Investment income replaces social-club activity

Plain-English summary

A social club sold the building it had held for affiliated fraternal organizations and stopped conducting social activities. After the sale, investment income represented 100 percent of its gross receipts, and its only remaining activity was making donations to the affiliated organizations. The IRS found that the club exceeded the outside-income limits and no longer operated for pleasure, recreation, or other social purposes. The IRS revoked its Section 501(c)(7) exemption and observed that a Section 501(c)(2) title-holding classification may have been more appropriate.

Ruling snapshot

• Question: Did the organization remain eligible under Section 501(c)(7) after selling its property and receiving all gross receipts from investment income?
• Outcome: Revocation effective June 1 of the redacted year.
• Key authorities: IRC §§ 501(c)(7) and 7428; Treas. Reg. § 1.501(c)(7)-1; Rev. Proc. 71-17; Public Law 94-568

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: 202110033
Release Date: 3/12/2021
UIL: 501.07-00
Date: September 17, 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. Your determination letter dated July 20XX 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 May 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

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.

Enclosures:
Publication 892

Sincerely,

Sean E. O'Reilly
Director, Exempt Organizations Examinations

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

Date: 05/06/2020
Taxpayer ID number: [redacted]
Form: [redacted]
Tax periods ended: [redacted]

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

Digitally signed by Russell T.

Russell T. Renwicks Renwicks
Date: 2020.05.05 10:40:30 -04'00'

For
Maria Hooke
Director, Exempt Organizations Examinations

Enclosures:
Form 886-A
Form 6018

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

Form 886-A (May 2017)
Department of the Treasury — Internal Revenue Service
Explanations of Items
Schedule number or exhibit: [redacted]
Name of taxpayer: [redacted]
Tax Identification Number (last 4 digits): [redacted]
Year/Period ended
May 31, 20XX
ISSUE:
Does [redacted] continue to qualify for exemption from Federal income tax under
section 501(c)(7) of the Internal Revenue Code as a Social Club?
FACTS:
[redacted] was incorporated in the state of [redacted] on December 4, 19XX. The
stated exempt purpose was to operate a social club and lodge room for the members of a fraternal
association known as the [redacted] ([redacted]). The

proposed activities were to conduct social events for the Council, and to purchase, take, hold,
lease, rent, sell or mortgage real property for the purpose of owning and operating a social club
and lodge room. The articles of incorporation include a clause that states upon the dissolution of
the corporation, all assets remaining after the payment of debts will become the property of
[redacted] in the City of [redacted], [redacted].

The bylaws for [redacted] states that “Any member of [redacted] of the
[redacted] shall be considered members of [redacted].”
The Form 990 filed for the tax period ending May 31, 20XX states that [redacted] was the
property-owning entity and had provided the facility for the
[redacted] and the [redacted]. The [redacted]
is a fraternal organization considered tax-exempt under section 501(c)(8) of the
Internal Revenue Code (IRC). The [redacted] is also a fraternal organization

considered tax-exempt under IRC section 501(c)(8).

[redacted] was formerly exempt under IRC section 501(c)(8) as a fraternal
organization but had filed for exemption under IRC section 501(c)(7) as a social club on May 16,
20XX.

The Form 1024, Application for Recognition of Exemption Under Section 501(a), filed by
[redacted] states that the primary activities are the ownership of property for the
[redacted] and Charitable Activities, and to provide a facility for the operation
of a weekly bingo where 0 percent of the proceeds are provided to the
[redacted] for charitable donations.

The organization was granted exemption under Internal Revenue Code Section 501(c)(7) on July
24, 20XX, effective May 28, 20XX. The Determination Letter 947 included the statement that “A
section 501(c)(7) organization is permitted to receive up to 35 percent of its gross receipts,
including investment income, from sources outside of its membership without losing its tax-exempt
status. Of the 35 percent, not more that 15 percent of the gross receipts may be derived from the
use of the club’s facilities or services by the general public. Income in excess of these limits may
jeopardize your continued tax-exempt status.”

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

Form 886-A (May 2017)
Department of the Treasury — Internal Revenue Service
Explanations of Items
Schedule number or exhibit: [redacted]
Name of taxpayer: [redacted]
Tax Identification Number (last 4 digits): [redacted]
Year/Period ended
May 31, 20XX

On January 18, 20XX, [redacted] sold the building and the land to
[redacted] of [redacted]. The purchase price was $0. [redacted] received $0 of the
proceeds in cash. The remaining $0 was credited to fees, taxes, etc. The organization deposited
the $0 received in cash into a money market account with [redacted] in January
20XX. On October 6, 20XX [redacted] withdrew the $0 and deposited it into their
account with [redacted]. On October 8, 20XX, [redacted] wrote and issued
check #0 to [redacted] in the amount of $0. The notation on the check indicates that is
was for a donation to the new [redacted]. The donation was made in accordance with the

dissolution clause included in the articles of incorporation that states upon the dissolution of the
corporation, all assets remaining after the payment of debts will become the property of
[redacted] in the City of [redacted], [redacted]. The determination specialist had granted exemption under IRC
section 501(c)(7) based on the governing documents provided.

The [redacted] bank account (regular shares) was set up for the deposits of
investment income earned from the [redacted] money market account. The
money market account was closed after the withdrawal of the $0 that was donated to the
[redacted]. The $0 in investment income reported on the Form 990 for the tax period ending
May 31, 20XX was from the [redacted] bank account. No other income was
reported on the Form 990 as all membership dues were paid to the [redacted].
[redacted] had similarly reported $0 in investment income as the only income
received for the tax period ending May 31, 20XX.

The investment income received by [redacted] since the sale of the property
represents one hundred percent of its gross receipts.

The organization has not conducted any social activities since the property was sold on
January 18, 20XX. The only activity currently conducted by the organization is providing
donations to the [redacted] and the [redacted]
for their activities.

LAW:

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

Section 1.501(c)(7)-1(a) of the Income Tax Regulations states that “The exemption provided by
section 501(a) for organizations described in section 501(c)(7) 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 inures to the benefit of any private
shareholder. In general, this exemption extends to social and recreation clubs which are

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

Form 886-A (May 2017)
Department of the Treasury — Internal Revenue Service
Explanations of Items
Schedule number or exhibit: [redacted]
Name of taxpayer: [redacted]
Tax Identification Number (last 4 digits): [redacted]
Year/Period ended
May 31, 20XX

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.”

IRC 501(c)(7) was amended in 1976 by Public Law 94-568 to allow organizations to receive a
greater amount of nonmember income without jeopardizing their exempt status. Prior to passage
of this law, IRC 501(c)(7) provided exemption for social clubs organized exclusively for pleasure,
recreation and other nonprofitable purposes. That law substituted the word "substantially" for
"exclusively."

The Committee reports show that this wording change was intended to make it clear that social
clubs may receive outside income, without losing their exempt status. However, the Committee
reports also specified clearly defined limits on this outside income, which if exceeded then invoke
the application of a facts and circumstances test. The audit standard of Rev. Proc. 71-17 has been
effectively raised, as of October 21, 19XX, to allow social clubs to receive up to 35% of their gross
receipts, including investment income, from sources outside their membership without losing their
exempt status. Within this 35%, no more than 15% of gross receipts may be derived from
nonmember use of club facilities and/or services. Gross receipts are defined for this purpose as
those receipts from normal and usual activities that have been traditionally conducted by the club
or by other social and recreational clubs of the same general type. For example, in the case of
country clubs, gross receipts include receipts from activities traditionally conducted by country
clubs. Unusual amounts of income, such as from the sale of a clubhouse or similar facility are not
to be included in either the gross receipts of the club or in the permitted 35 or 15 percent
allowances. It should be emphasized that gross receipts from the conduct of a nontraditional
business or other activity previously forbidden may not be included within the percentage
guidelines. The conduct of a business not traditionally carried on by social clubs unless it is
insubstantial, trivial, and nonrecurrent, should preclude exemption.

The committee reports provide that an organization described in section 501(c)(7) is permitted to
receive up to 35 percent of its gross receipts from nonmember sources, including investment
income, as long as the nonmember gross income does not represent more than 15 percent of total
gross receipts. See S. Rep. No. 94-1318, 94th Cong., 2d Sess. 4 (1976); 1976-2 C.B. 597, 599.
See also H.R. Rep. No. 94-1353, 94th Cong. 2d. Sess. 4 (1976). Where the permitted levels of
nonmember source income are exceeded, all facts and circumstances will be taken into account in
determining whether the social club continues to qualify for exempt status. Thus the 15% and 35%
rules are essentially safe-harbors.

TAX PAYER POSITION:

The treasurer for [redacted] stated that all members of [redacted] are
members of [redacted], and that [redacted], in conjunction with
[redacted], have hosted several activities since the sale of the building, including a Mother’s Day
breakfast (open to the general public as well as members), a pizza and dessert movie night, a

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

Form 886-A (May 2017)
Department of the Treasury — Internal Revenue Service
Explanations of Items
Schedule number or exhibit: [redacted]
Name of taxpayer: [redacted]
Tax Identification Number (last 4 digits): [redacted]
Year/Period ended
May 31, 20XX

cookies and hot chocolate social, and a ham dinner. The food was paid for from donations from
[redacted] and proceeds were donated to the [redacted].

The organization indicated that it is in agreement with the Government's position that the
organization does not qualify for exemption from Federal income tax under section 501(c)(7) of the
Internal Revenue Code as a Social Club.

GOVERNMENT POSITION:
We are proposing the revocation of the Tax-Exempt Status of [redacted] due to the

fact that 0 percent of the gross receipts received by the organization is from investment income
and has exceeded the 15 and 35 percent safe harbor that is provided by Public Law 94-568.

In addition, [redacted] has not conducted any social activities since the property was
sold on January 18, 20XX. The only activity currently conducted by the organization is providing
donations to the [redacted] and the [redacted]
for their activities.

The Service will not pursue the sale of property issue based on several factors. First, the proceeds
of the sale were donated to the [redacted] as required by the dissolution clause
included in the Articles of Incorporation. The determination specialist had granted exemption
under IRC section 501(c)(7) based on the governing documents provided. In addition, the actual

social activities were conducted by the [redacted], and not by the 501(c)(7)
organization. The primary purpose of the 501(c)(7) organization was to hold title to the property as
the local [redacted] was prohibited from owning property. The

organization should probably have been granted exemption under IRC 501(c)(2) as a title holding
corporation instead of an IRC 501(c)(7) social club.

Based on the information provided, it is recommended that the exempt status of the organization
be revoked effective June 1, 20XX.

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