506 F.2d 1278 (D.C. Cir. 1974), 74-1293, Eastern Kentucky Welfare Rights Organization v. Simon

Docket Nº74-1293.
Citation506 F.2d 1278
Party NameUSTC P 9177 EASTERN KENTUCKY WELFARE RIGHTS ORGANIZATION et al. v. William E. SIMON, Secretary of the Treasury, et al., Appellants.
Case DateOctober 09, 1974
CourtUnited States Courts of Appeals, Court of Appeals for the District of Columbia Circuit

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506 F.2d 1278 (D.C. Cir. 1974)

USTC P 9177

EASTERN KENTUCKY WELFARE RIGHTS ORGANIZATION et al.

v.

William E. SIMON, Secretary of the Treasury, et al., Appellants.

No. 74-1293.

United States Court of Appeals, District of Columbia Circuit

October 9, 1974

Argued June 12, 1974.

Rehearing Denied Dec. 6, 1974.

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[Copyrighted Material Omitted]

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Wesley J. Filer, Atty., Tax Div., Dept. of Justice, of the bar of the Supreme Court of Texas, pro hac vice, by special leave of court, with whom Scott P. Crampton, Asst. Atty. Gen., Earl J. Silbert, U.S. Atty., and Meyer Rothwacks and Leonard J. Henzke, Jr., Attys. Tax Div., Dept. of Justice, were on the brief, for appellants.

Marilyn G. Rose, with whom Joseph Onek, Jeffrey B. Schwartz, Laurens H. Silver, and Anthony Z. Roisman, Washington, D.C., were on the brief, for appellees.

John A. Beck, Washington, D.C., filed a brief on behalf of American Hospital Association as amicus curiae urging reversal.

Before WRIGHT and WILKEY, Circuit Judges, and JAMESON, [*] Senior District Judge.

JAMESON, Senior District Judge:

Defendants-appellants, the Secretary of the Treasury and Commissioner of Internal Revenue, have appealed from an order granting summary judgment to plaintiffs-appellees and holding that 'private nonprofit hospitals seeking tax exempt status as charitable organizations under 501(c)(3) of the (Internal Revenue) Code must provide free or below cost treatment to individuals unable to pay for such services' and that a revenue ruling modifying this requirement is void. 1

I. BACKGROUND

Sections 501(a) and (c)(3) of the Internal Revenue Code of 1954 (26 U.S.C. 501(a) and (c)(3)) exempt from federal income tax: '(3) Corporations, and any community chest, fund, religious, or foundation, organized and operated exclusively for charitable . . . purposes, . . . no part of the net earnings of which inures to the benefit of any private shareholder or individual . . .'. Other related sections of the Code provide that contributions to such tax exempt charitable organizations are deductible for purposes of computing federal income tax (26 U.S.C. 170) and estate and gift taxes (26 U.S.C. 2055(a) (2), 2106(a)(2)(A)(ii) and 2522(a)(2)).

Hospitals and other health organizations have never been expressly categorized as tax exempt organizations and have achieved that status only by qualifying as 'charitable' organizations under the Code. Long established Internal Revenue Service (I.R.S.) policy held that hospitals qualified as charitable organizations under 501(c)(3) only if they provided free or below cost service to those unable to pay. This policy was articulated in Revenue Ruling 56-185, which held that a hospital could qualify for tax exempt status only if it was 'operated to the extent of its financial ability for those not able to pay for the services rendered and not exclusively for those who are able and expected to pay'. 2

The I.R.S. modified this position in 1969 with the issuance of Revenue Ruling 69-545. The new ruling broadly defines 'charitable' in terms of community benefit and holds that the promotion of health constitutes a 'charitable purpose' in the 'generally accepted legal

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sense of that term' 3 and within the meaning of 501(c)(3) of the Code. According to the ruling,

'The promotion of health . . . is one of the purposes in the general law of charity that is deemed beneficial to the community as a whole even though the class of beneficiaries eligible to receive a direct benefit from its activities does not include all members of the community, such as indigent members of the community . . .'.

Based on this community benefit concept, a nonprofit hospital can qualify as a charitable organization under 501(c)(3) 'By operating an emergency room open to all persons and by providing hospital care for all those persons in the community able to pay the cost thereof either directly or through third party reimbursement . . .' (e.g. private health insurance, Medicare, or Medicaid). Thus, for a hospital to qualify as a tax exempt organization, the provision of free or below cost service to those unable to pay is no longer essential. 4

Alleging harm from this new ruling, the plaintiffs-appellees, a group of health and welfare organizations and indigent persons, brought this action seeking to declare Revenue Ruling 69-545 invalid and to enjoin its implementation. They submitted affidavits recounting incidents in various parts of the country involving the denial of hospital services to indigents by institutions enjoying tax exempt status as 'charitable' organizations.

Plaintiffs contended that (1) the Revenue Ruling constitutes an improper administrative alteration of the Internal Revenue Code in contradiction of longstanding Congressional tax policy and judicial interpretation; (2) the Ruling was not properly adopted due to the I.R.S. failure to grant interested parties an opportunity to be heard, allegedly a violation of the Administrative Procedure Act and the Fifth Amendment right of due process; and (3) the Ruling was an 'abuse of discretion'.

The defendants moved for dismissal of plaintiffs' complaint on the ground that the court lacked jurisdiction to entertain the action. The court denied this motion without opinion. Subsequently, upon the parties' cross motions for summary judgment, the court granted summary judgment in favor of the plaintiffs.

The court held:

(1) The plaintiffs have standing to maintain this action because they 'have demonstrated sufficient injury flowing from the issuance of Revenue Ruling 69-545' and fall within the zone of interests protected by the Code. 5

(2) The Federal tax exemption to the Declaratory Judgment Act, 28 U.S.C. 2201, and the Tax Injunction Act, 26 U.S.C. 7421(a), do not bar the suit.

(3) Judicial review of the Revenue Ruling is not precluded by the Administrative Procedure Act's provision in 5 U.S.C. 701(a)(2) which forbids review of 'agency action . . . committed to the agency discretion by law'.

(4) The new Revenue Ruling does not comport with Congressional intent but rather is clearly contrary to the relevant judicial, legislative and administrative history on the matter. In light of this,

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the 'community benefit' theory cannot 'justify the basic shift in policy'. The promulgation of the new ruling was therefore unauthorized.

Contentions on Appeal

Appellants level a dual attack against the judgment. First, they contend that the district court lacked jurisdiction in that the action is barred by (a) sovereign immunity, (b) the Anti-Injunction Act and the tax exemption to the Declaratory Judgment Act, and (c) the Administrative Procedure Act. 6 Second, appellants argue that Revenue Ruling 69-545 was authorized and does meet the charitable standard of 501(c)(3) of the Code. In addition to opposing the contentions of appellants, appellees argue that the Revenue Ruling was not promulgated in accordance with the notice and hearing requirement of the Administrative Procedure Act and constitutes an abuse of discretion.

II. JURISDICTION

(a) Soverign Immunity

The defense of sovereign immunity is jurisdictional. See United States v. Sherwood, 312 U.S. 584, 61 S.Ct. 767, 85 L.Ed. 1058 (1941). Generally, without specific authority, a court may not entertain an action against the sovereign. That doctrine, however, is not without its exceptions. The two primary exceptions were delineated in Larson v. Domestic and Foreign Corp., 337 U.S. 682, 69 S.Ct. 1457, 93 L.Ed. 1628 (1949): sovereign immunity will not serve to bar jurisdiction when (1) the actions of a government official are beyond the scope of his authority or (2) 'the statute or order conferring power upon the officer to take action in the sovereign's name is claimed to be unconstitutional'. Id. at 689-690, 69 S.Ct. at 1461; accord Dugan v. Rank, 372 U.S. 609, 621-622, 83 S.Ct. 999, 10 L.Ed.2d 15 (1963). Here plaintiffs alleged, and the district court found, that government officials had acted beyond their statutory power.

Appellants contend that (1) regardless of exceptions that may have been formulated in other judicial areas, sovereign immunity in matters of federal tax remains an absolute bar; (2) even if the Larson exceptions are viable in tax cases, the Commissioner was authorized by statute to interpret the term 'charitable' as he did; and (3) mere error by the Commissioner in his interpretation of 'charitable' would not negate the application of sovereign immunity, Larson, supra, 337 U.S. at 690, 69 S.Ct 1457.

Appellants rely on Louisiana v. McAdoo, 234 U.S. 627, 34 S.Ct. 938, 58 L.Ed. 1506 (1914) in support of their contention that the defense of sovereign immunity is absolute with respect to the area of federal taxes. McAdoo involved an action against the Secretary of the Treasury brought by the State of Louisiana as a sugar producer. Louisiana challenged the Secretary's determination of the tariff rates to be applied to sugar imported from Cuba. The Court held that the defense of sovereign immunity barred the action regardless of the fact that the State of Louisiana claimed that the action of the Secretary was not authorized by law.

McAdoo, however, must be viewed in its proper perspective. The Court decided that case in 1914. Since then, significant changes have occurred in the area of standing, and exceptions to the doctrine of sovereign immunity have been

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judicially recognized. Larson and Dugan, supra. Moreover, with the advent of the Administrative Procedure Act in 1946, the continued viability of sovereign immunity with respect to administrative actions has been seriously questioned. Scanwell Laboratories, Inc. v. Shaffer, 137 U.S.App.D.C. 371, 424 F.2d 859, 873 (1970).

The exceptions to the doctrine of sovereign immunity set forth in Larson have been applied in federal tax cases. In McGlotten v. Connally, 338 F.Supp. 448...

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