An educational lesson on UBIT

The Mayo Clinic’s activities met the requirements to be treated as educational and thereby were not subject to liability for unrelated business income tax (UBIT), a district court held.

Facts: The Mayo Clinic has been involved in litigation since 2018 concerning its ability to exclude debt-financed income from UBIT because of its claimed status as an educational organization. In 2019, a district court found in favor of Mayo, concluding that it is an educational organization (Mayo Clinic, 412 F. Supp. 3d 1038 (D. Minn. 2019); see also “Tax Matters: Mayo Clinic Held to Be an Educational Organization Despite Engaging in Noneducational Activities,” JofA, Nov. 2019).

In 2021, on appeal by the government, the Eighth Circuit reversed and remanded the case to the district court (Mayo Clinic, 997 F.3d 789 (8th Cir. 2021)). In response, the IRS issued an Action on Decision notice announcing that it does not acquiesce to a portion of the Eighth Circuit’s ruling; see “Tax Matters: IRS Diagnoses a Defect in Mayo Clinic,” JofA, March 2022). The district court then again attempted to answer the question of whether Mayo’s overall purpose and operation establish that it is organized and operated exclusively for educational rather than other purposes.

Issues: To determine Mayo’s overall purpose, the court analyzed four issues.

First was the question of how to evaluate Mayo’s primary purpose: whether it is appropriate to only examine the parent entity’s activities or if a more holistic approach of examining the entity’s systemwide activities is more appropriate. Primarily relying on Squire v. Students Book Corp., 191 F.2d 1018 (9th Cir. 1951), Mayo argued, and the court agreed, that the “integral part” doctrine is best suited for determining Mayo’s overall purpose. The court ultimately concluded, based on its finding of facts, that “Mayo’s system-wide entities were highly integrated, both structurally and financially. … The parent entity’s governing documents granted it broad affirmative powers over its subsidiaries, the subsidiaries’ governing documents reserved all substantial decisions for the parent, Mayo consolidated its financial statements, and Mayo’s executives had system-wide responsibilities. And Mayo’s subsidiaries conducted activities that supported the organization’s mission.”

Second, the court attempted to understand the meaning of “primary,” noting that the Eighth Circuit left open the legal question of whether to interpret it to mean a “substantial purpose” of the organization or its “most important purpose.” Adopting the Supreme Court’s interpretation of “primary” in Board of Governors of Federal Reserve System v. Agnew, 329 U.S. 441 (1947), the court concluded that “primary” means “substantial.” Furthermore, it reasoned that Regs. Sec. 1.501(c)(3)-1(d)(3)(ii) codifies the broad view of a tax-exempt educational purpose, highlighting example organizations such as zoos, museums, and symphony orchestras. Additionally, the court found support for this interpretation based on the judicial “consensus” that “the word ‘exclusively’ [as used in Sec. 501(c)(3)] should not be interpreted literally if the purposes underlying income tax exemptions and charitable deductions were to be achieved, because every organization has some noncharitable activities.”

Next, the court looked to determine whether the Mayo Clinic’s primary purpose was educational. In answering this question, the court found that the clinic was founded with the purpose of providing medical education and that it has consistently maintained its educational purpose over time. Supporting this conclusion, the court noted, is that its educational purpose is reflected in its bylaws and governance documents; its day-to-day operations; its finances; that it meets the statutory requirements of Sec. 170(b)(1)(A)(ii) related to faculty, curriculum, students, and place and that its education, research, and clinical practices are inextricably intertwined. The court concluded that education is a substantial part of Mayo’s reason to exist and said it would have arrived at the same conclusion had the test been whether it was Mayo’s “most important” purpose.

The final consideration was whether Mayo had any substantial noneducational purpose. A substantial noneducational purpose would “destroy the [UBIT] exemption regardless of the number or importance of truly educational purposes” (Mayo, 997 F.3d at 802, quoting Better Business Bureau of Washington, D.C., Inc., 326 U.S. 279, 283 (1945)). The court focused on the importance of whether any noneducational purpose was substantial, noting that “a noneducational activity is insubstantial if it is ‘merely incidental’ to educational purposes” (id. at 800). Since Mayo’s educational and support

functions are inextricably intertwined, the court concluded that Mayo did not have any substantial noneducational purposes.

Holding: The Mayo Clinic was found to be an educational organization under Sec. 170(b)(1)(A)(ii). As a result, the court entered judgment in favor of the Mayo Clinic and held it is entitled to repayment of the $11.5 million originally in question plus statutory interest.

■ Mayo Clinic, No. 16-cv-03113 (D. Minn. 11/22/22)

— Matthew Geiszler, Ph.D., is a lecturer in accounting within the College of Human Ecology; Nay Thu Rein (Jacky) Aung is a master of health administration candidate in the Sloan Program in Health Administration; and John McKinley, CPA, CGMA, J.D., LL.M., is a professor of the practice in accounting and taxation within the SC Johnson College of Business, all at Cornell University in Ithaca, N.Y. To comment on this column, contact Paul Bonner, the JofA’s tax editor.