Social club exemption revoked for excess nonmember income

Plain-English summary

A social club promoted horses and horsemanship through shows, play days, trail rides, meetings, and use of its hall and arena. Some activities and facilities were available to nonmembers and the general public. The IRS found that, in two consecutive years, the club exceeded both the 35% limit for combined investment and nonmember income and the 15% limit for income from nonmembers' use of club facilities. It revoked the club's Section 501(c)(7) exemption effective on the redacted date.

Ruling snapshot

• Question: Did the club remain exempt under Section 501(c)(7) after repeatedly exceeding the limits on investment and nonmember income?
• Outcome: revocation
• Key authorities: IRC §§ 501(a), 501(c)(7); Treas. Reg. § 1.501(c)(7); Pub. L. 94-568; Rev. Rul. 66-149; Rev. Rul. 60-324; 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 75242

TAX EXEMPT AND
GOVERNMENT ENTITIES Date: JAN 11 2018
DIVISION

Release Number: 201830018 Person to Contact:

Release Date: 7/27/2018 Identification Number:

UIL Code: 501.03-00 Contact Telephone Number:
In Reply Refer to: TE/GE Review Staff
EIN:

LAST DATE FOR FILING A PETITION
WITH THE TAX COURT:
APR 11 2018

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 January 1, 20XX.

Our adverse determination was made for the following reasons:

You have not established that you are operated substantially for pleasure and
recreation of its members or other non-profitable purposes and no part of the
earnings inures to the benefit of private shareholder within the meaning of
IRC section 501(c)(7).

You have made your services, use of recreational and social facilities
available to the general public. You have exceeded the non-member income test
for tax years ending December 31, 20XX and December 31, 20XX.

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 December 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.

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.

The Taxpayer Advocate Service (TAS) is an independent organization within the IRS that
can help protect your taxpayer rights. We can offer you help if your tax problem is causing a
hardship, or you've tried but haven't been able to resolve your problem with the IRS. If you
qualify for our assistance, which is always free, we will do everything possible to help you.
Visit taxpayeradvocate.irs.gov or call 1-877-777-4778.

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

Sincerely yours,

Maria Hooke
Director, Exempt Organizations Examinations

Enclosures:
Publication 892

Date:
July 7, 2017
Taxpayer Identification Number:

Department of the Treasury
Internal Revenue Service
IRS Tax Exempt and Government Entities

Exempt Organizations Examinations
Form:

Tax Year(s) Ended:
December 31, 20
December 31, 20
Person to Contact / ID Number:

Employee ID:
Contact numbers:

Telephone:

Fax:
Manager's Name / ID Number:

Employee ID:
Manager's Contact Number:

Response Due Date:
August 7, 2017
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).

After we issue the final revocation letter, we'll announce that your organization is no longer
eligible for contributions deductible under section 170 of the Code.

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.

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

You also 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.

Sincerely,

[illegible]
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
Explanation of Items

Name of Taxpayer Year/Period Ended
20XX
20XX
ISSUE
Whether ( ) continues to qualify for exemption under Internal

Revenue Code (IRC) § 501(c)(7)?

FACTS

The was granted as tax-exempt organization under section 501(c)(7) on
September 26, 19XX to provide social, recreational and other activities to its members.

It is organized and operated for the promotion of interests in horses and horsemanship
and to encourage a closer and personal relationship among horsemen and horse
lovers. The carried out such activities as horse shows, play days, barbeques and
meetings that bring families together in a social environment.

During the initial interview, the officer of the mentioned that the organization is a
small, non-profit entity to promote horsemanship, the use of rural land, and activities
involving children and their families. In addition the association also works with the
community on open space issues and improvements to trails and parks that everyone
can enjoy.

The organization owns the property consisting of 0-acres, with an arena, a single story
rental house separated by a chain-link fence, and a meeting hall along with a kitchen,
serving counter and a BBQ area in the back of the hall are located on the 0-acres
arena. The single story rental house was rented to a member for $0 a year and the
renter looks after the property and is responsible for hall rentals.

Hall Rentals? Who can rent the hall?
Hall rentals are tracked as member and non member?

The general meetings of the organization are held monthly with dinner served, cooked
by volunteers. The cost of the food reimbursed. Most attendees are members, but the
guests of members were also invited.

Horse shows are open to members only because the organization doesn't have a
health permit to sell food to the public.

What is a play day? How often held?
Play days are open to both members and nonmembers. The officer stated that the play
days usually include approximate 0 riders of which around 0 might be non-members.

Form 886-A(Rev.4-68) Department of the Treasury - Internal Revenue Service
Page: -1-

Form 886A Department of the Treasury - Internal Revenue Service
Explanation of Items

Name of Taxpayer Year/Period Ended
20XX

20XX

The organization holds a monthly trail ride on the 0 acre property. Around 0 riders
attended the monthly trail ride. A majority of them are members.

All events are coordinated and carried out by the volunteer members.

The officer stated that the organization separated member incomes from non-member
on the registration for various activities. They accept payments in the cash and check
forms. Additionally, they use Quicken to track income and pay bills with categories
such as Non-Member Hall Rental Deposit, Member Event Income and Non-Member
Event Income.

The organization reported the following sources and amounts of revenue on Forms 990-
EZ for the periods ending December 31, 20XX and December 31, 20XX:

12/31/20XX 12/31/20XX
Contribution $0 $0
Program Service Revenue $0 $0
Investment Income $0 $0
Gross Sales of Inventory $0 $0
Total Revenue $0 $0

The following worksheet provided the Gross Incomes, Investment Incomes and Non-
Member Incomes for the periods ending December 31, 20XX and December 31, 20XX:

Total Gross Investment & Non-Member Use Investment
Income Non-Member Income of Org’s Income
Income (0%) Facilities (0%)
Amount % Amount % Amount % Amount %
20XX $0 0 $0 0 $0 0 $0 0
20XX $0 0 $0 0 $0 0 $0 0

Based on conducting a two-year analysis of gross receipts, the organization received
0% and 0% from investment & non-members as well as 0% and 0% from non-members
during tax years ending December 31, 20XX and December 31, 20XX, respectively.

LAW

IRC § 501(c)(7) exempts from federal income tax clubs organized for pleasure,
recreation, and other non-profitable purposes, substantially all of the activities of which

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

Form 886A Department of the Treasury - Internal Revenue Service
Explanation of Items

Name of Taxpayer Year/Period Ended
20XX

20XX

are for such purposes and not part of the net earnings of which inures to the benefit of
any private shareholder.

Section 1.501(c)(7) of the Regulations provides that, in general, the exemption extends
to social and recreation clubs supported solely by membership fees, dues and
assessments. However, a club that engages in a business, such as making its social
and recreational facilities open to the general public, is not organized and operated
exclusively for pleasure, recreation and other non-profitable purposes, and is not exempt
under section 501(a).

Prior to its amendment in 1976, IRC § 501(c)(7) required that social clubs be operated
exclusively for pleasure, recreation and other nonprofitable purposes. Public Law 94-
568 amended the “exclusive” provision to read “substantially” in order to allow an IRC §
501(c)(7) organization to receive up to 35 percent of its gross receipts, including
investment income, from sources outside its membership without losing its tax-exempt
status. The Committee Reports for Public Law 94-568 (Senate Report No. 94-1318 2d
Session, 1976-2 C.B. 597) further states;

(a) Within the 35 percent amount, not more than 15 percent of the gross
receipts should be derived from the use of a social club’s facilities or services by the
general public. This means that an exempt social club may receive up to 35 percent of
its gross receipts from a combination of investment income and receipts from non-
members, so long as the latter do not represent more than 15 percent of total receipts.

(b) Thus, a social club may receive investment income up to the full 35 percent
of its gross receipts if no income is derived from non-members’ use of club facilities.

(c) In addition, the Committee Report states that where a club receives unusual
amounts of income, such as from the sale of its clubhouse or similar facilities, that
income is not to be included in the 35 percent formula.

Revenue Ruling 66-149 holds a social club as not exempt as an organization described
in IRC § 501(c)(7) where it derives a substantial part of its income from non-member
sources.

Revenue Ruling 60-324 states by making its social facilities available to the general
public the club cannot be treated as being operated exclusively for pleasure, recreation
or other non-profitable purposes.

Revenue Procedure 71-17 sets forth the guidelines for determining the effect of gross
receipts derived from the general public’s use of a social club’s facilities on exemption
under IRC § 501(c)(7). Where nonmember income from the usage exceeds the standard
as outlined in this Revenue procedure, the conclusion reached is that there is a non-

Form 886-A(Rev.4-68) Department of the Treasury - Internal Revenue Service
Page: -3-

Form 886A Department of the Treasury - Internal Revenue Service
Explanation of Items

Name of Taxpayer Year/Period Ended
20XX

20XX

exempt purpose and operating in this manner jeopardizes the organization's exempt
status.

TAXPAYER’S POSITION

Taxpayer's position has not been provided.

GOVERNMENT’S POSITION

Based on the examination, the organization does not qualify for exemption as a social
club described in IRC §501(c)(7) and Treas. Reg. §1.501(c)(7) which provides that in
general, this exemption extends to social and recreation clubs which are supported
solely by membership fees, dues, and assessments.

Rev. Ruls. 66-149 and 60-324 support this position stating that a social club that opens
to the public and derives a substantial part of its income from non-member sources is
not exempt as an organization described in 501(c)(7).

The organization permits use of its facilities and attendance at its events by the general
public. Records show that it had exceeded the 35% investment & non-member income
as well as 15% non-member income threshold as outlined in Public Law 94-568, on a
recurring basis during tax years ending December 31, 20XX with 0% / 0% and
December 31, 20XX with 0% / 0% respectively.

Accordingly, it is proposed that the organization’s tax-exempt status be revoked effective
January 1, 20XX.

CONCLUSION

The organization no longer qualifies for exemption under § 501(c)(7) of the Code as your
investment and non-member income has exceeded the 35% threshold as well as non-
member income exceeded 15% threshold on a continuing basis. Therefore, it is
proposed that your exempt status under § 501(c)(7) of the Code be revoked effective
January 1, 20XX.

Form 1120 Corporation Income Tax Return should be filed starting with tax periods
ending December 31, 20XX, December 31, 20XX and thereafter as long as you
continues to be subject to income tax.

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

Page: -4-