Public rentals revoke social club exemption

Plain-English summary

A social club maintained a building used as rental investment property and as a meeting place for a Section 501(c)(8) organization. It advertised the facilities to the public, and nonmember facility receipts exceeded the 15% limit for at least three consecutive years. Those receipts were earned throughout the year and accounted for all gross receipts, rather than arising from a single unusual event. The club also failed Revenue Procedure 71-17's recordkeeping requirements. The IRS concluded that the club was engaged in a rental business rather than operated substantially for members’ pleasure and recreation, and revoked its exemption.

Ruling snapshot

• Question: Did a social club remain exempt when public facility rentals produced all gross receipts and exceeded the 15% nonmember limit for several years?
• Outcome: Revocation effective January 1 of the redacted year.
• Key authorities: IRC § 501(c)(7); Treas. Reg. § 1.501(c)(7)-1; Rev. Proc. 71-17; Rev. Rul. 58-589; Rev. Rul. 60-324; Rev. Rul. 66-149

Full text (IRS public release)

DEPARTMENT OF THE TREASURY

INTERNAL REVENUE SERVICE
1100 Commerce Street, MC 4920DAL
Dallas, TX 75242

TAX EXEMPT AND
GOVERNMENT ENTITIES
DIVISION

Date: September 16, 2020
Taxpayer ID Number: [redacted]
UIL: 501.07-00
Form: [redacted]
Number: 202110025
For Tax Period(s) Ending: [redacted]
Release Date: 3/12/2021
Person to Contact: [redacted]
Identification Number: [redacted]
Telephone Number: [redacted]
Fax Number: [redacted]

CERTIFIED MAIL — Return Receipt Requested
LAST DAY FOR FILING A PETITION WITH THE TAX COURT: [redacted]

Dear [redacted]:

This is a final determination that you do not qualify for exemption from federal income tax under
Internal Revenue Code (IRC) Section 501(a) as an organization described in IRC Section
501(c)(7) for the tax period(s) above. Your determination letter dated March 19XX is revoked.

Our adverse determination as to your exempt status was made for the following reasons:

You have not established that you are operated substantially for pleasure and
recreation of your 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 recreational and social facilities available to
the general public. You have exceeded the non-member income test for tax year
ending January 31, 20XX.

Organizations that are not exempt under IRC Section 501 generally are required to file federal
income tax returns and pay tax, where applicable. For further instructions, forms, and
information please visit www.irs.gov.

If you decide to contest this determination, you may file an action for declaratory judgment under
the provisions of IRC Section 7428 in one of the following three venues: 1) United States Tax
Court, 2) the United States Court of Federal Claims, or 3) the United States District Court for the

1

District of Columbia. A petition or complaint in one of these three courts must be filed within
90 days from the date this determination was mailed to you. Please contact the clerk of the
appropriate court for rules and the appropriate forms for filing petitions for declaratory
judgment by referring to the enclosed Publication 892. You may write to the courts at the
following addresses:

United States Tax Court
400 Second Street, NW
Washington, DC 20217

U.S. Court of Federal Claims
717 Madison Place, NW
Washington, DC 20439

U. S. District Court for the District of Columbia
333 Constitution Ave., N.W.
Washington, DC 20001

Processing of income tax returns and assessments of any taxes due will not be delayed if
you file a petition for declaratory judgment under IRC Section 7428.

You may be eligible for help from the Taxpayer Advocate Service (TAS). TAS is an
independent organization within the IRS that can help protect your taxpayer rights. TAS 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 TAS assistance, which is always free,
TAS will do everything possible to help you. Visit www.taxpayeradvocate.irs.gov or call
1-877-777-4778.

Taxpayer Advocate assistance can’t be used as substitute for established IRS procedures,
formal appeals processes, etc. The Taxpayer Advocate is not able to reverse legal or
technically correct tax determination, nor extend the time fixed by law that you have to file a
petition in 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.

You can get any of the forms or publications mentioned in this letter by calling 800-TAX-
FORM (800-829-3676) or visiting our website at www.irs.gov/forms-pubs.

If you have any questions, you can contact the person listed at the top of this letter.

Sincerely,

Sean E. O'Reilly
Director, Exempt Organizations Examinations

Enclosures:
Publication 892

2

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

Date:
March 5, 2020
Taxpayer ID number: [redacted]
Form: [redacted]
Tax periods ended: [redacted]

Person to contact:
Name: [redacted]
ID number: [redacted]
Telephone: [redacted]
Fax: [redacted]

Manager's contact information:
Name: [redacted]
ID number: [redacted]
Telephone: [redacted]
Response due date: [redacted]

CERTIFIED MAIL — Return Receipt Requested

Dear [redacted]:

Why you’re receiving this letter

We enclosed a copy of our audit report, Form 886-A, Explanation of Items, explaining that we
propose to revoke your tax-exempt status as an organization described in Internal Revenue Code
(IRC) Section 501(c)(7).

If you agree

If you haven't already, please sign the enclosed Form 6018, Consent to Proposed Action, and
return it to the contact person shown at the top of this letter. We'll issue a final adverse letter
determining that you aren't an organization described in IRC Section 501(c)(7) for the periods
above.

If you disagree

1. Request a meeting or telephone conference with the manager shown at the top of this
   letter.

2. Send any information you want us to consider.

3. File a protest with the IRS Appeals Office. If you request a meeting with the manager or
   send additional information as stated in 1 and 2, above, you'll still be able to file a protest
   with IRS Appeals Office after the meeting or after we consider the information.

The IRS Appeals Office is independent of the Exempt Organizations division and
resolves most disputes informally. If you file a protest, the auditing agent may ask you to
sign a consent to extend the period of limitations for assessing tax. This is to allow the
IRS Appeals Office enough time to consider your case. For your protest to be valid, it
must contain certain specific information, including a statement of the facts, applicable
law, and arguments in support of your position. For specific information needed for a

Letter 3618 (Rev. 8-2019)
Catalog Number 34809F

valid protest, refer to Publication 892, How to Appeal an IRS Determination on Tax-
Exempt Status.

Fast Track Mediation (FTM) referred to in Publication 3498, The Examination Process,
generally doesn’t apply now that we’ve issued this letter.

4. Request technical advice from the Office of Associate Chief Counsel (Tax Exempt
   Government Entities) if you feel the issue hasn’t been addressed in published precedent
   or has been treated inconsistently by the IRS.

If you’re considering requesting technical advice, contact the person shown at the top of
this letter. If you disagree with the technical advice decision, you will be able to appeal to
the IRS Appeals Office, as explained above. A decision made in a technical advice
memorandum, however, generally is final and binding on Appeals.

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 adverse determination letter.

Contacting the Taxpayer Advocate Office is a taxpayer right

The Taxpayer Advocate Service (TAS) is an independent organization within the IRS that can
help protect your taxpayer rights. TAS 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 TAS assistance, which is always free, TAS will do everything possible to help you.
Visit www.taxpayeradvocate.irs.gov or call 877-777-4778.

For additional information

You can get any of the forms and publications mentioned in this letter by visiting our website at
www.irs.gov/forms-pubs or by calling 800-TAX-FORM (800-829-3676).

If you have questions, you can contact the person shown at the top of this letter.

Sincerely,

[illegible] for Maria Hooke
Director, Exempt Organizations
Examinations

Enclosures:
Form 886-A
Form 6018
Form 4621-A
Publication(s) 892 & 3498-A

2 Letter 3618 (Rev. 8-2019)
Catalog Number 34809F

Form 886A Department of the Treasury - Internal Revenue Service Schedule No. or
Explanation of Items Exhibit
Name of Taxpayer: [redacted] Year/Period Ended
December 31, 20XX

Date of Notice: March 3, 20XX

Issues:

Whether [redacted] (the organization), which qualified for
exemption from Federal income tax under Section 501(c)(7) of the Internal Revenue
Code, will continue to qualify as an exempt social club?

Facts:

The organization applied for tax-exempt status by filing the Form 1025, Exemption
Application, on March 10, 19XX, and was subsequently granted tax-exempt status

An organization exempt under 501(c)(7) needs to be operated exclusively for pleasure and
recreation of its members.

The organization was selected for audit to ensure that the activities and operations align
with their approved exempt status.

The organization's principal activity is to maintain a building for a Section 501(c)(8)
organization. This building is used as a rental investment property, as well as for
hosting the meetings of the Section 501(c)(8) organization.

During the examination, it was determined that the entity did not comply with the record
keeping requirements of Revenue Procedure 71-17, 1971-1 C.B. 683.

However, the Club receives income from outside its membership. Based on
examination of the organization's Form 990-EZ/990T for the period ending December
31, 20XX and review of their books and records, the percent of gross receipts from
nonmember use of facilities exceeded 15% for the year of the exam as well as for the prior
and subsequent years, while investment income was 0% for all years.

Law:

Internal Revenue Code (IRC) §501(c)(7) provides that a club organized and operated
exclusively for pleasure, recreation, and other nonprofitable purposes is exempt from
Federal income tax, provided no part of its net earnings inures to the benefit of any private
shareholder.

IRC §1.501(c)(7)-1 of the Income Tax Regulations provides that, in general, the exemption
extends to social and recreation clubs which are supported by membership fees, dues,

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

Form 886A Department of the Treasury - Internal Revenue Service Schedule No. or
Explanation of Items Exhibit
Name of Taxpayer: [redacted] Year/Period Ended
December 31, 20XX

and assessments. However, a club otherwise entitled to exemption will not be disqualified
merely because it raises revenue from members through the use of club facilities or in
connection with club activities.

IRC §1.501(c)(7)-1(b) of the Income Tax Regulations provides that, a club which engages
in business, such as making its social and recreational facilities available to the general
public is not organized and operated exclusively for pleasure, recreation, and other
nonprofitable purposes, and is not exempt under section 501(a).

Prior to its amendment in 1976, IRC Section 501(c)(7) required that social clubs be
operated exclusively for pleasure, recreation, and other non-profitable purposes. Public
Law 94-568 amended the “exclusive” provision to read “substantially” in order to allow a
section 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 further states:

Within this 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. These percentages supersede those provided in Revenue Ruling 71-17,
1971-1 C.B. 683.

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

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.

The Senate report also indicates that even though gross receipts from the general
public exceed this standard, it does not necessarily establish that there is a
nonexempt purpose. A conclusion that there is a nonexempt purpose will be based
on all the facts and circumstances including, but not limited to, the gross receipts
factor.

Revenue Ruling 58-589 sets forth the criteria for exemption under section 501(c)(7) of
the Code, and provides that a club must have an established membership of
individuals, personal contacts, and fellowship. It also provides that, while the
regulations indicate that a club may lose its exemption if it makes its facilities available

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

Form 886A Department of the Treasury - Internal Revenue Service Schedule No. or
Explanation of Items Exhibit
Name of Taxpayer: [redacted] Year/Period Ended
December 31, 20XX

to the general public, this does not mean that any dealings with nonmembers will
automatically cause a club to lose its exemption. A club may receive some income
from the general public, that is, persons other than members and their bona fide guests,
or permit the general public to participate in its affairs, provided that such participation is
incidental to and in furtherance of the club's exempt purposes, such dealings with the
general public and the receipt of income therefrom does not indicate the existence of a
club purpose to make a profit, and the income does not inure to club members.

Revenue Ruling 60-324 provides that a social club that made its social facilities
available to the general public through its member-sponsorship arrangement cannot be
treated as being operated exclusively for pleasure, recreation, or other nonprofitable
purposes and the club no longer qualified for exemption under 501(c)(7) of the Code.

Revenue Ruling 66-149 provides that a social club is not exempt from federal income
tax as an organization described in section 501(c)(7) of the code if it regularly derives a
substantial part of its income from non-member sources such as, for example,
dividends and interest on investments.

Revenue Ruling 68-119 provides that a club will not necessarily lose its exemption if it
derives income from transactions with other than bona fide members and their guests,
or if the general public on occasion is permitted to participate in its affairs, provided
such participation is incidental to and in furtherance of its general club purposes and
the income therefrom does not inure to members.

Revenue Procedure 71-17 sets forth guidelines for determining the effect of gross
receipts derived from nonmember use of a social club's facilities on exemption under
Internal Revenue Code Section 501(c)(7) and recordkeeping requirements. Failure to
maintain such records or make them available to the Service for examination will
preclude use of the minimum gross receipts standard and audit assumptions set forth
in this Revenue Procedure.

If a club exceeds the 15/35% test, then it will maintain its exempt status only if it can
show through facts and circumstances that “substantially all” of its activities are for
“pleasure, recreation and other nonprofitable purposes.”

The following are important facts and circumstances to take into account to determine
whether a club may maintain its exemption under IRC 501(c)(7):

• The actual percentage of nonmember receipts and/or investment income.

• Frequency of use of the club facilities or services by nonmembers. An
unusual or single event (that is, nonrecurring on a year to year basis) that
generates all the nonmember income is viewed more favorably than

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

Form 886A Department of the Treasury - Internal Revenue Service Schedule No. or
Explanation of Items Exhibit
Name of Taxpayer: [redacted] Year/Period Ended
December 31, 20XX

nonmember income arising from frequent use by nonmembers.

• Record of nonmember use over a period of years. A high percentage in one
year by nonmembers, with the other years being within permitted levels, is
viewed more favorably than a consistent pattern of exceeding the limits,
even by relatively small amounts. (See S. Rept. 94-1318, 2d Sess., 1976-2
C.B. 597,599).

• Purposes for which the club's facilities were made available to nonmembers.

• Whether the nonmember income generates net profits for the organization.
Profits derived from nonmembers, unless set aside, subsidize the club's
activities for members and result in inurement within the meaning of IRC
501(c)(7).

Organization’s Position

The organization's representative verbally advised that they agree with the Government's
Position and will seek exemption under the appropriate code section.

Government's Position

Based on the large percentages of gross nonmember income to total gross receipts of the
club which exceeds the limitation of 15% as set forth by IRC 501(c)(7) for each of these
years and the fact that it advertises the use of its facilities to the public, it is the
Government's position is that Club Inc is no longer operated exclusively for the pleasure
and recreation of its members and is not exempt under section 501(c)(7).

An organization exempt from federal income taxes as described in IRC section 501(c)(7)
must meet the gross receipts test in order to maintain its exemption. In order to meet the
gross receipts test, an organization can receive up to thirty-five percent (35%) of its gross
receipts, including investment income, from sources outside its membership without
losing its tax-exempt status. Within this 35% amount, not more than fifteen percent
(15%) of the gross receipts should be derived from the use of a social club's facilities or
services by non-members.

[redacted] has exceeded the 15% gross receipts standard for
nonmember income on a continuous basis for at least three years, with 100% of the
gross receipts coming from use of the facilities. The nonmember receipts are earned
throughout the year. There was no one single or unusual event that caused the club
to exceed the 15% threshold.

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

Form 886A Department of the Treasury - Internal Revenue Service Schedule No. or
Explanation of Items Exhibit
Name of Taxpayer: [redacted] Year/Period Ended
December 31, 20XX

Conclusion:

Based on the foregoing reasons, the organization does not qualify for exemption under
section 501(c)(7) and its tax-exempt status should be revoked.

It is the IRS's position that the organization failed to meet the gross receipts
requirements to be recognized as exempt from federal income tax under
IRC §501(c)(7). Furthermore, the general purpose of the facilities being available for
rent is evidence that the organization is engaged in a business and is not being
“operated exclusively for pleasure, recreation, or social purposes.”

[redacted] no longer meets the requirements of an exempt
organization under IRC §501(a) as described in §501(c)(7). Accordingly, the
organization's exempt status is revoked effective January 1, 20XX.

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