IRS denies social-club exemption for alcohol venue arrangement

Plain-English summary

An organization sought IRC § 501(c)(7) social-club exemption so it could obtain a private-club alcohol permit for an event venue owned by its president. Membership requirements were minimal, memberships were unlimited, and the IRS found little or no meaningful social commingling beyond purchasing alcohol at the same location. Management and lease agreements directed a large share of gross alcohol receipts to the president's for-profit company, and the president signed the agreements for both sides. The IRS denied exemption because the arrangement produced private inurement, served the related venue business, and did not operate primarily for pleasure, recreation, or other nonprofitable purposes.

Ruling snapshot

• Question: Did the organization qualify as a tax-exempt social club under IRC § 501(c)(7)?
• Outcome: Denied
• Key authorities: IRC § 501(c)(7); Treas. Reg. § 1.501(c)(7)-1(b); Rev. Rul. 58-588; Rev. Rul. 66-225; Rev. Rul. 69-635

Full text (IRS public release)

Department of the Treasury
Internal Revenue Service

P.O. Box 2508
IRS Cincinnati, OH 45201

Date: September 23, 2015

Release Number: 201551010 Employer ID number:
Release Date: 12/18/2015
UIL Code: 501.07-00 Contact person/ID number:

Contact telephone number:
Form you must file:

Tax years:

Dear

This letter is our final determination that you don’t qualify for tax-exempt status under Section 501(c)(7) of the
Internal Revenue Code (the Code). Recently, we sent you a proposed adverse determination in response to your
application. The proposed adverse determination explained the facts, law, and basis for our conclusion, and it
gave you 30 days to file a protest. Because we didn’t receive a protest within the required 30 days, the proposed
determination is now final.

You must file federal income tax returns for the tax years listed at the top of this letter using the required form
(also listed at the top of this letter) within 30 days of this letter unless you request an extension of time to file.

We’ll make this final adverse determination letter and the proposed adverse determination letter available for
public inspection (as required under Section 6110 of the Code) after deleting certain identifying information.
Please read the enclosed Notice 437, Notice of Intention to Disclose, and review the two attached letters that
show our proposed deletions. If you disagree with our proposed deletions, follow the instructions in the Notice
437 on how to notify us. If you agree with our deletions, you don’t need to take any further action.

If you have questions about this letter, you can contact the person listed at the top of this letter. If you have
questions about your federal income tax status and responsibilities, call our customer service number at
1-800-829-1040 (TTY 1-800-829-4933 for deaf or hard of hearing) or customer service for businesses at
1-800-829-4933.

We sent a copy of this letter to your representative as indicated in your power of attorney.

Letter 4040 (Rev. 7-2014)
Catalog Number 47635Z

Sincerely,

Jeffrey I. Cooper
Director, Exempt Organizations
Rulings and Agreements

Enclosures:
Notice 437
Redacted Letter 4034, Proposed Adverse Determination under IRC Section 501(a) Other Than 501(c)(3)

Redacted Letter 4040, Final Adverse Determination under IRC Section 501(a) Other Than 501(c)(3) - No
Protest

Letter 4040 (Rev. 7-2014)
Catalog Number 47635Z

Department of the Treasury
Internal Revenue Service

P.O. Box 2508
Cincinnati, OH 45201

Date: August 3, 2015

Employer ID number:

Contact person/ID number:

Contact telephone number:

Contact fax number:

Legend: UIL:

B= Name 501.07-00
C= Date 501.07-02

D = Name of Law 501.07-05

F = State

M=LLC Name

r = Number bb= Number
s = Number cc= Number
t dollars = Amount dd= Number
u dollars = Amount ee= Number
v dollars = Amount ff= Number
w = Number

x = Number

y = Number

z = Number

Dear

We considered your application for recognition of exemption from federal income tax under Section 501(a) of
the Internal Revenue Code (the Code). Based on the information provided, we determined that you don’t qualify
for exemption under Section 501(c)(7) of the Code. This letter explains the basis for our conclusion. Please
keep it for your records.

Issues
Do you qualify for exemption under section 501(c)(7) of the Code? No, for the reasons stated below.
Facts

You were formed in the state of F on C as an unincorporated association. Your Articles of Association state you
were organized to create a private club that “will be for the pleasure and enjoyment of its members, their

Letter 4034 (Rev. 7-2014)
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families and guests, and arrange for suitable facilities at a premise where activities of a hospitable, social, and
fraternal nature may be conducted as a private club in accordance with D.” D is the law in F concerning
requirements for private club alcohol licenses.

You claim to be a social club operating for the pleasure and enjoyment of your members, their families and
guests. You will begin sometime in the first quarter of the current year; you will apply for and obtain a Private
Club Alcohol permit and serve alcohol to members in accordance with D.

You will have one class of members. The qualifications and rights of such class are as follows:

1. All members shall be of legal drinking age.

2. Members must submit an application and be approved by the membership committee.

3. Dues for membership, if any, shall be determined by the board of directors.

4. Charter member dues are v dollars. Non-charter members do not pay dues.

5. Members may bring guests to the club, but the guests may not pay for the service of alcoholic beverages at
   any time.

6. There is no limit to the number of guests a member may bring.

Your bylaws indicate you will operate according to the pool system in accordance with F state law. F state law
requires you to have an operating account and an alcohol replenishment account under the pool system; your
members will contribute equally to the initial purchase of alcohol that is to be stored on club premises. The
initial replenishment percentage shall be w% for each gross service ticket for alcohol served to the members and
their guests. The percent will be determined by the board of directors and may be changed as needed by the
board.

Your bylaws, in addition, indicate your Membership Committee is appointed by your Board of Directors and
consists of a minimum of three members of the club. The committee shall meet within seven days to act on
membership applications received and shall meet, act, and record minutes of the meetings in accordance with D.
Additionally, employees of the club shall not be eligible to be on the Membership Committee per D.

You are governed by two board members, a President and a Secretary. Your president, B, is the owner of M, a
limited liability company, which is a for profit event planning venue. You have executed a management
contract and a lease agreement with M as well as a loan agreement; B signed and agreed to the terms of these
agreements/contracts on behalf of both you and M.

The management contract indicates M is being paid r% of the gross alcohol service tickets sales as a
management fee. Some of the provisions in the management agreement are:

1. The manager shall accept applications for membership in the club and shall
   provide applications for membership to the club’s membership committee within
   seven days of receiving such application.

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2. The manager shall comply with the F Alcohol Beverage Commission, its rules
   and regulations and cooperate with agents and representatives and all other law
   enforcement officers,

3. The Manager and staff shall serve from the Club’s pool system of alcoholic
   beverage storage, only to members of the Club, their families and guests, by the
   drink or in sealed, unsealed or broken containers of any legal size, for on premise
   consumption only, in accordance with D

The lease agreement shows M is being paid an additional s% of the gross alcohol service tickets to lease the
venue. The lease agreement also stipulates that you must apply for and obtain a private club alcohol permit and
serve alcohol to members.

You received a loan from M. The loan agreement shows the loan is in the amount of t dollars and must be paid
within two years of issuance at an interest rate of x percent. Furthermore, M has offered you a gift of u dollars
but you must obtain an F private club alcohol permit to qualify for this gift. Your Form 1024 shows that M
believes the alcohol permit will greatly benefit its business.

In the first year of operations, disbursements for the benefit of members for alcohol purchases total bb% of
gross receipts; cc% of gross receipts are budgeted for taxes, and as per your agreements with M, dd% of gross
receipts are fees paid to M. There is less than percent remaining after all disbursements.

In the second year, you project gross income to increase by %. Disbursements for the benefit of members for
alcohol purchases total ee%. Disbursements for taxes and state renewal fees total ff%. And as per your
agreements, dd% of gross receipts is fees paid to M. There is zero percent remaining after all disbursements.

Your Rules and Regulations document provides, in part, that persons may become regular members by
providing the required information and the payment of your annual membership which is currently set at zero.
Members may also bring guests to the club but only members may pay for the service of alcoholic beverages in
accordance with D. You currently have y members and expect to have z members in five years. Finally, you
explained you were created as a nonprofit because you were informed that F requires it in order for alcoholic
beverages to be served at the event center, M.

Law

Section 501(c)(7) of the Code provides for the exemption from federal income tax of clubs organized and
operated for pleasure, recreation, and other nonprofitable purposes, substantially all the activities of which are
for such purposes and no part of the net earnings of which inures to the benefit of any private shareholder.

Section 1.501(c)(7)-1(b) of the regulations states that a club which engages in business, such as making its
social and recreational facilities available to the general public or by selling real estate, timber, or other
products, is not organized and operated exclusively for pleasure, recreation, and other nonprofitable purposes,
and is not exempt under section 501(a).

Revenue Ruling 58-588, 1958-2 C.B. 265, holds that a social club that sells an unlimited number of
memberships to so-called "members," who have no voice in the management of the club and whose only rights
are to use the club's facilities upon payment of specified fees, is not a tax-exempt social club within the meaning
of section 501(c)(7) of the Internal Revenue Code. Income from the members was, in reality, income from the

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general public.

Revenue Ruling 66-225, 1966-2 C.B. 227, holds that a nonprofit organization which provides entertainment to
its members does not qualify for exemption under section 501(c)(7) of the Code where it is controlled by a
taxable corporation and operated as an integral part of such corporation's business.

Revenue Ruling 69-635, 1969-2 C.B. 126, holds that an automobile club whose principal activity is rendering
automobile services to its members but has no significant social activities, does not qualify for exemption under
section 501(c)(7) of the Code. The basis for this conclusion is the fact the club had no significant commingling
of its members.

In Chattanooga Automobile Club v. Commissioner, Warren Automobile Club, Inc. v. Commissioner, 182 F.2d
551 (6th Cir. 1950), the United States Court of Appeals 6th Circuit held that to be exempt under the Act of
Congress, a club must have been organized and operated exclusively for pleasure, recreation, and other non-
profitable purposes. The court further specified that the words "other non-profitable purposes" must be
construed as coming within the same classification as pleasure and recreation. In addition, there must be at least
some sort of commingling of members to constitute a club. The court held that the two automobile clubs
petitioning the court were not exempt under section 101(9) of the Internal Revenue Code of 1939 as a social
club because the members of these clubs did not commingle.

In Keystone Automobile Club v. Commissioner, 181 F.2d 402 (3rd Cir. 1950), the United States Court of
Appeals 3rd Circuit defined the word "club" to include some type of mingling of people together as well as a
common object. In this case, the court held that the Keystone Automobile Club was not exempt under section
101(9) of the Code for a number of reasons one of which was because they saw no evidence of the commingling
of members.

Application of law

You do not meet Section 501(c)(7) of the Code because your earnings are inuring to your founder, B through
M. For example, your tax exempt status will enable you to apply for and obtain an alcohol license for private
clubs. You indicated that M owned by your founder is willing to give you start up funds because M will benefit
with the additional business; in addition, your lease agreement with M is contingent upon you getting a private
club alcohol license in accordance with F state law. Inurement is indicated by the lease agreement provision that
M gets r% of gross alcohol sales as well as the comprehensive management agreement showing M gets s% of
gross alcohol sales. Finally, the agreements with M were not negotiated at arm’s length as substantiated by the
fact that B signed on your behalf as well as on M’s behalf.

You do not meet the requirements in Treasury Regulation 1.501(c)(7)-1(b). The facts that you have very
limited requirements for membership and will issue unlimited memberships show you are not operating
exclusively for pleasure, recreation, and other nonprofitable purposes.

You are similar to the organization described in Rev. Rul. 58-588. Like the organization in the revenue ruling,
social activities are not one of your material purposes but are merely incidental to the purpose of engaging in
the sale of alcohol to the general public. For example, anyone can become a member by meeting the minimum
requirements and you issue unlimited memberships. Therefore, income from your members is income from the
general public. This shows that membership is not a true membership but is a guise under which unlimited

Letter 4034 (Rev. 7-2014)
Catalog Number 47628K

numbers of individuals may utilize your club which ultimately benefits M, which is owned by your president, B.

You are also like the organization in Rev. Rul. 66-225. You were organized by B as an integral part of M’s
business so M can use your alcohol license to increase sales. Therefore you are not organized and operated
exclusively for pleasure, recreation, and other nonprofitable purposes.

Like the organization described in Rev. Rul. 69-635, you are primarily providing services with insignificant or
no commingling. By operating in such a way, you do not qualify for exemption under section 501(c)(7) of the
Code.

You are like the organizations described in Chattanooga Automobile Club v. Commissioner, Warren
Automobile Club, Inc. v. Commissioner, and Keystone Automobile Club v. Commissioner. You have not
demonstrated that members have any interaction other than being at the same location to purchase alcohol.
There is no common interest among your members and your social activities are only incidental. Because you
have demonstrated very little, if any, personal contact among members and there is no expectation of personal
contact among members, commingling is not a material part of your activities. Therefore you are not primarily
operating in accordance with 501(c)(7).

Your position

You explained that M, which is owned by B, does not receive unreasonable management fees or excessive rent
of facilities.

Our response to your position

Although you believe M does not receive unreasonable management fees or excessive rent of facilities, the facts
indicate your earnings are inuring to B through M; for example, the percentage M is receiving for management
fees and rent shows M is receiving almost one half of gross alcohol sales and there is no upper limit to the fees
M may receive. Your budgets also show there is little remaining after making disbursements to members for
alcohol, taxes and license renewal and fees paid to M. This shows M is sharing in your profits, which is
inurement. This precludes you from exemption under section 501(c)(7).

Conclusion

Based on the information provided, we conclude that you are not operated for pleasure, recreation or other
nonprofitable purposes described in section 501(c)(7) of the Internal Revenue Code. You do not meet the
membership and commingling requirements for organizations qualifying for exemption from federal income tax
under section 501(c)(7) of the Code and your net earnings are inuring to your founder, B through M.
Accordingly, you do not qualify for recognition of exemption under section 501(c)(7) of the Internal Revenue
Code.

If you don’t agree

You have a right to file a protest if you don’t agree with our proposed adverse determination. To do so, you
must send a statement to us within 30 days of the date of this letter. The statement must include:

Letter 4034 (Rev. 7-2014)
Catalog Number 47628K

• Your name, address, employer identification number (EIN), and a daytime phone
number

• A copy of this letter highlighting the findings you disagree with
• An explanation of why you disagree, including any supporting documents
• The law or authority, if any, you are relying on

• The signature of an officer, director, trustee, or other official who is authorized to sign for the
organization, or your authorized representative

• One of the following declarations:

For an officer, director, trustee, or other official who is authorized to sign for the organization:
Under penalties of perjury, I declare that I examined this protest statement, including

accompanying documents, and to the best of my knowledge and belief, the statement contains all
relevant facts and such facts are true, correct, and complete.

For authorized representatives:

Under penalties of perjury, I declare that I prepared this protest statement, including
accompanying documents, and to the best of my knowledge and belief, the statement contains all
relevant facts and such facts are true, correct, and complete.

Your representative (attorney, certified public accountant, or other individual enrolled to practice before the
IRS) must file a Form 2848, Power of Attorney and Declaration of Representative, with us if he or she hasn’t
already done so. You can find more information about representation in Publication 947, Practice Before the
IRS and Power of Attorney.

We’ll review your protest statement and decide if you provided a basis for us to reconsider our determination. If
so, we'll continue to process your case considering the information you provided. If you haven’t provided a
basis for reconsideration, we’ll forward your case to the Office of Appeals and notify you. You can find more
information about the role of the Appeals Office in Publication 892, How to Appeal an IRS Decision on Tax-
Exempt Status.

Where to send your protest
Please send your protest statement, Form 2848, if needed, and any supporting documents to the applicable
address:

U.S. mail: Street address for delivery service:
Internal Revenue Service Internal Revenue Service

EO Determinations Quality Assurance EO Determinations Quality Assurance
Room 7-008 550 Main Street, Room 7-008

P.O. Box 2508 Cincinnati, OH 45202

Cincinnati, OH 45201

Letter 4034 (Rev. 7-2014)
Catalog Number 47628K

You can also fax your statement and supporting documents to the fax number listed at the top of this letter. If
you fax your statement, please contact the person listed at the top of this letter to confirm that he or she received
it.

If you agree

If you agree with our proposed adverse determination, you don’t need to do anything. If we don’t hear from you
within 30 days, we’ll issue a final adverse determination letter. That letter will provide information on your
income tax filing requirements.

You can find all forms and publications mentioned in this letter on our website at www.irs.gov/formspubs. If
you have questions, you can contact the person listed at the top of this letter.

We sent a copy of this letter to your representative as indicated in your power of attorney.

Sincerely,

Jeffrey I. Cooper
Director, Exempt Organizations
Rulings and Agreements

Enclosure:
Publication 892

Letter 4034 (Rev. 7-2014)
Catalog Number 47628K