Social club exemption revoked after activities ceased and investment income exceeded limits

Plain-English summary

The IRS revoked the Section 501(c)(7) exemption of a social club that had sold the property it was formed to hold. After the sale, the organization stopped conducting its own social activities and made donations to related organizations instead. Its only reported receipts were investment income, which exceeded the safe-harbor limits for income from outside the membership. The IRS noted that the organization may originally have fit better as a Section 501(c)(2) title-holding corporation, but it had been recognized as a social club. Because it no longer operated substantially for pleasure, recreation, or similar nonprofitable purposes, the IRS revoked its exemption.

Ruling snapshot

• Question: Did the organization continue to qualify as a Section 501(c)(7) social club after selling its property and ceasing its own social activities?
• Outcome: Revocation
• Key authorities: IRC §§ 501(a), 501(c)(7), and 7428; Treas. Reg. § 1.501(c)(7)-1(a); Public Law 94-568

Full text (IRS public release)

DEPARTMENT OF THE TREASURY

TAX EXEMPT AND
GOVERNMENT ENTITIES
DIVISION

Date:
September 17, 2020

Number: 202242019 Taxpayer ID Number:

Release Date: 10/21/2022
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:

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 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

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:

Form:
Tax periods ended:

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

Manager's contact information:
Name:

CERTIFIED MAIL — Return Receipt Requested

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 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,

Russell T. Renwicks

For
Maria Hooke
Director, Exempt Organizations Examinations

Enclosures:
Form 886-A
Form 6018

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

Department of the Treasury — Internal Revenue Service
Form 886-A
Explanations of Items

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

ISSUE:

Does continue to qualify for exemption from Federal income tax under
section 501(c)(7) of the Internal Revenue Code as a Social Club?

FACTS:

was incorporated in the state of on . The stated
exempt purpose was to operate a and for the members of a
association known as the . The
proposed activities were to conduct social events for the Council, and to purchase, take, hold,
for the purpose of owning and operating a
,
and . 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 of
in the City of .

The bylaws for states that “Any member of of the
shall be considered members of .”

The Form filed for the tax period ending states that was the
property-owning entity and had provided the facility for the of
and the . The of
is a organization considered tax-exempt under section 501(c)(8) of the
Internal Revenue Code (IRC). The is also a organization
considered tax-exempt under IRC section 501(c)(8).

was formerly exempt under IRC section 501(c)(8) as a organization
but had filed for exemption under IRC section 501(c)(7) as a social club on
.

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

The organization was granted exemption under Internal Revenue Code Section 501(c)(7) on
effective . 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)

Department of the Treasury — Internal Revenue Service
Form 886-A
Explanations of Items

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

On , sold the building and the land to of
. The purchase price was $ . received
$ of the proceeds in cash. The remaining $ was credited to fees, taxes, etc.
The organization deposited the $ received in cash into a money market account with
in . On withdrew
the $ and deposited it into their account with . On
, wrote and issued check to in the amount of
$ . The notation on the check indicates that is was for a donation to the new
. 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 in the City
. The determination specialist had granted exemption under IRC section 501(c)(7)
based on the governing documents provided.

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

The investment income received by since the sale of represents
percent of its gross receipts.

The organization has not conducted any social activities since was sold on
. The only activity currently conducted by the organization is providing
donations to the of and the
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)

Department of the Treasury — Internal Revenue Service
Form 886-A
Explanations of Items

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

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, 1976, 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 stated that all members of are
members of , and that , in conjunction with
, have hosted several activities since the sale of , including a
(open to the general public as well as members), a , a

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

Department of the Treasury — Internal Revenue Service
Form 886-A
Explanations of Items

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

, and a . The food was paid for from donations from
and proceeds were donated to the .

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

In addition, has not conducted any social activities since was
sold on . The only activity currently conducted by the organization is providing
donations to the of and the
for their activities.

The Service will not pursue the sale of issue based on several factors. , the proceeds
of the sale were donated to the , 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 of , and not by the 501(c)(7)
organization. The primary purpose of the 501(c)(7) organization was to hold title to as
the local of was prohibited from owning . 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 .

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