Regulation is invalid; entity is “educational organization” entitled to UBIT refund

“Educational organization” entitled to UBIT refund

The U.S. District Court for the District of Minnesota determined that because the entity in this case is an “educational organization” and therefore qualifies for an exception in the unrelated debt-financed income rules, it is entitled to an $11.5 million refund of unrelated business income tax paid in prior years.


The federal district court concluded that because Congress did not include a primary-function requirement in the statute, Treasury exceeded its authority by including such a requirement in the regulation.

The case is: Mayo Clinic v. United States, No. 16-cv-03113 (D. Minn. August 6, 2019). Read the federal district court’s opinion [PDF 308 KB]


The entity is a Minnesota nonprofit corporation and tax-exempt organization that is the parent organization of several hospitals, clinics, and a college of medicine and science.

After conducting an audit, the IRS asserted in 2009 that the entity owed tax on certain income it received from partnerships because it was not an educational organization described in section 170(b)(1)(A)(ii) and therefore was not entitled to an exception in the unrelated debt-financed income rules available to those “qualified organizations.” Specifically, applying two tests from the applicable regulation, the IRS determined that (1) the entity’s primary function was not the presentation of formal instruction, and (2) its non-educational activities were more than merely incidental to its educational activities.

Federal district court’s decision

The federal district court, noting that the two tests relied upon by the IRS do not appear in the statute, applied the Chevron “two-step framework” to determine (1) whether Congress’s intent in enacting section 170(b)(1)(A)(ii) was ambiguous, and (2) if so, whether the regulation at issue was arbitrary, capricious, or manifestly contrary to the statute.  See Chevron U.S.A., Inc. v. Natural Resources Defense Council, Inc., 467 U.S. 837 (1984).

The federal district court concluded that “Congress unambiguously chose not to include a primary-function requirement” in the statute, and therefore that Treasury “exceeded the bounds of its statutory authority” when it included that requirement in the regulation. The court’s conclusion was based largely on the fact that the very next clause of the statute—section 170(b)(1)(A)(iii)—does contain the equivalent of a primary-function requirement, referencing the “principal purpose or functions” of providing medical or hospital care or medical education or medical research. The court found that this explicit presence of a primary purpose test in section 170(b)(1)(A)(iii) indicated that Congress’s omission of such a test in section 170(b)(1)(A)(ii) was deliberate.

Accordingly, the federal district court granted the entity’s motion for summary judgment because “there is no genuine issue of material fact that [the entity] qualifies as an ‘educational organization’ under section 170(b)(1)(A)(ii).”

KPMG observation

The IRS has not announced whether it will appeal the court’s decision, though some commentators have indicated their belief that such an appeal is likely.


For more information, contact a tax professional with KPMG’s Washington National Tax practice:

Ruth Madrigal | +1 202 533 8817 |

Preston Quesenberry | +1 202 533 3985 |

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