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Mayo Clinic Tax Fight Result May Be Savings for Major Hospitals (1)

Oct. 9, 2019, 5:01 PMUpdated: Oct. 9, 2019, 6:36 PM

Pending litigation over millions in tax refunds sought by Mayo Clinic could open up the same tax perk for other nonprofit hospitals with research and education arms.

The government on Oct. 4 appealed Mayo Clinic’s $11.5 million tax refund victory to the U.S. Court of Appeals for the Eighth Circuit, arguing education isn’t a large enough part of what Mayo Clinic does. Mayo Clinic, one of the largest academic medical centers, is a nonprofit parent organization to several hospitals, medical schools, and clinics.

An appeals court ruling in Mayo Clinic’s favor would mean similarly situated nonprofit hospital systems may look to the case for similar tax treatment in the future, practitioners said. Counsel for Mayo Clinic didn’t return requests for comment.

Although nonprofit hospital revenue exceeded expenses in 2018 for the first time in three years—many are still recovering from 2017, when they reported their lowest margins in 10 years, according to data from Moody’s Investors Service. Mayo Clinic reported $12.6 billion in revenue in 2018.

The U.S. District Court for the Court of Minnesota in August ruled that Mayo Clinic was entitled to have its unrelated business income tax (UBIT) payments refunded. The IRS had argued, according to the complaint, that Mayo Clinic had to treat debt-financed income as unrelated business income, subjecting it to UBIT, the tax nonprofits can owe on income stemming from a trade or business that isn’t tied to their primary purpose.

The appeals court outcome “will send a strong signal to all nonprofit hospitals whether it is OK for them to create a shell entity to take advantage of the tax break,” said Ge Bai, an associate professor of health policy and management at the Johns Hopkins Bloomberg School of Public Health.

Bloomberg Tax is operated by entities controlled by Michael R. Bloomberg, who is a graduate of Johns Hopkins University. He in 2018 donated $1.8 billion to the school, funds which were exclusively dedicated to undergraduate financial aid.

Debt-Financed Income

Certain income that tax exempt entities receive through a partnership, including unrelated debt-financed income, is considered income from an unrelated trade or business—meaning it is subject to UBIT. But, tax code Section 514(c)(9)(c) says that doesn’t apply in certain cases, including when the entity is an education organization.

Mayo Clinic said it meets the description of an education organization in Section 170(b)(1)(A)(ii). But the IRS argued that Mayo Clinic bills itself as a healthcare organization and its primary purpose isn’t providing education.

The ruling as it stands could have a broad impact, and “be a very easy backdoor way for any organization to claim that it is a public charity,” said Philip Hackney, a professor at the University of Pittsburgh School of Law.

“The IRS and the charitable community have long operated on the premise that the regulation providing that education had to be a primary purpose had to be right,” said Hackney, who previously worked in the IRS Office of the Chief Counsel with a focus on tax-exempt issues.

A IRS study of nonprofit hospitals found that 79% conducted regular lectures and seminars.

But, most hospitals with affiliated education programs likely don’t invest to the degree the Mayo Clinic does, said Lloyd Hitoshi Mayer, a professor at University of Notre Dame Law School. That could change though, he said.

The IRS doesn’t comment on pending litigation.

The Eighth Circuit’s stance in the debate will send a signal to other academic medical centers.

“If academic medical centers are organized similarly so that they can meet the criteria for an educational organization, they may be able to similarly benefit from this decision,” said Ivy Baer, senior director and regulatory counsel at the Association of American Medical Colleges. The association represents medical schools and teaching hospitals.

More hospitals may shift property investments to their academic centers in order to take advantage of the Section 514 treatment, practitioners said.

“I would certainly look to see systems restructuring, as systems are doing all the time anyway, to take advantage of this decision, said Elizabeth Mills, a Washington based attorney specializing in regulatory and tax issues.

Ripple Effect?

An Eight Circuit ruling in support of Mayo could also open the door up for more nonprofits to launch research programs of their own, pracititoners said, although whether they would depends on their size.

One of the key components of Mayo’s argument is that it has a full-time faculty and curriculum dedicated to research and academia. Still, given the operating cost that comes with similar education programs, expanding research and education might not be worth it.

“The implication is not just for Mayo. It’s for other nonprofits,” Bai said. “There is an opening to create more money—that was the message this lawsuit cast into the market.”

To contact the reporter on this story: Sam McQuillan in Washington at smcquillan@bloomberglaw.com

To contact the editors responsible for this story: Patrick Ambrosio at pambrosio@bloombergtax.com; Colleen Murphy at cmurphy@bloombergtax.com