Social club loses exemption after mineral income replaces member support

Plain-English summary

A family membership organization had been recognized as a tax-exempt social club under IRC § 501(c)(7). It reported no member dues in the examined years and instead received a mineral-lease signing bonus, rent, and other investment income. The IRS found that this nonmember income exceeded the 35 percent limit established by Public Law 94-568 and paid expenses that otherwise would have fallen on members. The IRS therefore concluded that the income inured to members and revoked the exemption. The organization argued that it had disclosed the mineral lease when applying and had relied on the IRS determination letter. The IRS granted relief under IRC § 7805(b), so the redacted effective date of revocation was later than the date initially proposed.

Ruling snapshot

• Question: Could a social club retain § 501(c)(7) status when mineral-lease and investment income exceeded the permitted nonmember-income limit and funded member expenses?
• Outcome: Exemption revoked, with § 7805(b) relief limiting the revocation’s retroactive effect
• Key authorities: IRC §§ 501(c)(7), 512(a)(3), 7805(b); Treas. Reg. § 1.501(c)(7)-1; Public Law 94-568; Rev. Rul. 66-149; Rev. Rul. 69-220

Full text (IRS public release)

Department of the Treasury Date: December 7, 2021
Internal Revenue Service

Tax Exempt and Government Entities Taxpayer ID number:
Form:
Tax periods ended:
Release Number: 202243014
Release Date: 10/28/2022\n\nPerson to contact:\nName:
Telephone:
Fax:

CERTIFIED MAIL - RETURN RECEIPT REQUESTED

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 no longer qualify for exemption under IRC Section 501(c)(7), as your non-member income has
exceeded the 35% non-member income limit set by Public Law 94-568.

Also, in response to your request for consideration of relief under IRC Section 7805(b), which was granted by
Director, Exempt Organizations Examinations on , the revocation of your tax-exempt status 1s
effective

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.

Letter 6337 (12-2020)
Catalog Number 74808E

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.

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.

Te: Oe,

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
Internal Revenue Service

Date:
November 9, 2020

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:
December 9, 2020

CERTIFIED MAIL — Return Receipt Requested

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

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

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).

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

Publications 892 & 3498

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

Department of the Treasury — Internal Revenue Service Schedule number or
Form 886-A Department of the Treasury — Internal Revenue Service

Explanations of Items exhibit

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

REVISED TO REFLECT RELIEF UNDER SECTION 7805(b)

ISSUE

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

FACTS

was incorporated in the of on
. It submitted Form , Application for Recognition of Exemption under Section 501(a), and
received exemption under section 501 (c)(7) with effective date

In article 3 of the EO’s Articles of Incorporation and on Form its stated purpose is

“i

The EO’s response to Information Document Request (IDR) #1, regarding
membership information states that there exists “only one class of members, all being living
descendants of ” This currently comprises _ individuals across

There is no member handbook and there is no mention of any organized activity or commingling in
the organization’s By-Laws or newsletter. In addition, there is no schedule of membership dues
listed in the EO’s By-Laws.

The EO does not list a website on its return, its By-Laws or its newsletter. In addition, no
other web or related social media accounts are mentioned. A simple online search does not yield
any results that suggest that the organization maintains an online presence.

Note of the EO’s Financial Statements submitted with Form , states: “Revenues are
comprised primarily of Member Dues and occasional Member Contributions. Member dues are
meant to approximate and taxes assessed annually. Member Contributions are
made periodically for maintenance and other purposes”.

According to the EO’s By-Laws, “Expenses” section, items and _ state: “to the extent that

has adequate funds, all expenses will be paid using such funds. To the extent
that does not have adequate funds, all expenses having to do with the property
are to be shared equally between the families involved.”

In response to IDR #1 issued during the audit seeking complete details for member activities in the
year under audit, the EO stated: “Various and activities. Exact dates and
participants are not maintained”.

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

Department of the Treasury — Internal Revenue Service Schedule number or
Form 886-A p rv

Explanations of Items exhibit

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

No member dues were reported on the organization’s return for years and . The EO’s
response to IDR #1 regarding member dues states: “no member dues were collected in

In previous years, member dues were paid to cover expenses of the property such as taxes and
maintenance”.

The EO entered into a -year mineral Lease Agreement with on
. It received a Bonus Consideration and rental payment of $ in
which the EO reported on Part I, Line 4 ( ) of its return and Part
I, Line ( ) on its return. The EO did not report on Schedule of Form
any income as a set aside. In , the EO also reported other investment income of $
from for a total of $ . Inspection of the EO’s return shows total
investment income of $ comprising Other Investment Income from

Section , Payments to Lessor, of the Lease Agreement with , Stipulates
that additional rental and royalty payments will be made to the EO according to certain conditions.
The EO’s newsletter which was included with EO’s response to IDR#1,
acknowledges that the EO has received a letter from describing their activity and states: “

The table below summarizes the income reported in years (year under audit) and
(inspected return).

Year ending

Member Dues $ $

Investment Income $ $

Total Revenue (line 9 of Form ) $ $

Percent of Total Revenue % %
LAW

Section 501(a) of the Internal Revenue Code exempts from taxation organizations described at
subsection 501(c)(7) as clubs organized for pleasure, recreation, and other non-profitable
purposes, substantially all of the activities of which are for such pleasure, recreation, and other
non-profitable purposes and no part of the net earnings of which inures to the benefit of any
private shareholder.

Section 1.501(c)(7)-1 of the Income Tax Regulations states in pertinent part, that:
(a) The exemption provided by § 501(c)(7) of the Code applies only to clubs which are

organized and operated exclusively for pleasure, recreation, and other non-profitable
purposes, but does not apply to any club if any part of its net earnings inures to the

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

Department of the Treasury — Internal Revenue Service Schedule number or
Form 886-A 6 ry

Explanations of Items exhibit

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

benefit of any private shareholder. In general, this exemption extends to social and
recreation clubs that 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 their products, is not
organized and operated exclusively for pleasure, recreation, or social purposes.

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.

Revenue Ruling 66-149; 1966-1 C.B., holds a social club as not exempt from Federal income tax
as an organization described in IRC § 501(c)(7) of the Internal Revenue Code of 1954 where it
derives a substantial part of its income from non-member sources such as, for example, dividends
and interest on investments which it owns.

Rev. Rul. 69-220, 1969-1 C.B. 154., describes 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 Code section 501(c)(7). The organization
was precluded from exemption because it regularly engaged in a business ordinarily carried on for
profit and because its net income from this activity inured to its membership in the form of
improved and expanded facilities.

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

Department of the Treasury — Internal Revenue Service Schedule number or
Form 886-A P y

Explanations of Items exhibit

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

Internal Revenue Code Section 512(a)(3)(B) states that for purposes of subparagraph (A), the
term "exempt function income" means the gross income from dues, fees, charges, or similar
amounts paid by members of the organization as consideration for providing such members or
their dependents or guests goods, facilities, or services in furtherance of the purposes constituting
the basis for the exemption of the organization to which such income is paid. Such term also
means all income (other than an amount equal to the gross income derived from any unrelated
trade or business regularly carried on by such organization computed as if the organization were
subject to paragraph (1)), which is set aside for a purpose specified in section 170(c)(4).

The sale of mineral rights or income derived from gas or oil extractions will result in unrelated
business taxable income to a social club. Such income is not exempt function income as defined
in section 512(a)(3)(B). The special non-recognition provisions of section 512(a)(3)(D) would not
apply. Further, if a social club were to lease mineral rights and were to receive royalty income from
such lease, the modification under section 512(b)(2) to exclude such income from tax is not
available to a social club.

TAXPAYER’S POSITION

The taxpayer did not omit or misstate material information in the application for exemption or
operate in a manner materially different from that originally represented in their application for
recognition of exemption. The taxpayer clearly noted the organization had entered into an

lease with , disclosed the $ signing bonus, and included a copy
of the lease with their application for exemption. The IRS approved the exemption application with
the knowledge the taxpayer would receive the one-time bonus, well in excess of the %
investment income threshold. The taxpayer relied on the determination letter in filing its and

tax returns and believes that it would be inequitable to retroactively revoke the taxpayer's

information. The taxpayer requests relief from retroactive revocation of its tax-exempt status.

GOVERNMENT’S POSITION

An organization exempt from federal income taxes as described in IRC section 501(c)(7) must
meet the gross receipts test in order to maintain its exemption. In order to meet the gross receipts
test, an organization can receive up to percent ( %) of its gross receipts, including
investment income, from sources outside its membership without losing its tax-exempt status.
Within this % amount, not more than fifteen percent ( %) of the gross receipts should be
derived from the use of a social club’s facilities or services by non-members.

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.

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

Department of the Treasury — Internal Revenue Service Schedule number or
Form 886-A pa v

Explanations of Items exhibit

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

Rev. Rul. 66-149 support 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.

Per Treas. Reg. Section 1.501(c)(7)-1(a) , substantially all of the organization’s activities are not
for pleasure, recreation, or other nonprofit purposes. All of its income is derived from non-member
sources, and as a result, income from non-member sources is used to defray membership costs
resulting in inurement to members.

Rev. Rul. 69-220 held a social club that receives a substantial portion of its income from the rental
of property and uses such income to defray operating expenses is not exempt under Section 501
(c) ( 7) of the Code. The organization entered into a lease agreement with the purpose to
generate income, decreasing the amounts needed to be contributed by its members. This income
is supporting its operations, and as it is decreasing the obligations of funds required to be paid by
members, it is inuring to their benefit.

The organization reported investment income that composed % of their gross income in .
Inspection of the organization’s return shows that investment income was, again, % of its
gross income. The organization exceeded the % non-member threshold as outlined in Public
Law 94-568. Moreover, the investment income defrays the ongoing operating cost and inures to
the benefit of members.

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

CONCLUSION

no longer qualifies for exemption under § 501(c)(7) of the Code as your
nonmember income has exceeded the % investment income threshold on a continuing basis.

Accordingly, is not entitled to tax exemption under 501(c)(7) of the Code and its tax-
exempt status should be revoked. The request for relief under IRC Section 7805(b) has been
granted and, therefore, the effective date of revocation is

Form , U.S. Corporation Income Tax, should be filed for tax year ending
and thereafter.

As a reminder, you have the right to file a protest if you disagree with this determination.

if you agree with this conclusion, please sign and return the enclosed Form 6018 by the
indicated response due date.

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