Social club lost exemption after recurring nonmember income exceeded the limit

Plain-English summary

A social and recreation club operated golf and other member facilities but also earned income from nonmembers and a cell-tower easement. The IRS found that nonmember income consistently exceeded the 35 percent limit and represented a recurring, substantial share of total revenue. It concluded that these business activities were not incidental, negligible, or nonrecurring. Because the club did not operate substantially for pleasure, recreation, or other nonprofit purposes, the IRS revoked its § 501(c)(7) exemption effective at the start of the redacted year. The club was required to file Form 1120 for that year and later years.

Ruling snapshot

• Question: Could the club retain § 501(c)(7) exemption when recurring nonmember income exceeded 35 percent of total income?
• Outcome: Revocation. The IRS found that recurring nonmember business income was substantial.
• Key authorities: IRC §§ 501(a), 501(c)(7), and 7428; Treas. Reg. § 1.501(c)(7)-1(b); Rev. Ruls. 66-149 and 69-220

Full text (IRS public release)

Scanned document; transcription proofread from IRS OCR. Obvious scan misreads were corrected, and unreadable signature text is marked [illegible]. Wording is otherwise verbatim.

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:
DIVISION OCT 30 2018
UIL: 501.03-00 Person to Contact:

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

EIN:

Number: 201907012
Release Date: 2/15/2019
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 (IRC). Your exemption from Federal income tax
under IRC section 501(c)(7) 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 exceeded the non-member income test for tax year ending
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 IRC section 7428.

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,

[illegible]

Maria Hooke
Director, Exempt Organizations Examinations
Enclosures:
Publication 892


Department of the Treasury Date:

Internal Revenue Service June 12, 2018
IRS Tax Exempt and Government Entities Division Taxpayer Identification Number:
Form:

Tax year(s) ended:

Person to contact / ID number:

Contact numbers:
Phone Number:

Fax Number:
Manager's name / ID number:

Manager's contact number:

Phone 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 may file a protest with the

Letter 3618 (Rev. 6-2012)

Catalog Number 34809F


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

Phone Number:

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

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


Form U.S. Treasury Department-Internal Revenue Service | Schedule No. or
886-A EXPLANATION OF ITEMS Exhibit

Year/Period Ended

Name of Taxpayer
December 31, 20XX

ISSUE:

Whether ( ) continue to qualify for exemption under IRC
Section 501(c)(7) when its nonmember income consistently exceeds the thirty five percent (35%)
limitation of total income?

FACTS:

was formed as a corporation in the state of and was granted exemption under IRC
501(c)(7) in December 19XX. The Form 1024 states that was formed for the following
purposes: To provide a golf course, swimming pool, tennis court, and clubhouse for its members
and their families. :

The Form 990 for the tax year ended December 31, 20XX was selected for examination. The
Form 990 states that is a social and recreation club. provides a meeting place and
facilities for individuals with common interests in golf.

During the examination it was noted that membership is based on submitting application and
paying fee. Membership is not limited. There is only one class of membership and all members
have voting privileges. The bylaws do not clarify who has privileges to use of the club grounds.

receives its revenue from membership dues, green fees, driving range fees, concessions,
merchandise, tournaments, member cart storage fees, lockers, dining room rent, cart rentals, and
rent from easement agreement for cell tower. The agreement was entered
on May 31, 20XX for a period of 0 years. A lump sum payment of $0 was paid at the execution
of the agreement with a monthly payment of $0 per month for first zero years. A 0% increase in
the payment every zero years.

For the tax year ended December 31, 20XX, 0% of the total revenue received was from unrelated
business income. A review of additional Forms 990 which were not audited shows that for the
tax years ended December 31, 20XX and 20XX respectively, approximately 0% of total revenue
received was from unrelated business income. (See attachment for breakdown of determination
of allocated unrelated business income.)

12/31/20XX | 12/31/20XX | 12/31/20XX
Unrelated Business Income 0 0 0
Lump Sum 0 0 0
Total Revenue on F990 0 0 0
Percentage of Nonmember Income over Total 0% 0% 0%
Revenue
Department of the Treasury - Internal Revenue Service Form 886-A

Page 1


Form U.S. Treasury Department-Internal Revenue Service | Schedule No. or
886-A EXPLANATION OF ITEMS Exhibit
Name of Taxpayer Year/Period Ended

December 31, 20XX

LAW:

Section 501(c)(7) of the Internal Revenue Code ("Code") provides for exemption from federal
income tax 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.

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 non-profitable purposes, and is not exempt under section 501(a). An
incidental sale of property will not deprive a club of its exemption.

Revenue Ruling 66-149, 1966-1 C.B. 146, provides that a social club is not exempt from federal
income tax as an organization described in section(c)(7) of the Code if it regularly derives a
substantial part of its income from nonmember sources such as, for example, dividends and
interest on investments. In this instance, the club’s funds were invested primarily for the purpose
of producing income through dividends, interest, or capital appreciation It is evident that 1) such
income is regularly derived from nonmember sources, 2) that the income is received in
fulfillment of and pursuant to a profit motive, and 3) that the income from investments is
substantial in relation to total income.

Revenue Ruling 69-220, 1969-1 C.B. 154, held that a social club that receives a substantial
portion of its income from the rental of property and uses such income to defray operating
expenses and to improve and expand its facilities is not exempt under section 501(c)(7) of the
Code.

Santee Club v. White. 87 F. 2d 5 (1936), held that where a club engages in income producing
transactions which are not a part of the club purposes, exemption will not be denied because of
incidental, trivial, or nonrecurrent activities such as sales of property no longer adapted to club

purpose.

National Mah Jongg League v. U.S.. 75 F. Supp. 769 (1947), stated that a corporation that was
organized for the purpose of promoting the game of Mah Jongg, but income from memberships
was insufficient to meet expenses and the corporation engaged in the commercial enterprise of
selling to the public lists and tiles, and the income therefrom enabled the corporation to meet its
deficit, carry on without an increase of dues or curtailment of operations, and to accumulate a
surplus which was donated to charity was not operated exclusively for social purposes or
charitable purposes. Therefore, the corporation was not exempt from federal income tax under
section 501(c)(7) of the Code or section 501(c)(3) of the Code.

Department of the Treasury - Internal Revenue Service Form 886-A
Page 2


Form U.S. Treasury Department-Internal Revenue Service | Schedule No. or
886-A EXPLANATION OF ITEMS Exhibit
Name of Taxpayer Year/Period Ended

December 31, 20XX

In United States of America v. Fort Worth Club of Fort Worth, Texas. 345 F. 2d 52, 57 (5th Cir.
1965), a social club which derived over half of its receipts, in amounts of hundreds of thousands
of dollars, from profitable outside business was not exempt from federal income taxes on ground
that it was organized and operated exclusively for pleasure, recreation, and other non-profitable
purposes. The court declared that for a social club to qualify for exemption under section
501(c)(7) of the Code, its outside profits must be 1) strictly incidental to club activities, not a
result of an outside business, and 2) either negligible or non-recurring.

GOVERNMENT’S POSITION:

does not meet the qualifications for exemption under section 501(c)(7) of the Code.
Although was initially formed for pleasure, recreation, and other non-profitable purposes,
substantially all of the activities are not for such purposes. is engaged in unrelated business
activities which do not fulfill a pleasure, recreation, or other non-profitable purpose.

is like the organization in Rev. Rul. 66-149 that did not qualify for exemption under
section 501(c)(7) of the Code. regularly derives income from nonmember sources,
specifically an easement for a tower that is received as rental revenue. Based on the financial
data provided for the income is regularly derived from these nonmember sources and the income
from these sources is substantial in relation to EO’s total income. EO is also similar to the
organization in Rev. Rul. 69-220 because it receives a substantial portion of income from sources
other than the members. Under section 501(c)(7) of the Code, transactions with outsiders should
not be a regular source of income.

is not similar to the organization in Santee Club v. White. income from the
unrelated business activities are not incidental or trivial. In addition, they are recurring. For the
past several years, has received a substantial amount of revenue from these sources. Per
Section 1.501(c)(7)-1(b) of the regulations, is engaging in business activities and is not
organized and operated exclusively for pleasure, recreation, and other non-profitable purposes.

is similar to the organization in National Mah Jongg League v. U.S. The majority of its
revenue is from unrelated business activities. The revenue from unrelated activities is recurring
and more than incidental. While may have been organized for pleasure and recreation, the
EO’s revenue clearly shows that it is not operating for these purposes.

Per United States of America v. Fort Worth Club of Fort Worth, Texas, rental income
must be incidental to your club activities and either negligible or non-recurring. Instead the
rental income is both recurring and substantial. For the tax years ended December 31, 20XX —
December 31, 20XX, over 0% of revenue was received from nonmember sources on a
recurring basis.

Department of the Treasury - Internal Revenue Service Form 886-A
Page 3


Form U.S. Treasury Department-Internal Revenue Service | Schedule No. or
886-A EXPLANATION OF ITEMS Exhibit
Name of Taxpayer Year/Period Ended

December 31, 20XX

TAXPAYER POSITION:
The taxpayer position is unknown at this time.

CONCLUSION:

does not meet the requirements for exemption under section 501(c)(7) of the Code.
receives the majority of its income from nonmember sources on a recurring basis. Providing
services to non-members, is engaging in a regular trade or business and derive a significant
profit from the activity. As a result, does not operate substantially for pleasure recreation,
or other non-profitable purposes. We are proposing revocation of the IRC Section 501(c)(7) tax
exemption for effective January 1, 20XX.

Department of the Treasury - Internal Revenue Service Form 886-A
Page 4