In Mayo Clinic v. US, No. 23-2246 (July 25, 2025), the United States Court of Appeals for the Eighth Circuit (Appeals Court) affirmed the United States District Court for the District of Minnesota's holding¹ that the Mayo Clinic (Mayo) qualifies as an "educational institution," and therefore is exempt from unrelated business income tax (UBIT) on acquisition indebtedness related to real property.

The Appeals Court found Mayo qualifies as an "educational institution" under IRC Section 170(b)(1)(A)(ii) because Mayo's provision of health care services is inextricably linked to Mayo's educational purpose and Mayo has no substantial noneducational purpose. Accordingly, the Appeals Court ruled that Mayo is entitled to an $11.5m refund of UBIT on income from certain debt-financed real property.

Background

Mayo, a Minnesota nonprofit corporation and a tax-exempt organization under IRC Section 501(c)(3), sought a refund of UBIT imposed by the IRS for tax years 2003, 2005–2007, and 2010–2012. The IRS had assessed Mayo $11,501,621 in unpaid UBIT from debt-financed real property, asserting that Mayo's primary function was not educational and that its non-educational activities were not merely incidental to its educational mission.

In general, IRC Sections 511-514 require tax-exempt organizations to pay tax on unrelated business income (UBI). An exclusion from UBI applies for certain types of passive income (e.g., dividends, interest, rents) unless the tax-exempt organization acquired or improved the property from which that income is earned using borrowed money (debt-financed property). A further exception excludes from UBI passive income that is earned from debt-financed real property by a "qualified organization." A qualified organization for this purpose is defined by IRC Section 514(c)(9)(C) to include organizations described as public charities in IRC Section 170(b)(1)(A)(ii) (i.e., educational organizations). Specifically, IRC Section 170(b)(1)(A)(ii) refers to "an educational organization which normally maintains a regular faculty and curriculum and normally has a regularly enrolled body of pupils or students in attendance at the place where its educational activities are regularly carried on." Treas. Reg. Section 1.170A-9(c)(1) also requires that the organization's "primary function" be educational and that any noneducational activities it engages in be "merely incidental" to its educational activities for it to qualify as an educational organization.

The district court initially ruled in favor of Mayo and its UBI refund claim, concluding that it is an educational organization exempt from UBIT on income from debt-financed real property (see Tax Alert 2022-1801). The district court invalidated the IRS's interpretation of Treasury Regulation Section 1.170A-9(c)(1), which required that an organization's primary function must be the presentation of formal instruction for it to qualify as an educational institution under IRC Section 170(b)(1)(A)(ii). On initial appeal, the Appeals Court agreed that the regulation was invalid, insofar as IRC Section 170(b)(1)(A)(ii) does not require that an educational institution's primary function be the presentation of formal instruction. The Appeals Court, however, consistent with the regulation, reversed the district court in ruling that an educational organization's primary purpose must be educational and any noneducational activities must be merely incidental to that primary purpose. The Appeals Court remanded the case to the district court for further proceedings to determine whether Mayo's primary purpose is educational and whether its noneducational activities are merely incidental to that primary purpose.²

On remand, the district court cited various facts reflecting Mayo's educational purpose, and how its educational functions are "inextricably intertwined" with its clinical and research functions, including:

• Mayo's articles of incorporation and bylaws, which emphasize the importance of integrating education, research and clinical practice
• Mayo's CEO's responsibility for setting system-wide funding levels for education
• Mayo's Education, Research and Clinical Practice Committees, which further system-wide integration so that "every initiative, old or new, was reviewed to determine if it effectively integrated education, research, and clinical practice"

During the tax years at issue, Mayo operated five schools to train healthcare professionals: (1) Mayo Clinic School of Graduate Medical Education; (2) Mayo Clinic School of Medicine; (3) Mayo Clinic School of Health Sciences; (4) Mayo Clinic School of Continuing Professional Development; and (5) Mayo Clinic Graduate School of Biomedical Sciences. Enrolled students were taught in many environments (e.g., classrooms, hospital wards, laboratories). Students included medical residents and fellows (doing post-graduate training), medical students, nurses, licensed physicians (earning continuing medical education hours), medical support staff and administrators. Most paid tuition, although medical residents and fellows were not charged tuition and typically were paid a small stipend for their clinical work.

The district court evaluated numerous factors to determine the importance and integration of education at Mayo. Factors weighing in Mayo's favor included: (1) its organization and governance reflect the principal role of education, (2) its extensive educational offerings and day-to-day operations reflect a substantial educational purpose, and (3) its finances reflect its substantial educational purpose, as Mayo spent more on education and research than it made from patient care. Importantly, the district court noted that Mayo expects each of its attending physicians (employees) to participate in education, research activities and clinical practice, and all are expected to obtain academic rank (i.e., assistant professor, associate professor, etc.). Accordingly, the district court found that Mayo has a substantial educational purpose. Similarly, the district court found that Mayo does not have a substantial noneducational purpose because it uniquely integrates education, research and clinical practice across all of its operations. The district court did not find any evidence of "a 'substantial' clinical practice function at Mayo that did not further the goal of providing training and education to the students at its colleges."

Law and analysis

For an organization exempt from federal tax under IRC Section 501(c)(3) to qualify as an educational institution under IRC Section 170(b)(1)(A)(ii), it must meet specific criteria under Treas. Reg. Section 1.170A-9(c)(1). To qualify as an educational institution, it must normally maintain (1) a regular faculty, (2) a curriculum that is structured and systematic, and (3) a regularly enrolled body of pupils or students who attend the institution where its educational activities are conducted. Further, the primary purpose of the organization must be educational. Any noneducational activities must be merely incidental to its educational purpose, meaning that while an educational institution can engage in noneducational activities, these should be insubstantial compared to its educational functions.

The Appeals Court's analysis focused on two overarching issues: (1) the interpretation of "primary" in the context of educational purpose and (2) whether Mayo has a substantial noneducational purpose.

Interpretation of "primary" purpose

The Appeals Court upheld the district court's interpretation that "primary" means "substantial" in the context of IRC Section 170(b)(1)(A)(ii), and that an organization can have more than one substantial purpose and function. The ruling referenced the Supreme Court's decision in Board of Governors of Federal Reserve System v. Agnew, which noted that "primary" can also mean "essentially" or "fundamentally." The Appeals Court found that Mayo's educational functions are substantial, or primary, and that its patient care activities, while significant, do not detract from its educational mission, but instead are "intertwined with every other Mayo function."

Substantial noneducational purpose

The IRS had argued that Mayo's extensive patient care activities constitute a substantial noneducational purpose, thereby disqualifying it from educational organization status under IRC Section 170(b)(1)(A)(ii). However, the district court found that Mayo's patient care is integrally linked to its educational mission and stated, "[P]atient care at Mayo cannot be completely detached from medical education" and " … patient care is not noneducational at Mayo." The Appeals Court highlighted that Mayo's operations are designed to enhance medical education, with patient care serving as a practical component of training for medical students and residents. The ruling emphasized that Mayo's patient care functions are not merely incidental to its educational objectives but rather are essential to those objectives.

Implications

The Appeals Court's ruling provides an avenue for tax-exempt hospitals and health systems with educational activities that are integrated with their clinical activities to potentially qualify for the "educational organization" UBIT exemption for debt-financed real property under IRC Section 514(c)(9)(C)(i). Under the Appeals Court's holding that "primary" means "substantial," even when most of a health system's activity involves patient care, the health system may qualify as an educational organization if its educational purpose and activities are substantial. The Appeals Court's ruling, however, is binding on the IRS only in the Eighth Circuit, which covers Minnesota, North Dakota, South Dakota, Iowa, Nebraska, Missouri and Arkansas. It is unlikely that the IRS will acquiesce to the Appeals Court's ruling in jurisdictions outside of the Eighth Circuit.