Public rentals and excess nonmember income revoke club exemption

Plain-English summary

A social club conducted community programs, hosted public speakers and classes, made its clubhouse available to outside groups, and awarded local scholarships. It also rented facilities to members and nonmembers but did not maintain records separating the two income sources. The IRS calculated that unrelated business or nonmember income exceeded 35 percent for each of four accounting periods. It concluded that the club had not shown a common recreational or social objective, advertised its facilities to the public, operated them for profit, and failed the recordkeeping requirements of Rev. Proc. 71-17. The club agreed to the proposed action, and the IRS revoked its IRC § 501(c)(7) exemption.

Ruling snapshot

• Question: Did the organization continue to qualify as a tax-exempt social club under IRC § 501(c)(7)?
• Outcome: Revocation because of public-facing business activity, excess nonmember income, inadequate records, and failure to establish a common exempt purpose.
• Key authorities: IRC §§ 501(c)(7), 512(a)(3); Treas. Reg. § 1.501(c)(7)-1; Rev. Proc. 71-17.

Full text (IRS public release)

DEPARTMENT OF THE TREASURY
Internal Revenue Service
TE/GE EO Examinations
1100 Commerce Street MC 4920 DAL
Dallas, TX 75424

TAX EXEMPT AND

GOVERNMENT ENTITIES Date: JUN 01 2016
DIVISION
Number: 201636045 Person to Contact:

Identification Number:
Contact Telephone Number:
In Reply Refer to:

EIN:

Release Date: 9/2/2016

UIL: 501.07-00
LAST DATE FOR FILING A PETITION
WITH THE TAX COURT:

CERTIFIED MAIL- Return Receipt Requested

Dear

This is a Final Adverse Determination Letter as to your exempt status under section
501(c)(7) of the Internal Revenue Code. Your exemption from Federal income tax under
section 501(c)(7) of the code is hereby revoked effective June 1, 20XX.

Our adverse determination was made for the following reasons:

You have not demonstrated that your members are bound by a common
cause and you are operated exclusively for pleasure and recreation of its
members or other non-profitable purposes within the meaning of I.R.C.
section 501(c)(7). Organizations described in I.R.C. section 501(c)(7) and
exempt under section 501(a) must be organized and operated exclusively
for exempt purposes.

You have provided information that your facilities were made available
for use of non-members and being operated for profit.

You did not comply with the recordkeeping requirements of Revenue
Procedure 71-17 and exceeded the 35% nonmember income for the past

four tax periods.

You are required to file Federal income tax returns on Form 1120. These returns should be
filed with the appropriate Service Center for the year ending May 31, 20XX and for all years
thereafter.

Processing of income tax returns and assessment of any taxes due will not be delayed should
a petition for declaratory judgment be filed under section 7428 of the Internal Revenue

Code.


-1-

If you decide to contest this determination in court, you must initiate a suit for declaratory
judgment in the United States Tax Court, the United States Claim Court or the District
Court of the United States for the District of Columbia before the 91st day after the date this
determination was mailed to you. Contact the clerk of the appropriate court for the rules for
initiating suits for declaratory judgment.

You also have the right to contact the office of the Taxpayer Advocate. However, you
should first contact the person whose name and telephone number are shown above since this
person can access your tax information and can help you get answers.

You can call 1-877-777-4778 and ask for Taxpayer Advocate assistance. Or you can contact
the Taxpayer Advocate from the site where the tax deficiency was determined by calling,
Tel: , or write:

Local Taxpayer Advocate:
Taxpayer Advocate Office

Taxpayer Advocate assistance cannot be used as a substitute for established IRS procedures,
formal appeals processes, etc. The Taxpayer Advocate is not able to reverse legal or
technically correct tax determinations, nor extend the time fixed by law that you have to file a
petition in the United States Tax Court. The Taxpayer Advocate can, however, see that a
tax matter that may not have been resolved through normal channels gets prompt and
proper handling.

If you have any questions, please contact the person whose name and telephone number are
shown in the heading of this letter.

Sincerely yours,

Margaret Von Lienen

Director, EO Examinations

Enclosures:
Publication 892


Department of the Treasury Date: March 22, 2015

Internal Revenue Service Taxpayer Identification Number:
IRS Tax Exempt and Government Entities Taxpayer Identification Number:

Exempt Organizations Examinations
Form:

Tax Year(s) Ended:

Person to Contact/ID Number:

Contact Numbers:
Telephone:
Fax:

Manager’s Name/ID Number:

Manager’s Contact Number:
Response due date:
Certified Mail — Return Receipt Requested

Dear

Why you are receiving this letter

We propose to revoke your status as an organization described in section 501(c)(7) of the
Internal Revenue Code (Code). Enclosed is our report of examination explaining the proposed
action.

What you need to do if you agree

If you agree with our proposal, please sign the enclosed Form 6018, Consent to Proposed
Action — Section 7428, and return it to the contact person at the address listed above (unless
you have already provided us a signed Form 6018). We'll issue a final revocation letter
determining that you aren't an organization described in section 501(c)(7).

If we don't hear from you

If you don’t respond to this proposal within 30 calendar days from the date of this letter, we'll
issue a final revocation letter. Failing to respond to this proposal will adversely impact your legal
standing to seek a declaratory judgment because you failed to exhaust your administrative
remedies.

Effect of revocation status
If you receive a final revocation letter, you'll be required to file federal income tax returns for the
tax year(s) shown above as well as for subsequent tax years.

What you need to do if you disagree with the proposed revocation
If you disagree with our proposed revocation, you may request a meeting or telephone
conference with the supervisor of the IRS contact identified in the heading of this letter. You also

Letter 3618 (Rev. 6-2012)
Catalog Number 34809F


may file a protest with the IRS Appeals office by submitting a written request to the contact
person at the address listed above within 30 calendar days from the date of this letter.
The Appeals office is independent of the Exempt Organizations division and resolves most

disputes informally.

For your protest to be valid, it must contain certain specific information including a statement of
the facts, the applicable law, and arguments in support of your position. For specific information
needed for a valid protest, please refer to page one of the enclosed Publication 892, How to
Appeal an IRS Decision on Tax-Exempt Status, and page six of the enclosed Publication 3498,
The Examination Process. Publication 3498 also includes information on your rights as a
taxpayer and the IRS collection process. Please note that Fast Track Mediation referred to in

Publication 3498 generally doesn't apply after we issue this letter.

You also may request that we refer this matter for technical advice as explained in Publication

892. Please contact the individual identified on the first page of this letter if you are considering
requesting technical advice. If we issue a determination letter to you based on a technical
advice memorandum issued by the Exempt Organizations Rulings and Agreements office, no
further IRS administrative appeal will be available to you.

Contacting the Taxpayer Advocate Office is a taxpayer right

You have the right to contact the office of the Taxpayer Advocate. Their assistance isn't a
substitute for established IRS procedures, such as the formal appeals process. The Taxpayer
Advocate can't reverse a legally correct tax determination or extend the time you have (fixed by
law) to file a petition in a United States court. They can, however, see that a tax matter that
hasn't been resolved through normal channels gets prompt and proper handling. You may call
toll-free 1-877-777-4778 and ask for Taxpayer Advocate assistance. If you prefer, you may

contact your local Taxpayer Advocate at:

Internal Revenue Service
Office of the Taxpayer Advocate

For additional information
If you have any questions, please call the contact person at the telephone number shown in the

heading of this letter. If you write, please provide a telephone number and the most convenient
time to call if we need to contact you.

Thank you for your cooperation.

For Paul A. Marmolejo
Acting Director, EO Examinations

Enclosures:

Report of Examination
Form 6018
Publication 892
Publication 3498

2 Letter 3618 (Rev. 6-2012)
Catalog Number 34809F


Form 886A Department of the Treasury - Internal Revenue Service Schedule No. or Exhibit
Explanation of Items

Name of Taxpayer: Year/Period Ended:
May 31, 20XX

Issues:

Does the continue to qualify for exemption from Federal

income tax under Internal Revenue Code section 501(c)(7)?

Facts:
The Articles of Incorporation show the incorporated on November 8, 19XX
in the State of (attachment 1). The Second Article provides the

purpose is for the

The Bylaws, dated June 20XX, Article I, Section 2 state the purpose of the
shall be self-improvement, mutual help, community work and usefulness to
humanity (attachment 2).

Article II, Membership, Section 1 states membership shall consist of all who have
been duly elected and have paid their dues.

Form 1024, Application for Recognition of Exemption Under Section 501(a), and a
Determination Letter do not exist.

Internal Revenue Service (Service) records show the is exempt from Federal
income tax as an organization described in Code section 501(c)(7).

The has a website, , and the site has

tabs; , ; , , and

The Home tab states the isa . The
tab also provides (attachment 3).

Form 886-A (Rev.4-68) Department of the Treasury - Internal Revenue Service

Page: 1 of 5


Form 886A Department of the Treasury - Internal Revenue Service Schedule No. or Exhibit
Explanation of Items

Name of Taxpayer: Year/Period Ended:

May 31, 20XX
The tab shows annual membership dues, a listing of the current officers,
and a list of projects the has been involved with over the years
(attachment 4).
The tab provides information about the (attachment 5).
The tab provides information of for the 20XX year
(attachment 6).
The tab provides information about the 20XX
(attachment 7).
The President stated during the interview that the
primary exempt purpose was service to the community, self-improvement, and
community luncheons. The allows other charitable organizations, such as
, the use of the clubhouse at no cost. The allows the local high school to have
functions in the clubhouse at no cost. The also provides two or three annual

scholarships to local high school seniors.

The also hosts guest speakers on various subjects and the meetings are
open to the public. For an example a representatives from , an organization
dedicated to , and a police department representative spoke at a
meeting. The hosts weekly classes; the classes are free to
members and the general public is charged $XX. The hosts a ; the
invites high school girls and their mothers to attend and serves them and

The former President stated the also selects a few to feature.

The selects a night, invites the public to visit the , and the
asks for a $XX donation; one of the was featured in the November

20XX edition of magazine.

The Profit & Loss Statement for the period under examination shows the
largest source of income is (attachment 8). The to
members and non-members but did not separate the member from the non-member
income. The provided XX agreements dated from June 6, 20XX to
March 23, 20XX; only three agreements identified the renter as a member.

The did not maintain records as required by Revenue Ruling 71-17 to separate its
member income from its non-member income. The Profit & Loss Statement shows only
as revenue stream indicative of a . The received $XX in

, which represents X% of its income and meaning up to XX% of the income for

the period under examination was from nonmembers.

Form 886-A (Rev.4-68) Department of the Treasury - Internal Revenue Service
Page: 2 of 5


Form 886A

Department of the Treasury - Internal Revenue Service

Explanation of Items

Schedule No. or Exhibit

Name of Taxpayer:

Year/Period Ended:

May 31, 20XX
The total income and unrelated business income percentage calculated using
the last four filed Forms 990EZ, Short Form Return of Organization Exempt

From Income Tax, and Forms 990T, Exempt Organization Business Income Tax Return,
shows the Unrelated Business Income (UBI) exceeds 35% for each accounting period.

Period Ending:| 05/31/XX} 05/31/XX|_05/31/XX| 05/31/XX

Total Income Per Form 990EZ: XXXXX XXXXX XXXXX XXXXX
UBI Per 990T: XXXXX XXXXX XXXXX XXXXX

UBI Percentage: XX% XX% XX% XX%

Law:
Internal Revenue Code (Code):
Code section 501 exempts from tax organizations described in Code section 501(c).

Code section 501(c)(7) provides exemption for clubs organized for pleasure, recreation,
and other non-profitable purposes, substantially all of 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.

Federal Tax Regulations (Regulations):

Regulations section 1.501(c)(7)-1(a) addresses social clubs and states in part the
exemption provided by Code section 501(a) for organizations described in Code section
501(c)(7) applies only to clubs which are organized and operated exclusively for pleasure,
recreation, and other non-profitable purposes, but does not apply to any club if any part of
its net earnings inures to the benefit of any private shareholder. In general, this exemption
extends to social and recreation clubs which are supported solely by membership fees,
dues, and assessments. However, a club otherwise entitled to exemption will not be
disqualified because it raises revenue from members through the use of club facilities or in
connection with club activities.

Regulations section 1.501(c)(7)-1(b) states in part 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 non-profitable purposes, and is not exempt under section
Code section 501(a). Solicitation by advertisement or otherwise for public patronage of its
facilities is prima facie evidence that the club is engaging in business and is not being
operated exclusively for pleasure, recreation, or social purposes. However, an incidental
sale of property will not deprive a club of its exemption.

Department of the Treasury - Internal Revenue Service

Form 886-A (Rev.4-68)
Page: 3 of 5


Form 886A Department of the Treasury - Internal Revenue Service Schedule No. or Exhibit
Explanation of Items

Name of Taxpayer: Year/Period Ended:
May 31, 20XX

Revenue Procedures:

Revenue Procedure 71-17, 1971-1 C.B. 683, describes the record-keeping requirements
for social clubs exempt under Code section 501(c)(7) with respect to nonmember use of
their facilities; it sets forth guidelines for determining the effect gross receipts derived by
the general public have on a club's exemption from Federal Income Tax under Code
section 501(c)(7). Revenue Procedure 71-17 also describes the records a club must
maintain when nonmembers use a club's facilities and the circumstances under which a
host guest relationship will be assumed, which are relevant both for purposes of
determining adherence to the exemption requirements and for computing exempt function
income under Code section 512(a)(3).

Section 3 provides a set of assumptions as to the status of nonmembers using club
facilities. If nonmember use can be classified into one of the assumptions listed in
Revenue Procedure 71-17, then the income derived from these individuals will be income
from guests and treated as if from members and therefore be classified as exempt
function income. Clubs are required to provide detailed records of nonmember use to
substantiate the assumptions.

Section 4 describes the records that a social club must maintain with respect to the
assumption listed in section 3. Section 4 also describes the books and records that must
be maintained when the assumptions contained in Section 3 do not apply.

Section 4 states that failure to maintain such records or make them available to the
Service for inspection will preclude use of the minimum gross receipts standard and audit
assumptions set forth in this Revenue Procedure.

Gross Receipts Test/Public Law 94-568:

Section 501(c)(7) was amended in 1976 by Public Law 94-568 to provide that section
501(c)(7) organizations could receive some outside income without losing their exempt
status. Senate Report No. 94-1318 (1976), 2d Session, 1976-2 C.B. 597, explains that a
social club is permitted to receive up to 35% of its gross receipts, including investment
income, from sources outside of its membership without losing its tax-exempt status. It is
also intended that within this 35% amount not more than 15% of the gross receipts should
be derived from the use of a social club's facilities or services by the general public
(nonmembers). In effect, the latter modification increases from 5% (Rev. Proc. 71-17,
1971-1 C.B. 683) to 15% the proportion of gross receipts a club may receive from making
its club facilities available to the general public without losing its tax exempt status.

The Senate Report also states that it is not intended that these organizations should be
permitted to receive, within the 15% or 35% allowances, income from the active conduct of
businesses not traditionally carried on by these organizations. In cases where an

Form 886-A (Rev.4-68) Department of the Treasury - Internal Revenue Service
Page: 4 of 5

Form 886A Department of the Treasury - Internal Revenue Service Schedule No. or Exhibit
Explanation of Items

Name of Taxpayer: Year/Period Ended:
May 31, 20XX

organization's nontraditional income would cause the organization to exceed the 15% or
35% allowances, consideration should be given as to whether the organization continues
to be substantially operated for Code section 501(c)(7) purposes.

According to the Committee Reports, where a club receives income from other sources
(non-traditional or unusual), including income from the sale of its clubhouse or similar
facility, that income is not to be included in the formula; that is, such income is not to be
included in either the numerator or the denominator for purposes of computing the 35% or
15% allowances.

The Committee Reports provide that gross receipts include, charges, admissions,
membership fees, dues, assessments, investment income (such as dividends, rents, and
similar receipts), and normal recurring capital gains on investments, but excluding initiation
fees and capital contributions.

The Taxpayer agrees with the proposed revocation and executed Form 6018, Consent to
Proposed Action — Section 7428.

Government’s Position:
The does not qualify as a tax exempt organization described in Code section
501(c)(7) because the did not prove its members are bound together by a
common objective directed toward pleasure, recreation, or other non-profitable purpose.

The advertises availability of its facilities to the general public which is
prima facie evidence the is engaged in business and is not being
operated exclusively for pleasure, recreation, or other social purpose.

The also did not comply with record keeping requirements in Revenue
Procedure 71-17 and exceeded the 35% nonmember income for the past four accounting
periods.

Conclusion:
The does not continue to qualify for exemption under Code section 501(c)(7).
Form 886-A (rev.4-68) Department of the Treasury - Internal Revenue Service

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