Eastern Kentucky Welfare Rights Organization v. William E. Simon, Secretary of the Treasury

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.

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

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 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.

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

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.

(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 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 (D.D.C.1972), a nontaxpayer challenged the exempt status of a fraternal organization with racially discriminatory membership policies. The three-judge court rejected a sovereign immunity argument, holding that the 'action falls readily within the two longstanding exceptions to that doctrine'. Id. at 454, n. 27.7 This court recognized the application of those exceptions in Americans United v. Walters, 155 U.S.App.D.C. 284, 477 F.2d 1169 (1973), reversed on other grounds sub nom., Alexander v. Americans United, 416 U.S. 752, 94 S.Ct. 2053, 40 L.Ed.2d 518 (1974).8

The Government is correct in contending that 'a claim of error' in the exercise of an officer's powers is not sufficient to invoke the scope of authority exception to the sovereign immunity doctrine. Larson, supra, 337 U.S. at 690, 69 S.Ct. 1457. Plaintiffs in this case, while not challenging the fact that the Secretary or Commissioner has the authority to prescribe rules and regulations for the administration of the revenue laws, nevertheless do challenge the authority of the Commissioner to interpret a revenue statute in a manner contrary to long-established Congressional policy. Thus, more than mere error on the part of the Commissioner is alleged. The court, therefore, has jurisdiction to determine whether or not the action of the Commissioner was authorized. The court has jurisdiction to determine its jurisdiction, Land v. Dollar, 330 U.S. 731, 739, 67 S.Ct. 1009, 91 L.Ed. 1209 (1947), even though such a determination requires a decision on the merits. Larson, supra, 337 U.S. at 690, 69 S.Ct. 1457; Bell v. Hood, 327 U.S. 678, 682-683, 66 S.Ct. 773, 90 L.Ed. 939 (1946); Junior Chamber of Commerce, supra.

That sovereign immunity does not serve as a bar to the present action is further established by this court's position that the Administrative Procedure Act constitutes a waiver of sovereign immunity. Quoting from Estrada v. Ahrens, 296 F.2d 690, 698 (5 Cir. 1941), this court in Scanwell,supra, 424 F.2d at 873 stated:

'By providing judicial review in an action brought by 'any person adversely affected or aggrieved by any agency action' Congress permitted suits which under established tests would certainly be barred as suits against the government . . .. The Act thereby makes a clear waiver of sovereign immunity in actions to which it applies.'

We conclude that the district court correctly held that the action was not barred by the doctrine of sovereign immunity.

(b) Anti-Injunction and Declaratory Judgment Acts

The Anti-Injunction Act (26 U.S.C. 7421(a)) provides in relevant part: '. . . no suit for the purpose of restraining the assessment or collection of any tax shall be maintained in any court by any person, whether or not such person is the person against whom such tax was assessed'. In Bob Jones University v. Simon, 416 U.S. 725, 94 S.Ct. 2038, 2046, 40 L.Ed.2d 496 (1974), the Court stated:

'The Court has interpreted the principal purpose of this language to be the protection of the Government's need to assess and collect taxes as expeditiously as possible with a minimum of preenforcement judicial interference, 'and to require that the legal right to the disputed funds be determined in suit for a refund.' Enochs v. Williams Packing and Navigation Co., 370 U.S. 1, 7, 82 S.Ct. 1125, 1129, 8 L.Ed.2d 292 (1962).'

Here, the plaintiffs as nontaxpayers seek to have the I.R.S. enjoined from granting tax exempt status to hospitals which fail to provide free or reduced-charge services to indigents. The case of McGlotten v. Connally, supra, is analogous. In McGlotten a black American brought a class action 'to enjoin the Secretary of Treasury from granting tax benefits to fraternal and nonprofit organizations which exclude nonwhites from membership'. Id., 338 F.Supp. at 450. In rejecting the contention that the Anti-Injunction Act barred the suit, the court concluded that the action had 'nothing to do with the assessment or collection of taxes. He (the plaintiff) does not contest the amount of his own tax, nor does he seek to limit the amount of tax revenue collectible by the United States. The preferred course of raising his objections in a suit for refund is not available. In this situation we cannot read the statute to bar the present suit.' Id. at 453-454.

The McGlotten rationale was followed by this court in Americans United v. Walters, 155 U.S.App.D.C. 284, 477 F.2d 1169 (1973) in holding that a corporation in challenging the revocation of its tax exempt status was not attempting to restrain the assessment or collection of taxes. The Supreme Court, however, in Alexander v. Americans United, Inc., 416 U.S. 752, 94 S.Ct. 2053, 40 L.Ed.2d 518 (1974) reversed. The Court held that the purpose of the suit was to restrain the collection of taxes from contributors to the corporation. Accordingly, the Anti-Injunction Act applied and barred the action. The Court further stressed that an adequate legal remedy existed in the form of refund litigation.

Americans United, however, did not involve the factual situation presented in McGlotten and in this action. Here, as in McGlotten, rather than attempting to negate the levy of a tax, the plaintiffs are seeking to force the Government to impose a tax on contributions to certain hospitals. This, therefore, is not a case wherein the Government is faced with any threat to the actual assessment or collection of the taxes to which it deems itself entitled.

In addition, there is merit in the claim that there is no other adequate legal remedy.9 Obviously neither the tax exempt charitable hospitals nor their contributors will institute refund litigation, as the contributions are tax free. It is apparent from a close analysis of the Anti-Injunction Act that it did not contemplate barring actions, such as this, where the litigation did not threaten to deny anticipated tax revenues to the Government.

Appellants next contend that, even if the Anti-Injunction Act is held inapplicable, the tax exemption provision of the Declaratory Judgment Act (28 U.S.C. 2201) bars the action. That provision authorizes federal courts to grant declaratory judgments 'except with respect to Federal taxes'. Appellants argue that the Declaratory Judgment Act is much broader in scope than the Anti-Injunction Act.

In McGlotten, supra, the court concluded that the Anti-Injunction Act and Declaratory Judgment Act are coterminous. This court in Americans United, supra, following the rationale of McGlotten, held that while the tax exemption provision of the Declaratory Judgment Act is literally broader than the Anti-Injunction Act provision, nevertheless the two are coterminous. The court reasoned that it would be paradoxical to authorize injunctive relief in some cases 'while depriving courts the authority to declare the rights of the parties in connection with the injunctive relief'. Id., 477 F.2d at 1176.

Although the Supreme Court reversed Americans United, it did not deal with the issue of whether or not the Declaratory Judgment Act was broader than the Anti-Injunction Act.10 A reexamination of the legislative history of the tax exemption provision leads this court to conclude, as it did in Americans United, that the Declaratory Judgment Act and the Anti-Injunction Act were intended to be coterminous.11 Therefore, just as the Anti-Injunction Act does not bar this action, neither does the Declaratory Judgment Act.

(c) Administrative Procedure Act

In contending that the Administrative Procedure Act precludes this action, appellants rely on 5 U.S.C. 701(a)(1), which indicates that administrative actions are not subject to review 'to the extent that (1) statutes preclude judicial review'. With respect to this exception, the Supreme Court has held that access to judicial review will generally not be denied unless there is a showing by 'clear and convincing evidence' of a contrary legislative intent. Rusk v. Cort, 369 U.S. 367, 379-380, 82 S.Ct. 787, 7 L.Ed.2d 809 (1962). Appellants argue that the Anti-Injunction Act, the tax exception to the Declaratory Judgment Act and the doctrine of sovereign immunity, combined with specific procedures established by Congress for review of tax matters, all indicate Congressional intent to 'preclude judicial review'.

We have concluded, however, that the Anti-Injunction Act, Declaratory Judgment Act and sovereign immunity do not bar this action. It is of course true, as appellants contend, that Congress has prescribed procedures for challenging administrative determinations of tax liability. Those procedures, however, are applicable only to cases involving the imposition of a tax, whereas here the challenge is made to a determination that certain hospitals are exempt from taxation as charitable organizations. We find no 'clear and convincing evidence' that Congress intended to preclude judicial review in a case such as this.12

If anything, the pertinent Congressional enactments indicate a Congressional intent that the actions of the Internal Revenue Service be subject to judicial review. The provision for review of the 'assessment and collection' of taxes by the I.R.S. are the basis for many hundreds of taxpayer and I.R.S. suits every year. By means of refund and deficiency actions, the courts review the policies, practices, rulings, interpretations and actions of the Internal Revenue Service. Those cases cannot be commenced until after the assessment and collection of taxes. As noted supra, the rationale limiting suits to the postcollection period is not applicable in this case. To limit plaintiffs to a refund action under these facts is, as the district court concluded, equivalent to denying them judicial relief. That result is without foundation in the relevant law.

In holding that 'Revenue Ruling 69-545 was improperly promulgated and is without effect', the district court concluded that 'based on relevant judicial, legislative, and administrative decisions' the new Ruling constituted an unauthorized reversal of a long-established policy of requiring exempt hospitals 'to offer special financial consideration to persons unable to pay'. The court recognized that 'as a matter of jurisdiction and efficient tax administration . . . courts have regularly paid deference to the expertise attributed to the I.R.S. in tax related matters and therefore judicial interference has been reluctantly employed'. The court continued: 'However, this exhibition of restraint is predicated upon the assumption that administrative rulings will do no more than effectuate, implement and clarify the provisions of the Code which have been Congressionally enacted . . .. When this assumption is proven wrong, the courts must act to rectify any administrative determination which is not in

accord with the Code.'

We do not disagree with these principles of judicial interpretation of administrative rulings, but our own analysis of the judicial, legislative, and administrative decisions leads to a contrary result. We conclude that Revenue Ruling 69-545 is not inconsistent with 26 U.S.C. 501(c)(3) and that the modification of the prior ruling was authorized.

The definition of the term 'charitable' has never been static and has been broadened in recent years. Prior to 1959, Treasury Regulations generally defined charitable organizations as those operated for the relief of the poor.13 In 1959, however, a comprehensive set of regulations interpreting 501(c) (3) was issued.14 These regulations adopted a broad concept of 'charitable'. The key provision, 1.501(c)(3)-1(d)(2) reads:

'(2) Charitable defined. The term 'charitable' is used in section 501(c)(3) in its generally accepted legal sense and is, therefore, not to be construed as limited by the separate enumeration in section 501(c)(3) of other tax exempt purposes which may fall within the broad outlines of 'charity' as developed by judicial decisions. Such term includes: Relief of the poor and distressed or of the under-privileged; advancement of religion; advancement of education or science; erection or maintenance of public buildings, monuments, or works; lessening of the burdens of Government; and promotion of social welfare by organizations designed to accomplish any of the above purposes, or (i) to lessen neighborhood tensions; (ii) to eliminate prejudice and discrimination; (iii) to defend human rights secured by law; or (iv) to combat community deterioration and juvenile delinquency.'

This Treasury Regulation was cited in Green v. Connally, supra, wherein the three-judge district court stated with respect to 501(c)(3):

'. . . clearly, the term 'charitable' is used 'in its generally accepted legal sense,' Treas.Reg. 1.501(c)(3)-1(d)(2), and not in a street or popular sense (such as, e.g., benevolence to the poor and suffering). See H. Reiling, 'What is a Charitable Organization?' 44 A.B.A.J. 525, 527 (1958). Thus 'strong analogy' can be derived from the general common law of charitable trusts, at least for close interpretative questions.' 330 F.Supp. at 1157.15

In promulgating Revenue Ruling 69-545, the Commissioner did rely on an analogy to the law of charitable trusts. As indicated earlier, the Commissioner cited both the Restatement (Second) of Trusts, sec. 368 and sec. 372,16 and IV Scott on Trusts (ord ed. 1967) sec. 368 and sec. 37217 in holding that the promotion of health is a charitable purpose within the meaning of 501(c)(3).

The term 'charitable' is thus capable of a definition far broader than merely the relief of the poor. The law of charitable trusts supports the broader concept. The question involved here then is whether the term 'charitable' as used in 501(c)(3) may be broadly interpreted as was done in Revenue Ruling 69-545 or is to be restricted to its narrow sense of relief of the poor.

We cannot conclude, as did the district court, that Congress intended the latter construction. While it is true that in the past Congress and the federal courts have conditioned a hospital's chartable status on the level of free or below cost care that it provided for indigents,18 there is no authority for the conclusion that the determination of 'charitable' status was always to be so limited. Such an inflexible construction fails to recognize the changing economic, social and technological precepts and values of contemporary society.

In the field of health care, the changes have been dramatic. Hospitals in the early part of this nation's history were almshouses supported by philanthropy and serving almost exclusively the sick poor.19 Today, hospitals are the primary community health facility for both rich and poor. Philanthropy accounts for only a minute percentage of the hospital's total operating costs.20 Those costs have soared in recent years as constant modernization of equipment and facilities is necessitated by the advances in medical science and technology.21 The institution of Medicare and Medicaid in the last decade combined with the rapid growth of medical and hospital insurance has greatly reduced the number of poor people requiring free or below cost hospital services. Much of that decrease has been realized since the promulgation of Revenue Ruling 56-185. Moreover, increasingly counties and other political subdivisions are providing nonemergency hospitalization and medical care for those

unable to pay.22 Thus, it appears that the rationale upon which the limited definition of 'charitable' was predicated has largely disappeared.23 To continue to base the 'charitable' status of a hospital strictly on the relief it provides for the poor fails to account for these major changes in the area of health care.

In holding Revenue Ruling 69-545 void, the district court placed undue emphasis on the fact that Congress in 1969 failed to amend the Internal Revenue Code by including language which would have conformed the Code to the new ruling. The Senate Finance Committee in deleting a House provision which would have allowed exempt status to institutions 'organized and operated exclusively for the providing of hospital care' stated:

'The committee deleted from the bill those provisions which would have conformed the code to the result reached by the 1969 ruling. The committee decided to reexamine this matter in connection with pending legislation on Medicare and Medicaid.'24

This action or inaction by Congress cannot be interpreted as disapproving the new ruling. Congress could have rejected the ruling had it determined that it was not in conformity with the Code. Instead, it committed the matter for further study in the light of Medicare and Medicaid. No further action has been taken by Congress since the ruling became effective in 1969.

It is important to note also that Revenue Ruling 69-545 rather than overruling Revenue Ruling 56-185 simply provides an alternative method whereby a nonprofit hospital can qualify as a tax exempt charitable organization. That method entails the operation of an emergency room open to all regardless of their ability to pay and providing hospital services to those able to pay the cost either directly or through third party reimbursement. Thus, to qualify as a tax exempt charitable organization, a hospital must still provide services to indigents.

The required provision of emergency room services is of great import to the indigent. Emergency room service is often the only means of access that the poor have to medical care.25 Further-more, the fact that hospitals seeking to qualify as charities pursuant to Revenue Ruling 69-545 must accept Medicare and Medicaid patients is also significant. A large percentage of the indigent populace of the nation is now covered by either Medicare or Medicaid. In the final analysis, Revenue Ruling 69-545 may be of greater benefit to the poor than its predecessor Ruling 56-185.26 Certainly Ruling 69-545 is more in conformity with the concept of 'charitable' as defined in the Treasury Regulation adopted, after extensive study, in 1959 and interpreting 501(c)(3).

In summary, we conclude that Revenue Ruling 69-545 is founded on a permissible definition of the term 'charitable' and is not contrary to any express Congressional intent.

IV. NOTICE AND HEARING REQUIREMENTS OF APA; ABUSE AND DISCRETION

Appellees contend that, if this court should find that the Commissioner was authorized to promulgate Revenue Ruling 69-545, the district court must nevertheless be sustained because appellants had the legal obligation under 5 U.S.C. 553 to afford appellees an opportunity to be heard.27 They argue that Revenue Ruling 69-545 is a substantive rule as opposed to an interpretative ruling and therefore 553 of the APA is applicable.

Section 553 of the Administrative Procedure Act expressly excepts interpretative rules from the notice and hearing requirements of the Act. This court distinguished interpretative and substantive rules in Gibson Wine Co. v. Snyder, 90 U.S.App.D.C. 135, 194 F.2d 329 (1952):

'Generally speaking, it seems to be established that 'regulations', 'substantive rules' or 'legislative rules' are those which create law, usually implementary to an existing law; whereas interpretative rules are statements as to what the administrative officer thinks the statute or regulation means . . .. 'A substantive rule is one which . . . is intended to implement the statutory structure or the statutory powers of an agency. An interpretative rule is one which does not have the full force and effect of a substantive rule but which is in the form of an explanation of particular terms in an Act. If you had an expression in a statute such as 'Interurban Railway,' the query might come up as to what is an 'interurban railway.' A particular agency may adopt a rule defining an interurban railway. That, in a sense, may be called an interpretative rule." Id. at 331-332.28

Here the Commissioner interpreted the m