Revocation of 501(c)(7) social-club exemption for living on investment income and lacking individual membership

Plain-English summary

The IRS revoked the tax-exempt status of a social club recognized under
section 501(c)(7). The club ran a social hall for a fraternal society,
letting members use it for meetings, lectures, and meals, and occasionally
letting a few nonmembers use it once a month for a small donation. On
audit, the IRS found the club's only real source of revenue was investment
income from trading securities. A 501(c)(7) club may take in no more than
35 percent of its gross receipts from outside its membership, including
investment income, and this club exceeded that limit year after year. The
IRS also concluded the club was not organized as a genuine membership
organization, so it failed the basic requirement that a social club have
individual members who commingle for fellowship. Relying on the social-club
regulation, the commingling rulings (Rev. Rul. 58-589 and related), and the
nonmember-income cases, the IRS proposed revocation. Once revoked, the club
must file regular income tax returns. This document combines the final
revocation letter (Letter 6337), the earlier proposed-revocation letter
(Letter 3618), and the Form 886-A audit explanation.

Ruling snapshot

• Question: Does a social club keep its IRC § 501(c)(7) exemption when
  nearly all its income is investment income and it is not organized as a
  membership organization?
• Outcome: Revoked (taxpayer provided no position)
• Key authorities: IRC § 501(c)(7); Treas. Reg. § 1.501(c)(7); Pub. L.
  94-568 (Senate Report No. 94-1318); Rev. Rul. 58-589; Rev. Rul. 66-149;
  Rev. Rul. 60-324; Rev. Rul. 63-190; Rev. Proc. 71-17

Full text (IRS public release)

Department of the Treasury                    Date: July 28, 2021
Internal Revenue Service
IRS Tax Exempt and Government Entities        Taxpayer ID number:

Form:
Tax periods ended:
Number: 202240021

Release Date: 10/7/2022                       Person to contact:
Name:
ID number:
Telephone:
Fax:
UIL: 501.07-00

CERTIFIED MAIL - RETURN RECEIPT REQUESTED
Dear

Why we are sending you this letter
This is a final determination that you don't 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 periods
above. Your determination letter dated        , 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, recreation, and other nonprofitable purposes and no
part of the net earnings inures to the benefit of any private shareholder within the meaning of IRC Section
501(c)(7). You have exceeded the non-member income test for tax year ending        .

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.

What you must do if you disagree with this determination
If you want to contest our final determination, you have 90 days from the date this determination letter was
mailed to you to file a petition or complaint in one of the three federal courts listed below.

How to file your action for declaratory judgment
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.

Please contact the clerk of the appropriate court for rules and the appropriate forms for filing an action for
declaratory judgment by referring to the enclosed Publication 892, How to Appeal an IRS Determination on
Tax-Exempt Status. You may write to the courts at the following addresses:

United States Tax Court        U.S. Court of Federal Claims    U.S. District Court for the District of Columbia
400 Second Street, NW          717 Madison Place, NW           333 Constitution Ave., N.W.
Washington, DC 20217           Washington, DC 20439            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.

Letter 6337 (12-2020)
Catalog Number 74808E

Information about the IRS Taxpayer Advocate Service
The IRS office whose phone number appears at the top of the notice can best address and access your tax
information and help get you answers. However, you may be eligible for free help from the Taxpayer Advocate
Service (TAS) if you can't resolve your tax problem with the IRS, or you believe an IRS procedure just isn't
working as it should. TAS is an independent organization within the IRS that helps taxpayers and protects
taxpayer rights. Contact your local Taxpayer Advocate Office at:

Or call TAS at 877-777-4778. For more information about TAS and your rights under the Taxpayer Bill of Rights,
go to taxpayeradvocate.irs.gov. Do not send your federal court pleading to the TAS address listed above. Use
the applicable federal court address provided earlier in the letter. Contacting TAS does not extend the time to
file an action for declaratory judgment.

Where you can find more information
Enclosed are Publication 1, Your Rights as a Taxpayer, and Publication 594, The IRS Collection Process, for
more comprehensive information.
Find tax forms or publications by visiting www.irs.gov/forms or calling 800-TAX-FORM (800-829-3676).
If you have questions, you can call the person shown at the top of this letter.

If you prefer to write, use the address shown at the top of this letter. Include your telephone number, the best
time to call, and a copy of this letter.

Keep the original letter for your records.

Sincerely,

Sean E. O'Reilly
Director, Exempt Organizations Examinations

Enclosures:
Publication 1
Publication 594
Publication 892

Letter 6337 (12-2020)
Catalog Number 74808E


Department of the Treasury                    Date: January 19, 2021
Internal Revenue Service                      Taxpayer ID number:
Tax Exempt and Government Entities
Form:
Tax periods ended:

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

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

CERTIFIED MAIL - Return Receipt Requested
Dear

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,

Sean E. O'Reilly
Director, Exempt Organizations Examinations

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

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


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

ISSUES:
Whether        Incorporated is organized and operated exclusively under Internal Revenue Code (IRC)
§ 501(c)(7) as a social club? And,
Whether or not        Activities and Revenues are in furtherance of its exempt purpose under section 501(c)(7)?

FACTS:
The        is exempt as an organization described in IRC § 501(c)(7) to provide social, recreational and other
related activities to its members.

Activities:
        is currently active. The purpose of the        Incorporated for which the corporation is formed was to
provide a social hall for Fraternal society & also to provide support for members by allowing them use of the hall
for meeting, lectures & meals. They also allowed a few non members to use the hall for        once a month for a
small donation.

Revenue Sources:
        only source of revenue for tax year ending        is from investment income.
The organization reported the following sources and amounts of revenue on Form        for the periods ended
        and subsequent year        :

for period        
CONTRIBUTIONS, GIFTS GRANTS & OTHER SIMILAR AMOUNTS
1a  Federated Campaigns
1b  Membership dues
1c  Fundraising events
1d  Related organization
1e  Government grants (contributions)
1f  All other contributions, gifts, grants & similar amounts not included above
1g  Noncash contributions included in lines 1a - 1f

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 or exhibit
Explanations of Items
Name of taxpayer          Tax Identification Number (last 4 digits)          Year/Period ended

1h  Total (Add lines 1a - 1f)
INVESTMENT INCOME
3   Investment Income (including dividends, interest & other similar amount)
4   Income from investment of tax-exempt bond proceeds
5   Royalties
7a  Gross Amount from sales of Assets & other than Inventory
7b  Less Cost or other Basis and Sales expenses
7c  Gain or Loss
12  Total Revenue

for period        
CONTRIBUTIONS, GIFTS GRANTS & OTHER SIMILAR AMOUNTS
1a  Federated Campaigns
1b  Membership dues
1c  Fundraising events
1d  Related organization
1e  Government grants (contributions)
1f  All other contributions, gifts, grants & similar amounts not included above
1g  Noncash contributions included in lines 1a - 1f
1h  Total (Add lines 1a - 1f)
INVESTMENT INCOME
3   Investment Income including dividends, interest & other similar amount
4   Income from investment of tax-exempt bond proceeds
5   Royalties
7a  Gross amounts from sales of assets other than inventory
12  Total Revenue

As shown on Lines        of both returns filed, total Investment Income was reported at $        and $
respectively.

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.

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 or exhibit
Explanations of Items
Name of taxpayer          Tax Identification Number (last 4 digits)          Year/Period ended

IRC 501(c)(7) further establishes that the ordinary meaning of the term "club" implies that there must be club
members, and that there must be a "commingling" of the members for social, recreational, or similar purposes.
The commingling requirement has been stated in Rev. Rul. 58-589, 1958-2 C.B. 266, Rev. Rul. 70-32, 1970-1
C.B. 132, and Rev. Rul. 74-30, 1974-1 C.B. 137. Commingling is present if such things as meetings, gatherings
and regular meeting FACILITIES ARE EVIDENT.

Rev. Rul. 58-589, 1958-2 C.B. 266, discusses the criteria for exemption under IRC 501(c)(7) and holds that a
club must have an established membership of individuals, commingling, and fellowship to be a social club within
the meaning of the statute. While this does not mean that a club cannot have artificial entities, such as
corporations, as members, a federation composed completely of artificial entities (clubs) was held to be not
exempt under IRC 501(c)(7) in Rev. Rul. 67-428, 1967-2 C.B. 204. The rationale of that case was that a
federation of clubs was a collection of artificial entities not capable of the kind of commingling required of the
membership of exempt clubs. Thus, corporate memberships will not automatically disqualify a club as long as
there are sufficient individual members to provide the requisite amount of fellowship and commingling. (See Rev.
Rul. 74-168, 1974-1 C.B. 139).

Section 1.501(c)(7) 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).

Clubs must be organized for pleasure, recreation and other non-profitable purposes. The Service has held that
these other nonprofitable purposes must be similar to providing pleasure and recreation. Sponsoring activities
of a noncommercial nature can lead to denial or revocation if the activities are not similar to providing pleasure
and recreation. In Rev. Rul. 63-190, 1963-2 C.B. 212, an organization was held not to qualify for exemption
under IRC 501(c)(7) where it provided its members with sick and death benefits.

Social and recreational clubs were originally granted exemption in the Revenue Act of 1916. Congress stated
that the reason for their exemption was that the experience of the Treasury Department had been that securing
returns from clubs had been a source of expense and annoyance and had resulted in the collection of little or no
tax. By contrast, the justifications offered by Congress for the majority of other exempt classifications are that
they provide some sort of community service or public benefit.

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

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 or exhibit
Explanations of Items
Name of taxpayer          Tax Identification Number (last 4 digits)          Year/Period ended

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.

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

Revenue Ruling 60-324 states by making its social facilities available to the general public the club cannot be
treated as being operated exclusively for pleasure, recreation or other non-profitable purposes.

Revenue Procedure 71-17 sets forth the guidelines for determining the effect of gross receipts derived from the
general public's use of a social club's facilities on exemption under IRC § 501(c)(7). Where nonmember income
from the usage exceeds the standard as outlined in this Revenue procedure, the conclusion reached is that
there is a non-exempt purpose and operating in this manner jeopardizes the organization's exempt status.

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

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 or exhibit
Explanations of Items
Name of taxpayer          Tax Identification Number (last 4 digits)          Year/Period ended

GOVERNMENT'S POSITION
Based on the examination results and the facts listed under the heading of this report,        does not qualify for
exemption as a social club described in IRC § 501(c)(7) and Treas. Reg. § 1.501(c)(7) which provides that in
general, this exemption extends to social and recreational clubs which are supported solely by membership fees,
dues, and assessments.

The examination results and the information returns filed by        for fiscal year ended        show that        % of
the revenues came from investment income, trading securities. Therefore, it precludes the        from tax
exemption under IRC § 1.501(c)(7). In addition, the following revenue rulings supports this conclusion.

Rev. Rulings. 66-149 holds "a social club as not exempt as an organization described in IRC § 501(c)(7) where
it derives a substantial part of its income from non-member sources".

The organization has exceeded the        % non-member threshold as outlined in Public Law 94-568, on a
recurring basis during tax years ended        and        .

Sources of Income:
Per our revenue reconciliation from Form        return and your books and records including: General Ledger,
Balance Sheet, checking account (        ), Investment account (LPL Financial), we found investment income as
the main source of income reported. The investment income was recorded on the following accounts        .

Based on Form        and analysis of gross receipts, it was noted that the organization income received from
investments (trading securities) for both fiscal years ended        and        respectively. Over        percent of its
gross receipts was derived from non-members use of club facilities.

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 or exhibit
Explanations of Items
Name of taxpayer          Tax Identification Number (last 4 digits)          Year/Period ended

Conduct of an Unrelated Business
The percentage guidelines and facts and circumstances tests apply only to nonmember use of club facilities.
P.L. 94-568 does not allow a social club to include income from sources other than nonmember use of club
facilities and investment income within the percentage guidelines and was not intended to allow a club to
engage in activities previously forbidden. While the law was intended to increase the allowance of nonmember
income from club facilities, it was not meant to eliminate the prohibition against engaging in nontraditional
business. The Committee reports state:

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.

The conduct of a business "not traditionally carried on" by social clubs should preclude exemption. An example
of a business not traditionally carried on would be the sale of sporting goods to the general public from a
location not physically attached to the club. This has all the characteristics of a business: solicitation of the
general public, a recurring activity, and the conduct of an activity unrelated to the exempt function of a social
club. Current thinking within the Service, although not yet finalized, is that the phrase "not traditionally carried
on" means, in this context, not normally and usually engaged in by social clubs generally (as opposed to the
particular club in question).

However, where an activity is recurring, or the club obtained property with the motive of generating a profit
instead of furthering its exempt purposes, then it appears that the resulting income would not be the type of
income Congress intended to exclude and would jeopardize the club's exempt status.

Membership:
In addition,        is not organized as a membership organization. This in itself would preclude        from tax
exemption under IRC § 1.501(c)(7) and as noted under Rev. Rul. 58-589, 1958-2 C.B. 266, discusses the
criteria for exemption under IRC 501(c)(7) and holds that a club must have an established membership of
individuals, commingling, and fellowship to be a social club within the meaning of the statute. While this does
not mean that a club cannot have artificial entities, such as corporations, as members, a federation composed
completely of artificial entities (clubs) was held to be not exempt under IRC 501(c)(7) in Rev. Rul. 67-428,
1967-2 C.B. 204.

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 or exhibit
Explanations of Items
Name of taxpayer          Tax Identification Number (last 4 digits)          Year/Period ended

CONCLUSION
        no longer qualifies for exemption under § 501(c)(7) of the Code since your nonmember income has
exceeded the        % nonmember threshold on a continuing basis. Therefore, it is proposed that your exempt
status under § 501(c)(7) of the Code be revoked effective        .

Should this revocation be upheld, Form        must be filed starting with tax periods beginning        .

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