the appellate court stated has no long history of congressional acceptance. Therefore, according to the Eighth Circuit, an organization can qualify under Section 170(b)(1)(A)(ii) even though its primary function is not the presentation of formal instruction provided, however, it meets the statutory criteria of faculty, curriculum, students, and place, and its primary purpose is broadly educational and its noneducational activities are merely incidental to that primary purpose.

In its conclusion, the court noted that how to measure educational activity as opposed to noneducational activity, as well as the degree to which education must be Mayo’s primary purpose, are disputed. The government relies on expenses and revenue disclosed on Mayo’s Form 990, while Mayo emphasizes a totality of the circumstances approach. Additionally, the government believes that education including the operation of medical schools must be the Section 501(c)(3) taxpayer’s principal or most important purpose, while Mayo contends that it need only be substantial. Second, Mayo’s status as an academic medical center means that its medical and educational purposes—and the operations supporting those functions—are inextricably intertwined. According to the appellate court, separating out the educational from the noneducational, while difficult, is not impossible. “In these circumstances,” the court stated, “we leave these difficult and fact-intensive issues of fact and law to the district court on remand.”

IRS Nonacquiescence

Subsequently, in AOD 2021-4, the IRS announced that it will not acquiesce in the Eighth Circuit’s holding, so that the position of the IRS continues to be that an educational organization described in Section 170(b)(1)(A)(ii) must have the presentation of formal instruction as its primary function. An IRS nonacquiescence is not binding on courts or taxpayers but merely reflects the position of the IRS that it disagrees with a court decision. Although the IRS disagreed with the decision of the Eighth Circuit with respect to the formal instruction requirement, it stated that it did “recognize the precedential effect of the decision to cases appealable to the Eighth Circuit and will follow it for cases within the Eighth Circuit in which the facts are not materially distinguishable. We do not, however, acquiesce to the opinion and will continue to litigate the formal instruction requirement in cases in other circuits.”

The IRS further stated that it will continue to apply the statutory faculty-curriculum-student-place requirement of Section 170(b)(1)(A)(ii) because this requirement was not before, and therefore not considered by, either the district court or the Eighth Circuit. Furthermore, the IRS indicated that it will continue to apply the regulatory requirement expressly affirmed by the Eighth Circuit that the term “educational organization” does not include an organization “engaged in both educational and noneducational activities unless the latter are merely incidental to the educational activities.”

This article does not necessarily reflect the opinion of The Bureau of National Affairs, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.

Author Information

Richard L. Fox is a founding partner of the Law Offices of Richard L. Fox. He concentrates his practice in the areas of charitable giving, tax-exempt organizations, private foundations, estate planning, and trusts and estates.

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