IRS disqualifies a self-declared 501(c)(7) immigrant social club that lived on rental income from its building

Plain-English summary

A social club that served working-class immigrants had treated itself as tax-exempt under IRC § 501(c)(7) without ever getting a determination letter from the IRS ("self-declared" status). On audit, the IRS found the club did not qualify and disqualified it. A § 501(c)(7) club is meant to be supported by member dues, fees, and assessments, and can take only limited income from outside the membership. This club charged no dues at all. It owned a two-story building, used the second floor for its social activities, and rented the first floor to the general public. That rental income (which the club had reported as investment income on Form 990-EZ, and separately on Form 990-T as unrelated business income) was its only reported income and made up nearly all of its revenue, far exceeding the 15% limit on non-member income and the 35% limit on outside income under Public Law 94-568. Citing Rev. Rul. 66-149, Rev. Rul. 69-220, and Rev. Rul. 58-589, the IRS concluded the club was engaged in a business and not operated exclusively for pleasure and recreation. The taxpayer signed Form 6018 consenting to the disqualification, making this the final determination; going forward the organization must file Form 1120.

Ruling snapshot

• Question: Does a self-declared § 501(c)(7) social club that charges no dues and lives on rental income from its building keep its exempt status?
• Outcome: Revocation (final adverse determination; taxpayer consented via Form 6018)
• Key authorities: IRC § 501(c)(7); Treas. Reg. § 1.501(c)(7)-1(a), (b); Public Law 94-568; Rev. Rul. 58-589; Rev. Rul. 66-149; Rev. Rul. 69-220

Full text (IRS public release)

DEPARTMENT OF THE TREASURY
INTERNAL REVENUE SERVICE
1160 Commerce Street, MC 4920DAL
Dallas, TX 75242

TAX EXEMPT AND
GOVERNMENT ENTITIES
DIVISION
                                                    Date: March 3, 2021
Number: 202226015
Release Date: 7/1/2022                              Taxpayer ID Number:
                                                    Form:
                                                    For Tax Period(s) Ending:
                                                    Person to Contact:
                                                    Identification Number:
                                                    Telephone Number:
UIL: 501.07-00

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

Dear

This is a final determination explaining why your organization doesn't qualify as an
organization described in Internal Revenue Code (IRC) Section 501(c)(X) [(d)] for the tax
period(s) listed above.

In the future, if you believe your organization qualifies for tax-exempt status and would like a
determination letter from the Internal Revenue Service, you can request a determination by
filing Form 1024, Application for Recognition of Exemption Under Section 501(a), or Form
1024-A, Application for Recognition of Exemption Under Section 501(c)(4) of the Internal
Revenue Code (as applicable) and paying the required user fee.

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

You have not established that you are organized and operated exclusively for an exempt
purpose within the meaning of IRC Section 501(c)(7). You have not established that you are
organized and operated exclusively for pleasure, recreation, and other nonprofitable
purposes, substantially all 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.

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.

We previously provided you a report of examination explaining the proposed denial of your tax-
exempt status. At that time, we informed you of your right to contact the Taxpayer Advocate, as
well as your appeal rights. On June 23, 20__ you signed Form 6018, Consent to Proposed
Action — Section 7428, in which you agreed to the denial of your tax exempt status as described
under IRC 501(c)(7). This is a final determination letter with regards to your federal tax-exempt
status under IRC Section 501(a).

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 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

------------------------------------------------------------------------

Department of the Treasury                          Date: April 20, 2020
Internal Revenue Service
Tax Exempt and Government Entities                  Taxpayer ID number:
200 Sheffield Street, 2nd Floor
Mountainside, NJ 07092                              Form:

                                                    Tax periods ended:

                                                    Person to contact:
                                                    Name:
                                                    ID number:
                                                    Telephone:
                                                    Fax:
                                                    Address:

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

Dear

Why you're receiving this letter
We enclosed a copy of our audit report, Form 886-A, Explanation of Items, explaining that your
organization doesn't qualify as an organization described in Internal Revenue Code (IRC)
Section 501(c)(7).

This letter is not a determination of your tax-exempt status under IRC Section 501 for any period
other than the tax periods above.

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.

Letter 4102 (Rev. 8-2017)
Catalog Number 48373U

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.

In the future, if you believe your organization qualifies for tax-exempt status and would like a
status determination letter from the IRS, you can request a determination by filing Form 1024,
Application for Recognition of Exemption Under Section 501(a), and paying the required user
fee.

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,

Maria Hooke
Director, Exempt Organizations
Examinations

Enclosures:
Form 886-A
Form 6018
Publication 3498
Publication 892

Letter 3618 (Rev. 8-2019)
Catalog Number 34808F

------------------------------------------------------------------------

Form 886-A          Department of the Treasury — Internal Revenue Service
(May 2017)                        Explanations of Items

Name of taxpayer          Tax Identification Number (last 4 digits)    Year/Period ended

ISSUE:
Whether the                          qualifies for self-declared tax-exempt status under
Internal Revenue Code (IRC) Section 501(c)(7) when it derives significant income from a substantial,
nontraditional ongoing business activity outside of its membership.

FACTS:

The                          , hereinafter referred to as the      , has self-declared as
an organization described in IRC Section 501(c)(7). The      has not received a ruling or determination
letter granting tax-exempt status and is not covered under a group exemption ruling. The      main
purpose is to promote, encourage and foster the      among its members of the working-class
immigrants and persons of      through recreation and social activities.

The      has      members and provide a place for the members to commingle, socialize, and take part in
recreational activities which include playing      , and watching television. The members have access
to magazines, newspapers, and other materials related to their      . The      also provides
food, coffee, tea and other beverages to members which is donated by various      in the
community.

The members of the      do not pay membership dues and initiation fees because they receive a small
amount of donation from      to host various activities for members such as
      . The      also provides help to the
community with immigration services and help with funeral and burial for those in need of assistance. The
      operates on the second floor of the building which is owned by the      and the first floor is rented to
the general public for use as a      .

The only income reported on the Form 990-EZ, Short Form Return of Organizations Exempt From
Income Tax, from the year ended 12/31/20__ was investment income. The      did not report membership
dues or any other income from the members of the      . During the examination of the books and records
for the year ended 12/31/20__ it was verified that the investment income was rental income received from
renting the first floor of the facility. The rental income was reported on Form 990-T, Exempt Organization
Business Income Tax Return.

Review of Form 990-EZ for the periods of December 31, 20__ through December 31, 20__ are shown
below. Had      % non-member income for consecutive years.

Form 990

Nonmember Income (gross
rents)                    $        $        $
Total Revenue             $        $        $
Percentage of non-member
income                    %        %        %

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

LAW

IRC § 501(c)(7) exempts from federal income tax clubs organized for pleasure, recreation, and other
non-profitable purposes, substantially all the activities of which are for such purposes and not part of
the net earnings of which inures to the benefit of any private shareholder.

Section 1.501(c)(7)-1(a) of the Regulations provides that, in general, the exemption extends to social
and recreation clubs supported solely by membership fees, dues and assessments. However, a club
that engages in a business, such as making its social and recreational facilities open to the general
public, is not organized and operated exclusively for pleasure, recreation and other non-profitable
purposes, and is not exempt under section 501(a).

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). However, an incidental sale of property
will not deprive a club of its exemption.

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

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

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

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

The Committee Reports for Public Law 94-568 state that it is not "intended that these organizations should
be permitted to receive, within the 15 or 35 percent allowances, income from the active conduct of
businesses not traditionally carried on by these organizations." This language means that Congress
intended that exempt social clubs should not be permitted to receive income from activities not conducted
in furtherance of their exempt purposes. Therefore, a club that engages in nontraditional business activity
can jeopardize its exempt status even when its gross receipts are within the permissible limits.

Revenue Ruling 58-589, 1958-2 C.B. 266 states that a social club's business activity will defeat exemption
unless such activity is incidental, trivial or nonrecurrent; which the IRS has interpreted to mean
"insubstantial" for this purpose.

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

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 IRC section 501(c)(7).

Revenue Ruling 66-149, 1966-1 C.B. 146, holds a social club as not exempt as an organization
described in IRC § 501(c)(7) where it regularly derives a substantial part of its income from non-
member sources.

TAXPAYER'S POSITION
Taxpayer's position has not been provided.

GOVERNMENT'S POSITION

Rental income earned from the property does not demonstrate a causal relationship to the      and the
requirements to be described as a tax exemption organization under Internal Revenue Code (IRC) Section
501(c)(7).

Rev. Rul. 66-149 support this position stating that a social club is not exempt under Code section
501(c)(7) if the organization regularly derives a substantial part of its income from non-member sources,
such as investment income. The organization's income derives from renting the first floor to a private
citizen which is used as a      and the income is      % of the gross income for the year under audit.
This income is well in excess of both 15% limitation on non-member income and 35% limitation on
investment income.

The      is like the organization in Revenue Ruling 69-220 that did not qualify for exemption under IRC
section 501(c)(7) because it receives a substantial portion of its income from sources other than members.

As prescribed in Treasury Regulation section 1.501(c)(7)-1(b), the      is engaging in business activities
and is therefore not organized and operated exclusively for pleasure, recreation, and other nonprofitable
purposes.

CONCLUSION

The financial data for calendar year December 31, 20__ indicates that the only reported investment
income on Form 990-EZ which is from the rental of the first floor of the property where the      is located.
The income has exceeded the 15 percent non-member income and 35 percent investment income
limitations for year ending December 31, 20__. The      does not meet the requirements for a tax
exemption organization described under IRC Section 501(c)(7).

We propose to disqualify      self-declared tax-exempt status
under IRC section 501(c)(7) for the year ending December 31, 20__ effective January 1, 20__

Should this revocation be upheld, Form 1120 must be filed for tax period ending December 31, 20__
If you agree to this conclusion, please sign the attached Forms.

If you disagree please submit a statement of your position

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