Revocation of 501(c)(7) social-club exemption for investment income exceeding the nonmember limit

Plain-English summary

The IRS revoked the tax-exempt status of a members' club recognized under
section 501(c)(7). The club's stated purpose was educating members in the
safe handling of firearms and conservation, and members met on club
property. A 501(c)(7) club may take in only up to 35 percent of its gross
receipts from outside its membership (including investment income), and no
more than 15 percent from public use of its facilities. This club sold
certain rights in its property under a long-term promissory note, and the
interest and payments from that note produced investment income that,
year after year, pushed the club well past the 35 percent limit. The IRS
found the club had consistently and (in its words) egregiously exceeded
the nonmember-income limit, so it no longer operated substantially for
pleasure and recreation. The examiner cited the social-club regulation and
a line of cases (Adirondack League Club, Coastal Club, West Side Tennis
Club) where outside income from timber, oil and gas, or similar sources
cost clubs their exemption. Because status is 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
  investment income from selling property rights consistently exceeds the
  35 percent nonmember-income limit?
• Outcome: Revoked (taxpayer provided no position)
• Key authorities: IRC § 501(c)(7); Treas. Reg. § 1.501(c)(7)-1; Pub.
  L. 94-568 (S. Rep. No. 94-1318); Rev. Rul. 66-149; Adirondack League
  Club v. Commissioner; Coastal Club, Inc., 43 T.C. 783 (1965); West Side
  Tennis Club v. Commissioner, 111 F.2d 6

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:
Number: 202240024
Release Date: 10/7/2022

Form:
Tax periods ended:

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 received more than 35 percent of your gross receipts from a combination of investment income and
receipts from non-members as well as more than 15 percent of gross receipts from non-member use of facilities.

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

cc:

Letter 6337 (12-2020)
Catalog Number 74808E


Department of the Treasury                    Date: March 9, 2021
Internal Revenue Service                      Taxpayer ID number:
IRS 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.

After we issue the final adverse determination letter, we'll announce that your organization is no
longer eligible to receive tax deductible contributions under IRC Section 170.

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.

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

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.

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

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

If we don't hear from you
If you don't respond to this proposal within 30 calendar days from the date of this letter, we'll
issue a final adverse determination letter.

Contacting the Taxpayer Advocate Office is a taxpayer right
The Taxpayer Advocate Service (TAS) is an independent organization within the IRS that can
help protect your taxpayer rights. TAS can offer you help if your tax problem is causing a
hardship, or you've tried but haven't been able to resolve your problem with the IRS. If you
qualify for TAS assistance, which is always free, TAS will do everything possible to help you.
Visit www.taxpayeradvocate.irs.gov or call 877-777-4778.

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

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


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
Form 6018
Form 4621-A
Publication 892
Publication 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          Year/Period ended

Issue:
        has failed to meet the eligibility requirements under Internal Revenue Code Section 501(c)(7) as the
organization's investment income has exceeded the limit of non-member income imposed by the Code. Because
the organization has consistently exceeded the 35-percent non-member income limit; should the organization
retain its tax-exempt status under the Internal Revenue Code 501(c)(7)?

Facts:
        was organized under State Law on        .        filed form        for exemption under IRC 501(c)(7) on
        .        received Determination Letter 948 (DO/CG) on        , granting the organization tax exempt status
under IRC Section 501(c)(7).

        primary purpose is the education of its members in the proper safe methods of        and conservation, and
the safe use of firearms.

        maintains a property in        , in        ,        . The organization's members meet and conduct the club's
activities on this property.

        had        members during the year under examination.

        has filed a Form        for the tax years ending        through        .

        has filed a Form        for the tax years ending        through tax year ending        .

        has no paid employees.

The Service has reviewed the Forms        and Forms        reporting period starting        and ending        .

On        , the organization entered into an Promissory Note agreement to sell their        to        , for $
(        ) together with the fixed rate of interest of        percent per annum on the outstanding principal balance.
The payment shall be due on        and the Note shall be due and payable in full including any outstanding
principal, any accrued interest and other charges, not later than        .

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          Year/Period ended

Facts (Continued):
The income received from the promissory note has been reported on their Forms        and Forms        for the
period of        through        .

The organization has reported the following amounts for investment income on their books and records and on
their Forms        and Forms        returns for the Tax Year Ending        :

        , Investment Income of $        which is        -percent of the total income of $        .
        , Investment Income of $        which is        -percent of the total income of $        .
        , Investment Income of $        which is        -percent of the total income of $        .
        , Investment Income of $        which is        -percent of the total income of $        .

Law:
Internal Revenue Code § 501(c)(7) — Social Clubs
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 1.501(c)(7)-1 Social Clubs
(a) 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 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.

(b) 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).
Solicitation by advertisement or otherwise for public patronage of its facilities is prima facie evidence that
the club is engaging in business and is not being operated exclusively for pleasure, recreation, or social
purposes. However, an incidental sale of property will not deprive a club of its exemption.

P.L. 94-568
Before 1976, IRC Section 501(c)(7) required a tax-exempt club to be organized and operated "exclusively"
for pleasure, recreation, and other nonprofitable purposes. P.L. 94-568 amended IRC Section 501(c)(7) to
require that "substantially all" of a tax-exempt club's activities are dedicated for pleasure, recreation, and
other nonprofitable purposes. The amendment was intended to allow IRC Section 501(c)(7) organizations
to receive up to 35 percent of their gross receipts, including investment income, from sources outside their
membership without losing their exempt status. See S. Rep. No. 94-1318 (1976). Within the 35 percent, no
more than 15 percent of gross receipts should come from the general public's use of the social club's

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          Year/Period ended

Law (Continued):
facilities or services. If an organization has outside income over the 35-percent or 15-percent limit, the
organization is in jeopardy of losing their tax-exempt status.

Revenue Ruling 66-149
Rev. Rul. 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.

Adirondack League Club, Petitioner v. C.I.R. Respondent
Petitioner is a nonprofit New York membership corporation organized and operated for: (1) The
preservation and conservation of the Adirondack forests and the proper protection of game and fish in the
Adirondack Region. (2) The establishment and promotion of an improved system of forestry. (3) The
maintenance of an ample preserve for the benefit of its members for the purpose of hunting, fishing, rest,
and recreation. Petitioner lost its tax-exempt status as of 1943 upon respondent's determination that
petitioner received a substantial amount of income from timber operations conducted on its property. Aside
from its timber income, petitioner collected membership dues and charged fees for the facilities and services
used by members and their guests. The expenses incurred in maintaining and providing the facilities and
services exceeded the membership dues and fees charged for them and petitioner offset the excess expenses
against the timber income with the result that petitioner reported no taxable income during the years in issue.
Held, to the extent the expenses incurred in maintaining and providing facilities and services for members
exceeded the income received therefrom, they are not deductible under sec. 162(a), since they did not arise
from the 'carrying on of any trade or business' within the intendment of that section.

Coastal Club, Inc., 43 T.C. 783 (1965)
By transactions entered into for profit petitioner, a corporation, organized as a duck-hunting club, repeatedly
leased its property for the exploration for and production of oil and gas. During the years in issue the oil and
gas income predominantly exceeded the amounts received from its members in the form of dues, and service
and guest charges, and supplied from in excess of two-thirds to as much as four-fifths of the amounts
required and expended for operations, repairs, maintenance, and improvements. And not only that but
through such income plus the interest from U.S. Government bonds in which the oil and gas income
remaining after payment of club costs had been invested, petitioner built its accumulated surplus. It was
held, that respondent did not err in his determination that petitioner, during the taxable years, was not
exempt from tax under section 501(c)(7) of the Internal Revenue Code. It was further held, that respondent
did not abuse his discretion in revoking his prior ruling of exemption.

West Side Tennis Club v. Commissioner (111 F.2d 6)
The court determined that more than an insubstantial amount of income received from non-members would
jeopardize the tax-exempt status of an organization described in IRC § 501(c)(7).

Taxpayer Position:
The taxpayer has not provided a position at this time.

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          Year/Period ended

Government Position:
        investment income has consistently exceeded the        -percent non-member income limit imposed by the
Code. The organization entered into a Promissory Note agreement to sell their        rights to        , with the first
payment due on        and continuing until        . The organization has been reporting the investment income on
their Forms        and        .

The organization has consistently exceeded the 35-percent limit imposed under the Code. The Service has
provided the information reported on the organization's returns for the periods starting on        and ending on        .

Below are the calculations of the Percentage of Total Revenue for all income sources for        :

[Redacted revenue table — the scan of this chart is illegible; the row labels
(program service revenue, investment income, and their percent-of-total-revenue
lines) and all figures were not machine-readable.]

Using the information obtained from the organization's records and the information previously reported on
filed returns, the Investment Income as a percentage of Total Revenue, the organization has consistently
exceeded the 35-percent non-member income limit imposed by the Internal Revenue Code.

Social clubs are permitted to receive income from non-member sources, but when that income exceeds
35-percent, the organization's exemption is in jeopardy of being revoked. As the organization has consistently
exceeded the limits imposed by the Internal Revenue Code, the Treasury Regulations, and further specified
in Public Law 94-568. Also, as per the terms of the promissory note agreement, the investment income will
continue until        .

As the organization has egregiously exceeded the non-member limits imposed by the code there is no way
that the organization can retain its tax-exempt status. The organization has reported non-member income
that has averaged approximately        percent of their total income during the period examined.

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          Year/Period ended

Conclusion:
The action of        entering into a promissory note agreement has led to the generation of non-member
investment income. The income generated on the sale of the        rights, as evidenced on the promissory note,
made between the organization and        , has caused the organization to consistently exceed the 35-percent
non-member income limit imposed by the Internal Revenue Code.

This has led to the determination that the organization is no longer qualified under Internal Revenue Code
Section 501(c)(7), and the organization's tax-exempt status must be revoked.

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