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Judge rules IRS owes $11.5 million to Mayo Clinic

The question at the heart of this dispute was whether Mayo Clinic should be considered an educational institution.

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Mayo Clinic's Gonda Building March 22, 2021, in downtown Rochester.
Joe Ahlquist / Post Bulletin file photo
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ROCHESTER — After six years of a back-and-forth lawsuit, a judge ruled this week that Mayo Clinic “operated exclusively for educational purposes,” so the IRS must repay the clinic for $11.5 million of taxes paid on revenue generated by "debt-financed real-estate investment."

U.S. District Judge Eric Tostrud issued the bench ruling in Mayo Clinic’s favor on Tuesday. It is unknown if the IRS intends to appeal the decision, as it did following a previous ruling on this case.

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Tostrud wrote: “... Judgment will be entered for Mayo. The better answer on the trial record is that, during the refund years, Mayo was organized and operated exclusively for educational purposes and had no noneducational purpose that was substantial in the relevant sense.”

This is the latest ruling in a case that was filed in 2016, though the specifics of the dispute date back well before that.

Mayo Clinic Communications Manager Kristy K. Jacobson released a statement about the ruling.

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"We are pleased with the court’s decision, which affirms the integral role that education has had in Mayo Clinic’s mission from its earliest days. While Mayo Clinic is largely exempt from paying income taxes due to its nonprofit status, it still pays millions of dollars of taxes annually from various activities," according to the statement released. "Today’s ruling will help ensure that Mayo Clinic receives the same treatment under federal tax laws as other educational organizations. Mayo plans to invest the refunded money to continue support for our three-shield mission."

The question at the heart of the case is whether Mayo Clinic should be considered an educational institution. Universities are exempt from paying taxes on that type of real estate revenue. Nonprofit hospitals are not exempt.

While the two sides agreed that Mayo Clinic does offer education, the IRS position was that medical care is Mayo Clinic’s primary purpose. It considered Mayo Clinic to be "a parent company of a health-care system as its primary purpose and function."

Mayo refuted that. Its lawyers said education was part of the clinic’s daily mission.

In 2009, the IRS issued a notice of "adjustment" for seven years of Mayo Clinic filings — 2003, 2005-2007, and 2010-2012. The IRS billed Mayo Clinic for $11.5 million in back taxes.

While Mayo Clinic paid the $11.5 million, the clinic filed a lawsuit in 2016 claiming it should be exempt and asking for the money back. Judge Tostrud issued a summary judgment in 2019 in Mayo Clinic’s favor, which meant that Mayo Clinic would be exempt from paying taxes on "debt-financed real-estate investment” revenue in the future.

The IRS appealed the decision and the Eighth Circuit Court of Appeals invalidated the previous ruling in 2021. The appellate court ruled that Tostrud did not address the core issue and that he needed to try again .

A bench trial was held from April 25-29, 2022. Mayo Clinic had four witnesses testify, including former CEO Dr. John Noseworthy and its former Chief Legal Officer and Corporate Secretary Jonathan Oviatt. The IRS called no witnesses.

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The IRS and Mayo Clinic did agree about the basic facts of the situation.

Tostrud wrote: “It also seems important to note that trial of this case showed the parties do not seriously dispute the truth of each other’s factual assertions, but rather dispute the relevance of certain facts and the application of facts to the governing law.

”In other words, trial proved to be less about what facts are true and more about, in view of the governing law, what facts matter and how those facts drive the case’s outcome.”

Mayo Clinic issued a statement in response to the ruling: "We are pleased with the court’s decision, which affirms the integral role that education has had in Mayo Clinic’s mission from its earliest days. While Mayo Clinic is largely exempt from paying income taxes due to its nonprofit status, it still pays millions of dollars of taxes annually from various activities. Today’s ruling will help ensure that Mayo Clinic receives the same treatment under federal tax laws as other educational organizations. Mayo plans to invest the refunded money to continue support for our three-shield mission."

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, 2005-2007 and 2010-2012. 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 did 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.

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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.

Jeff Kiger writes a daily column, "Heard Around Rochester," in addition to writing articles about local businesses, Mayo Clinic, IBM, Hormel Foods, Crenlo and others. The opinions of my employer do not necessarily reflect my opinions. He has worked in Rochester for the Post Bulletin since 1999. Send tips to jkiger@postbulletin.com or via Twitter to @whereskiger . You can call him at 507-285-7798.
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