An almost three-year legal battle with the IRS over whether Mayo Clinic can be classified as a school has ended with a judge ruling that the question at the heart of the case exceeds the government's bounds of authority and is "unlawful."

U.S. District Court Judge Eric Tostrud issued a summary judgement in favor of Mayo Clinic on Tuesday. If the ruling stands, it means that the IRS owes the clinic an $11.5 million refund. It also clears the way for the clinic to save millions in taxes on future investment earnings.

"Obviously, it's a big decision for Mayo … an important decision for Mayo," said Joe Colaiano of Mayo Clinic's legal department. "We were happy of the outcome and we thought we were right all along."

The dispute stems from the IRS claiming that the non-profit Mayo Clinic's annual revenue generated by “debt-financed real-estate investment” is taxable as "unrelated business income." While non-profit hospitals and medical institutions are taxed on that type of revenue, IRS statute says schools and educational institutions are exempt from those taxes.  

The IRS claimed that while Mayo Clinic does have educational offerings, a U.S. Treasury regulation said it has to be primarily a school to avoid the investment earnings taxes. Mayo Clinic disputed that and filed a lawsuit against the United States of America in September 2016 to recover $11.5 million in taxes paid on investment revenue.

The ruling found that the Treasury regulation cited by the IRS does not clearly require judging if an organization is primarily one thing or another. Since the IRS did concede that Mayo Clinic "normally maintains a regular faculty and curriculum and normally has a regular enrolled body of pupils or students…" as a school, the lawsuit had no basis to go forward.

"This analysis shows that the regulation does more than the law allows because it adds requirements — the primary-function and merely incidental tests — Congress intended not to include in the statute. Because the government’s position is based entirely on these impermissible requirements, Mayo is entitled to the sued-for refunds. Mayo’s summary-judgment motion will be granted, and the government’s motion will be denied," Tostrud wrote.

Colaiano explained that without the Treasury regulation's question of what Mayo Clinic "primarily" is, the judge could rely "on the plain language of the statute… There's no question what we are."

Mayo Clinic's stance is that it is an institution that features medical practice, education, and research activities "intertwined."

Attorney Curtis Weidler, who represented the IRS, referred questions about the ruling to the Dept. of Justice's Office of Public Affairs. The Office of Public Affairs did not respond to questions before the Post Bulletin's press deadline.

The big question is whether the IRS will appeal Tuesday's ruling. If the IRS appeals the decision, the $11.5 million tax refund will be held until there is a final resolution to the case, explained Mayo's Colaiano. The IRS team has at least 30 days to decide if it will appeal.

This ruling will not affect Mayo Clinic's tax filings since 2009. Mayo Clinic's Corporate Tax Director Christie Lohkamp explained that the annual filings did not list the investment earnings as taxable.

"We have always believed that we were likely to win," she said.

While the ruling is significant, it probably will not make a big difference to other organizations as a precedent.

"There aren't a lot organizations that normally maintain a regular faculty, curriculum, etc. that you wouldn't say are an educational organization," said Colaiano.

How it started

In 2009, the IRS audited Mayo Clinic and issued a notice of “adjustment” for the years 2005 and 2006. Those recalculations later expanded to include a total of seven years of Mayo Clinic tax returns — 2003, 2005 to 2007 and 2010 to 2012. The years 2004, 2008 and 2009 were not included, because no income of that type was reported.

The IRS concluded in 2014 that Mayo Clinic does not qualify for tax exemption on revenue generated by “debt-financed real-estate investment.”

That type of revenue is not taxed for nonprofit educational institutions or schools. For other tax-exempt institutions, that type of revenue is considered “Unrelated Business Income,” which is taxable.

The additional payments totaled $11,501,621. The bulk of that came from 2006, when the IRS said Mayo Clinic owed $9.3 million.

The clinic dutifully paid the money and then asked for a refund of the $11.5 million. In August 2016, the IRS rejected that refund claim. Mayo Clinic soon filed suit to recover the disputed $11.5 million plus “statutory interest as provided by law.”

This is not Mayo Clinic’s first time in court facing the IRS on issues related to education.

The two tangled previously over whether medical residents are students or employees.

While lower courts agreed with Mayo Clinic that medical residents are students, the U.S. Supreme Court eventually ruled in 2011 that they are employees. As employees, the medical residents have payroll taxes, Social Security and Medicare taxes that must be paid.

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Business Reporter

Jeff has worked at newspapers as a reporter, columnist, editor, photographer and copy editor since 1992. He started at the Post Bulletin in 1999. Kiger is the PB's business reporter and writes a daily column, "Heard on the Street."