Social club exemption revoked for recurring nonmember income

Plain-English summary

A recreational social club received nonmember income from investments, royalties, securities, and rent. Although it reported some unrelated business income, it did not report all investment or royalty income there and did not make set-aside elections for the investment income. The club's nonmember investment income repeatedly exceeded the percentage allowed for a section 501(c)(7) organization over several years. The IRS concluded that the income was recurring and far above the statutory threshold. It revoked the club's exemption because the club was not supported primarily by membership fees, dues, and assessments.

Ruling snapshot

• Question: Could a social club remain exempt after recurring investment, royalty, and rental income exceeded the permitted nonmember-income threshold?
• Outcome: Revocation
• Key authorities: IRC § 501(c)(7); Public Law 94-568; Rev. Rul. 66-149

Full text (IRS public release)

DEPARTMENT OF THE TREASURY

TAX EXEMPT AND
GOVERNMENT ENTITIES
DIVISION
Date:
September 23, 2020

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 legally 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: _ "Sincerely,
Publication 892

ho E, ORM;

a
Sean E. O'Reilly
Director, Exempt Organizations Examinations

Department of the Treasury oe May 5, 2020

Internal Revenue Service Taxpayer ID number:
IRS Tax Exempt and Government Entities

Tax periods ended:

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

Manager’s contact information:
Name:
ID number:

Telephone:
Response due date:

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.

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

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

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). 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
2 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

ISSUE

Should
(hereafter EO) continue to qualify as an organization described in Section 501(c)(7) of the Internal
Revenue Code?

FACTS

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

under State Law on to provide its members with
, and . The EO was granted exemption from the Internal Revenue Service
on
On the RA interviewed the Treasurer, , and discovered the EO
has a total of acres of primarily located at
; . On that is
; ; ; ,anda and has running water, ,anda
. The is used for the EO’s parties that include
an weekend, and work parties throughout the year. Members are
responsible for providing their own food and drinks. The EO holds meetings with the members on
the first of every month at a local restaurant in , . The EO does not conduct

any of its activities with non-members.

was selected for examination for tax year ending
. During the examination, the RA discovered the EO received non-member
income that included investment income, royalties, and rents.

• The EO receives from their for the purpose of ;
  ,and . The EO has and with
  due to being divided into ,

acres and the other acres.

The EO has investment accounts with that reported investment income
that included dividends, interest income, and gains on sale of securities. The Treasurer informed
the RA, that the EO sold their securities in order to maintain a cash fund to expand their
organization.

The EO received a from that reported rent income to the
EO. The Treasurer stated _is unsure why the income was reported as rental income. The EO
only received rental income for the tax year ending

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

. - i Schedule number
Form 886- A Department of the Treasury Internal Revenue Service or exhibitt
Explanations of Items

Name of taxpayer Tax Identification Number (/ast 4 digits) | Year/Period ended
The EO filed Form , Exempt Organization Business Income Tax Return, for tax years ending
thru . The EO only reported their as
on the Form . The EO did not report their investment or on the Form
The EO did not make set-aside elections on the Form for their investment income. Their
total investment income below includes their . The EO has consecutively exceeded
the % investment income limitation.
Form
Total Investment $ $ $
Income
Gross Income $ $ $
Percentage of % % %
investment Income

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 no
part of the net earnings of which inures to the benefit of any private shareholder.

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).

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.

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

Explanations of Items or exhibitt

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

(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.

TAXPAYER’S POSITION
The EO has not stated their position.

GOVERNMENT’S POSITION

Based on the examination, the organization 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 recreation clubs which are supported solely by membership fees,
dues, and assessments.

Rev. Rul. 66-149 supports this position stating that a social club is not exempt under Code section
501(c)(7) if it regularly derives a substantial part of its income from nonmember sources, such as
investment income.

The organization has investment income from royalties, dividends and other income from
securities, and rent which totaled % of their gross income for the year under examination. For
the -year period from through , the organization’s non-member investment income
consistently exceeded % of its revenue, far exceeding the % non-member threshold as
outlined in Public Law 94-568, on a recurring basis during tax years ending -

Accordingly, it is proposed that the organization’s tax-exempt status be revoked effective

CONCLUSION

no longer qualifies for exemption under IRC § 501(c)(7) of
the Code as the non-member income has exceeded the % investment income threshold on a
continuing basis, therefore the RA is proposing revocation of your tax-exempt status under IRC §
501(c)(7) of the Code effective .

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

If you agree to this conclusion, please sign the attached Form 6018.

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

Form 886-A

Department of the Treasury — Internal Revenue Service

Explanations of Items

Schedule number
or exhibitt

Name of taxpayer

Tax Identification Number (last 4 digits) | Year/Period ended

If you disagree please submit a statement of your position.

Catalog Number 20810W

Page 4 www.irs.gov

Form 886-A (Rev. 5-2017)