Nonmember income costs social club its exemption

Plain-English summary

The IRS revoked a social club's Section 501(c)(7) exemption after investment and rental income exceeded the 35% limit on investment and nonmember income in four of five examined years. The organization also used recurring losses from a residential rental activity to offset investment income. Because the rental activity had produced losses for many years and lacked a profit motive, the IRS concluded that those losses could not offset the investment income. If revocation were not upheld, the alternative position would require the club to report the underreported investment income and pay unrelated business income tax without the rental-loss offset.

Ruling snapshot

• Question: Did a social club remain exempt after repeatedly exceeding the investment/nonmember-income limit, and could it offset investment income with losses from a rental activity lacking a profit motive?
• Outcome: Revocation effective January 1 of the redacted year; alternatively, investment income was taxable without the rental-loss offset.
• Key authorities: IRC §§ 501(c)(7), 511, and 512(a)(3); Treas. Reg. § 1.501(c)(7)-1; Rev. Rul. 66-149; Rev. Rul. 81-69; Portland Golf Club v. Commissioner

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

Number: 202110028
Release Date: 3/12/2021
UIL: 501.07-00

Date: September 23, 2020
Taxpayer ID Number: [redacted]
Form: [redacted]
For Tax Period(s) Ending: [redacted]
Person to Contact: [redacted]
Identification Number: [redacted]
Telephone 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.

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 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 recreational and social facilities available to the
general public. You have exceeded the non-member income test for tax year ending
December 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 20005

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 about this letter, please contact the person whose name and
telephone number are shown in the heading 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:
04/21/2020
Taxpayer ID number: [redacted]
Form: [redacted]
Tax periods ended: [redacted]
Person to contact: [redacted]

Manager's contact information: [redacted]

CERTIFIED MAIL — Return Receipt Requested

Response due date: [redacted]

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 IRC 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
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.

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

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.

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]

Director, Exempt Organizations Examinations

Enclosures:
Form 886-A, Form 4621 A,
Form 6018, Pub 892, Pub 3498

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

Form 886-A Department of the Treasury — Internal Revenue Service Schedule number
(May 2017) Explanations of Items or exhibit
Name of taxpayer: [redacted] Tax Identification Number (last 4 digits): [redacted] Year/Period ended
20XX

Issues:

1) Should [redacted] ([redacted]) an organization described in
IRC § 501(c)(7) be revoked for exceeding investment/nonmember income limitation for all years
beginning on or after January 01, 20XX?

2) Can the organization utilize the net operating loss (NOL) from rental activity to offset investment
income?

Facts:

The [redacted] ([redacted]) was incorporated in the state of
[redacted] in 19XX. The corporate address is [redacted], [redacted], [redacted].

The organization was issued a determination letter dated May 27, 19XX granting exemption under
the Internal Revenue Code of 19XX as an organization described in section 501(c)(7). The
organization is a membership organization founded to collect, preserve and disseminate
genealogical and historic information relating to the origin and spread of the [redacted] family in
America.

Membership in the [redacted] is open to any person whose ancestor or whose spouse's ancestor was
surnamed [redacted], or alternate spellings of the name. The [redacted] conducts the following activities,
holds reunions in even-numbered years in [redacted], issues a quarterly newsletter and other
publications, and sponsors tours of interest to its members. The organization has an active web
site, [redacted]. The organization through its website, sells its products, solicits new
membership, allows current members to pay dues, informs members of upcoming events and
provides access to its newsletter and publications. In the year of 20XX, the organization
sponsored a member tour, The [redacted] at a cost of $0. The organization
program service revenue was $0 and the membership dues was $0.

The organizations primary sources of revenue are program service revenues, membership fees,
investment income and rental income.

The organization received investment income from its investments. The organization received
rental income from its property located at [redacted]; [redacted]. The property
is the historical home of [redacted]. The property is rented to [redacted]. POA stated
that the tenant is not a member of the organization.

All rental income and related deductions of the property were reported on form 990T. The
organization has reported a net operating loss (NOL) on Form 990T on the rental activity. The
organization offset its losses from the rental activity against the earnings from its investments and
reported no unrelated business taxable income and no income tax.

Per the organization 20XX Form 990-EZ, the organization reports total revenues of $0. The
organization reported $0 as program service revenues, $0 as membership dues and

Catalog Number 20810W Page 1 www.irs.gov Form 886-A (Rev. 5-2017)

Form 886-A Department of the Treasury — Internal Revenue Service Schedule number
(May 2017) Explanations of Items or exhibit
Name of taxpayer: [redacted] Tax Identification Number (last 4 digits): [redacted] Year/Period ended
20XX

assessments, $0 as sale of merchandise, $0 as fund raising income, $0 as other revenue, $0 as
rental income and $0 as investment income.

For the year of 20XX, the organization reported investment income on form 990 in the amount of
$0, the organization reported $9 as investment income on form 990T.

As per initial interview with the organizations POA [redacted], POA stated that the correct
amount of investment income was $0 and the amount reported on Form 990T of $0 was in error.
The investment income was underreported on form 990T for 20XX in the amount of $0 and
underreported on form 990T for 20XX in the amount of $0.

The investment income and rental income represents 0% of the organization’s total revenue for
20XX.

As per Form 990 and Form 990T, the organization has reported the following amounts of
investment/nonmember income in 20XX, 20XX, 20XX, 20XX and 20XX.

Investment/Nonmember Income 20XX — 20XX

TABLE DELETED

The [redacted] has exceeded the 35% investment income/Nonmember limitation for 4 out 5 of the
identified years. [redacted] has also exceeded the nonmember limitation.

Law

Section 501(c)(7) of the Internal Revenue Code (the Code) provides for the exemption from
federal income tax for clubs organized for pleasure, recreation, and other nonprofitable 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.

Treasury Regulation Section 1.501(c)(7)-1(a) states that exemption provided by Section 501(a)
of the Code for organizations described in Section 501(c)(7) of the Code applies only to clubs
which are organized and operated exclusively for pleasure, recreation, and other nonprofitable
purposes, but does not apply to any club if any part of its net earnings inure 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 by club facilities or
in connection with club activities.

Catalog Number 20810W Page 2 www.irs.gov Form 886-A (Rev. 5-2017)

Form 886-A Department of the Treasury — Internal Revenue Service Schedule number
(May 2017) Explanations of Items or exhibit
Name of taxpayer: [redacted] Tax Identification Number (last 4 digits): [redacted] Year/Period ended
20XX

Treasury Regulation Section 1.501(c)(7)-1(b) 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) of the Code.

Revenue Ruling 58-589, 1958-2 C.B. 266, held that a social club must establish (1) that it is a
club both organized and operated exclusively for pleasure, recreation and other nonprofitable
purposes.

Revenue Ruling 66-149, 1966-1 C.B. 146, held that a social club is not exempt from Federal
income tax as an organization described in Section 501(c)(7) of the Internal Revenue Code of
1954 where it regularly derives a substantial part of its income from nonmember sources such as,
for example, dividends and interest on investments which it owns.

Public Law 94-568, 1976-2 C.B. 896, provides that a social club may receive up to 35 percent of
its gross receipts, including investment income, from sources outside its membership without
losing exemption. 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 a club exempt from taxation described in Section 501(c)(7) is to be permitted to
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.

Revenue. Procedure. 71-17, 1971 WL 26186, 1971-1 C.B. 683 sets forth guidelines for
determining the effect gross receipts derived from use of a social club's facilities by the general
public have on the club's exemption from federal income tax under section 501(c)(7) of the Code.
The club must maintain books and records of each such use and the amount derived therefrom.
This requirement applies even though the member pays initially for such use.

Pittsburgh Press Club v. U.S., 536 F.2d 572 (1976); 579 F.2d 751 (1978); and 615 F.2d 600
(1980), the court found that a substantial portion of the club’s total gross receipts was from
nonmember use of club facilities (determined to be between 11–17% of gross income). This
indicated to the court that the club was engaged in business with the general public. Other factors
noted by the court to consider in addition to the level of nonmember income include the purposes
for which the club’s facilities were made available to nonmember groups, the frequency of use of
the club facilities by nonmembers, and the amount of net profits derived from the nonmember
income.

U.S. v. Fort Worth Club of Fort Worth, Tex., 345 F.2d 52, [a social clubs’] exemption stands on
a different footing from that of charitable and educational institutions. There is no basis in the
statute or its history for treating unrelated rental income of social clubs differently from any other
unrelated club income.

Catalog Number 20810W Page 3 www.irs.gov Form 886-A (Rev. 5-2017)

Form 886-A Department of the Treasury — Internal Revenue Service Schedule number
(May 2017) Explanations of Items or exhibit
Name of taxpayer: [redacted] Tax Identification Number (last 4 digits): [redacted] Year/Period ended
20XX

Coastal Club, Inc., 43 T.C. 783 (1965), the Tax Court held a corporation organized as a duck-
hunting club which repeatedly leased its property for the exploration for and the production of oil
and gas was not exempt from income tax under section 501(c)(7). The Court noted that the oil and
gas lease income exceeded the amounts received from its members in the form of dues and
service and guest charges and also supplied more than half of the amounts required and
expended for operations, repairs, maintenance, and improvements, the Court felt that if the
petitioner were held exempt under the statute, such holding would attribute an intent to Congress
that in enacting section 501(c)(7), Congress had not intended.

Taxpayer Position

The taxpayer has not yet been presented with this formal report.

Government Position

Issue #1

The cited Code and Regulations above provide criteria for recognition of a tax-exempt
organization under IRC 501(c)(7). Generally, an organization is to be organized and operated
exclusively for pleasure, recreation, and other nonprofit purposes. In general, this exemption
extends to social and recreation clubs which are supported solely by membership fees, dues, and
assessments.

In the case of the organization under examination, it was granted exemption in 19XX, as a social
club under IRC 501(c)(7). IRC 501 c 7 organizations are limited to the amount of
investment/nonmember income that it can receive and still maintain its exempt status.

IRC 501 c 7 organization investment/nonmember income limitation is 35% of the gross revenue
received.

In U.S. v. Fort Worth Club of Fort Worth, Tex., 345 F.2d 52, [a social clubs’] There is no basis in
the statute or its history for treating unrelated rental income of social clubs differently from any
other unrelated club income.

In the year of examination, [redacted] investment/nonmember income was 0% of the total income
received. The facts provided about the organization under examination shows that for the years
20XX — 20XX, the entity received an average of 0% of its revenue from rental and investment
income.

The [redacted] has exceeded the 35% investment income/nonmember limitation for 4 out 5 of the
identified years.

The subject organization does not qualify for exemption under IRC 501 C 7.

Conclusion

Based on the above facts and circumstances, and considering the statutory law and rulings cited.
The organization has exceeded the 35% investment/nonmember income limitation for 4 out 5

Catalog Number 20810W Page 4 www.irs.gov Form 886-A (Rev. 5-2017)

Form 886-A Department of the Treasury — Internal Revenue Service Schedule number
(May 2017) Explanations of Items or exhibit
Name of taxpayer: [redacted] Tax Identification Number (last 4 digits): [redacted] Year/Period ended
20XX

years. The organization does not qualify for tax-exemption under IRC §501(c)(7) and should be
revoked. The proposed date of the revocation is January 1, 20XX.

Form 1120, U.S. Corporation Income Tax Return should be filed for 20XX and thereafter if the
organization continues to be subject to income tax.

Issue #2

Can the organization utilize the net operating loss (NOL) from rental activity to offset investment
income?

Facts

The organization receives rental income from its residential property located at
[redacted]. The organization has shown a net operating loss (NOL) from its
rental activities for the last 0 years. The rental income and the NOL have been reported on form
990T. The organization offset its losses from the rental income against the earnings from its
investment income and reported no unrelated business taxable income or tax.

For the tax years of 20XX and 20XX, the organization underreported the amount of investment
income on form 990T. For 20XX the correct total amount of investment income that should have
been reported on form 990T was $0, the organization reported $0. For 20XX the correct total
amount of investment income that should have been reported on form 990T was $0, the
organization reported $0.

As per form 990T

Form 990T 20XX, [redacted] has a loss of $0 from rental activity and net investment income of $0, NOL
applied $0, tax liability zero.

Form 990T 20XX, [redacted] has a loss of $0 from rental activity and net investment income of $0, NOL
applied $0, tax liability zero.

Form 990T 20XX, [redacted] has a loss of $0 from rental activity and net investment income of $0, NOL
applied $0, tax liability zero.

Form 990T 20XX, [redacted] has a loss of $0 from rental activity and net investment income of $0, NOL
applied $0, tax liability zero.

Form 990T 20XX, [redacted] has a loss of $0 from rental activity and net investment income of $0, NOL
applied $0, tax liability zero.

Catalog Number 20810W Page 5 www.irs.gov Form 886-A (Rev. 5-2017)

Form 886-A Department of the Treasury — Internal Revenue Service Schedule number
(May 2017) Explanations of Items or exhibit
Name of taxpayer: [redacted] Tax Identification Number (last 4 digits): [redacted] Year/Period ended
20XX

Law

IRC section 501(c)(7) provides exemption from income taxes for “clubs organized for pleasure,
recreation, and other nonprofitable 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.”

Regulations §1.501(c)(7)-1(a) further provides that “In general, this exemption extends to social
and recreation clubs which are supported solely by membership fees, dues, and assessments

IRC§ 511(a)(1) imposes a tax on the unrelated business taxable income (UBTI) of organizations
described in § 501(c).

IRC § 512(a)(3)(A) defines unrelated business taxable income for IRC 501(c)(7) social clubs as
gross income excluding any exempt function income, less the deductions allowed that are directly
connected with the production of the income.

IRC § 512(a)(3)(B) Exempt function income is defined as “gross income from dues, fees,
charges, or similar amounts paid by members of the organization as consideration for providing
such members or their dependents or guests goods, facilities, or services in furtherance of the
purposes constituting the basis for the exemption of the organization to which such income is
paid.”

Rev Rul 81-69, 1981-1 CB 351 addresses the issue of deducting from net investment income the
losses incurred on sales to nonmembers. In this ruling, a social club exempt under IRC 501(c)(7)
consistently had losses over a period of years from the sale of food and beverages to
nonmembers. They also had income from investments undertaken for profit. It was determined
that the sales to nonmembers were not profit motivated because of the continuous losses from the
activity. As such, the exempt organization could not offset losses from this activity against income
from investments which were profit motivated.

Portland Golf Club v. C.I.R., 497 U.S. 154, losses incurred as a result of taxpayer's sales to
nonmembers could be offset against investment income only if nonmember sales were
undertaken with intent to profit.

North Ridge Country Club v. Commissioner, 877 F.2d 750 (1989), the Court ruled that a social
club “can properly deduct losses from a non-member activity only if it undertakes that activity with
the intent to profit, where profit means the production of gains in excess of all direct and indirect
costs.

U.S. v. Fort Worth Club of Fort Worth, Tex., 345 F.2d 52, [a social clubs’] exemption stands on
a different footing from that of charitable and educational institutions. There is no basis in the
Statute or its history for treating unrelated rental income of social clubs differently from any other
unrelated club income.

Catalog Number 20810W Page 6 www.irs.gov Form 886-A (Rev. 5-2017)

Form 886-A Department of the Treasury — Internal Revenue Service Schedule number
(May 2017) Explanations of Items or exhibit
Name of taxpayer: [redacted] Tax Identification Number (last 4 digits): [redacted] Year/Period ended
20XX

Crile v. C.I.R., T.C. Memo. 2014-202, taxpayer had actual and honest objective of making a profit
from her work as artist, despite history of losses and only occasional profits, and thus taxpayer's
art activity was trade or business for which she could deduct business expenses.....The Court
relying on Hulter v. Commissioner, 91 T.C. 371, held that to be entitled to deductions under [IRC
§162], the taxpayer must show that she engaged in the activity with an actual and honest objective
of making a profit.

The Supreme Court ruled on this issue in the case of Portland Golf Club v Commissioner of
Internal Revenue, No. 89-530, June 21, 1990 (497 U.S. 154, 110 S.Ct. 2780). The court held
that the net loss from the sales to nonmembers was only deductible from the investment income if
the nonmember activity was motivated by intent to profit. The nonmember sales activity was
determined not to be profit motivated because for eight straight years the club reported losses
from its nonmember sales activity.

Taxpayer Position

The taxpayer has not yet been presented with this formal report.

Government Position

In this case, the organization has reported losses via its rental activity in 0 out of the last 0 years.
Therefore, there is no intent to profit from the organization’s rental activity. Because there is no
intent to make a profit, the losses from the rental activity cannot be used to reduce the investment
income. Rev Rul 81-69 stated that intent to profit could not be shown when there were continuous
losses from the activity. Portland Golf Club v Commissioner of Internal Revenue, The
Supreme Court ruled that losses from nonmember sales were only deductible from investment
income when there was intent to profit from the activity.

Unrelated business income tax must be paid on the investment income of $0 for 20XX and $0 for
20XX less expenses and specific deduction allowed for each year.

Conclusion:

Investment income cannot be offset with losses from an unrelated trade or business that is
determined to be not profit motivated. The government concludes that NOL from the rental activity
is not profit motivated, as per Portland Court case. Unrelated business income tax must be paid
on the investment income of $0 for 20XX and $0 for 20XX less expenses and specific deduction
allowed for each year.

Catalog Number 20810W Page 7 www.irs.gov Form 886-A (Rev. 5-2017)

Form 886-A Department of the Treasury — Internal Revenue Service Schedule number
(May 2017) Explanations of Items or exhibit
Name of taxpayer: [redacted] Tax Identification Number (last 4 digits): [redacted] Year/Period ended
20XX

Family 990T Adjustment

Alternative Position

Issue

If the proposed revocation of exempt status is not upheld, should the organization be required to
pay tax on the investment income and not utilize the NOL to offset the investment income?

Facts

The organization filed form 990 and reported rental income and investment income. The
organization filed form 990T and underreported its investment income on form 990T for the years
ending 20XX and 20XX.

The rental expenses exceeded the rental income and the organization has reported a NOL. The
organization has reported a NOL for zero years on the rental activity. The organization has utilized
the NOL from the rental activity to offset the investment income and pay no income tax.

Law

IRC§ 511(a)(1) imposes a tax on the unrelated business taxable income (UBTI) of organizations
described in § 501(c).

IRC § 512(a)(3)(A) defines unrelated business taxable income for IRC 501(c)(7) social clubs as
gross income excluding any exempt function income, less the deductions allowed that are directly
connected with the production of the income.

IRC § 512(a)(3)(B) Exempt function income is defined as “gross income from dues, fees,
charges, or similar amounts paid by members of the organization as consideration for providing

Catalog Number 20810W Page 8 www.irs.gov Form 886-A (Rev. 5-2017)

Form 886-A Department of the Treasury — Internal Revenue Service Schedule number
(May 2017) Explanations of Items or exhibit
Name of taxpayer: [redacted] Tax Identification Number (last 4 digits): [redacted] Year/Period ended
20XX

such members or their dependents or guests goods, facilities, or services in furtherance of the
purposes constituting the basis for the exemption of the organization to which such income is
paid.”

Rev Rul 81-69, 1981-1 CB 351 addresses the issue of deducting from net investment income the
losses incurred on sales to nonmembers. In this ruling, a social club exempt under IRC 501(c)(7)
consistently had losses over a period of years from the sale of food and beverages to
nonmembers. They also had income from investments undertaken for profit. It was determined
that the sales to nonmembers were not profit motivated because of the continuous losses from the
activity. As such, the exempt organization could not offset losses from this activity against income
from investments which were profit motivated.

Portland Golf Club v. C.I.R., 497 U.S. 154, losses incurred as a result of taxpayer’s sales to
nonmembers could be offset against investment income only if nonmember sales were
undertaken with intent to profit.

North Ridge Country Club v. Commissioner, 877 F.2d 750 (1989), the Court ruled that a social
club “can properly deduct losses from a non-member activity only if it undertakes that activity with
the intent to profit, where profit means the production of gains in excess of all direct and indirect
costs.

U.S. v. Fort Worth Club of Fort Worth, Tex., 345 F.2d 52, [a social clubs’] exemption stands on
a different footing from that of charitable and educational institutions. There is no basis in the
statute or its history for treating unrelated rental income of social clubs differently from any other
unrelated club income.

Crile v. C.I.R., T.C. Memo. 2014-202, taxpayer had actual and honest objective of making a profit
from her work as artist, despite history of losses and only occasional profits, and thus taxpayer's
art activity was trade or business for which she could deduct business expenses.....The Court
relying on Hulter v. Commissioner, 91 T.C. 371, held that to be entitled to deductions under [IRC
§162], the taxpayer must show that she engaged in the activity with an actual and honest objective
of making a profit.

Portland Golf Club v Commissioner of Internal Revenue, No. 89-530, June 21, 1990 (497
U.S. 154, 110 S.Ct. 2780). The court held that the net loss from the sales to nonmembers was
only deductible from the investment income if the nonmember activity was motivated by intent to
profit. The nonmember sales activity was determined not to be profit motivated because for eight
straight years the club reported losses from its nonmember sales activity.

Conclusion

The organization has conducted rental activity for over ten years. The organization has not
reported a profit on this activity in over ten years. The organization has utilized the NOL from its

Catalog Number 20810W Page 9 www.irs.gov Form 886-A (Rev. 5-2017)

Form 886-A Department of the Treasury — Internal Revenue Service Schedule number
(May 2017) Explanations of Items or exhibit
Name of taxpayer: [redacted] Tax Identification Number (last 4 digits): [redacted] Year/Period ended
20XX

rental activity to offset the investment income and pay no tax. The rental activity has not showed a
profit motive and therefore the losses cannot be used to offset the investment income. The
organization shall increase the amount of underreported investment income on form 990T for the
years ended December 31, 20XX and December 31, 20XX and pay the appropriated tax after
allowed expenses and special deductions.

Family 990T Adjustment

Catalog Number 20810W Page 10 www.irs.gov Form 886-A (Rev. 5-2017)