IRS revokes a social club whose outside catering income exceeded the nonmember-income limit

Plain-English summary

A section 501(c)(7) social club operated a gathering place for business executives and contracted with an outside catering company. The club received monthly revenue from that arrangement, classified it as nonmember income and unrelated business income, and paid unrelated business income tax after expenses. The IRS found that this revenue was most of the club's gross receipts and that nonmember income exceeded the permitted limit in the examination year and surrounding years. Because the income recurred throughout each year, it was not an unusual one-time event. The club agreed to the proposed revocation. The IRS revoked its exemption and required it to file corporate income tax returns for open years.

Ruling snapshot

• Question: Did the club remain exempt under IRC § 501(c)(7) when recurring income from an outside catering company exceeded the limit on nonmember receipts?
• Outcome: Revocation
• Key authorities: IRC § 501(c)(7); Treas. Reg. § 1.501(c)(7)-1; Pub. L. 94-568; Rev. Rul. 58-589, 60-324, 66-149, and 68-119; Rev. Proc. 71-17

Full text (IRS public release)

DEPARTMENT OF THE TREASURY

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

Taxpayer ID Number:

Release Number: 202243016 Form:

Release Date: 10/28/2022

UIL Code: 501.07-00 For Tax Period(s) Ending:

Person to Contact:

Identification Number:
Telephone Number:

CERTIFIED MAIL — Return Receipt Requested
LAST DAY FOR FILING A PETITION WITH THE TAX COURT:

Dear

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.

Sincerely,

Sean E. O'Reilly
Enclosures: Director, Exempt Organizations Examinations

Publication 892

Department of the Treasury Date: June 3, 2020

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

Forms:

Tax periods ended:

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

Manager’s contact information:
Name:
ID number:

Telephone:
Response due date: July 3, 2020

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.

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.

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

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).

2 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

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

Department of the Treasury Date: September 23, 2020

Internal Revenue Service Taxpayer ID number:
IRS Tax Exempt and Government Entities
Form:
Tax periods ended:
Person to contact:
Name:
ID number:
Telephone:

Refer reply to:

Dear ,

We're sending the enclosed material under the provisions of your power of attorney or other
authorization on file with us, for the taxpayer listed below.

If you have questions, you can contact the person listed above.

Sincerely,

EO Mandatory Review Staff
Enclosures:
Final Letter
cc:

Letter 3697 (Rev. 8-2019)
Catalog Number 34786R

Form 886-A Department of the Treasury - Internal Revenue Service Schedule No. or
Explanation of Items Exhibit

Name of Taxpayer Year/Period Ended
ISSUE:
Whether the will continue to qualify as an exempt under section
501(c)(7) of the Code?
FACTS:
The (the “ ”) was granted exemption as a exempt from Federal
income tax under Internal Revenue Code section 501(c)(7) pursuant to a ruling issued in

. The was established as a private business in as a gathering

place for business executives. The organization’s mission is “

”

The principal activity is providing facilities and services for the pleasure and recreation of

its members and their guests. The contracts with an outside vendor which provides
service for the . The received income as a result of a

between the and the outside catering corporation. The received gross revenue of

$ per month totaling $ for the year ended as a result of the

income received from the outside catering corporation. The income received from the outside

catering corporation was correctly classified as nonmember income and Unrelated business

revenue on Form , however this gross revenue was a majority of the total gross

revenue. The reflected $ correctly on Form and paid the Unrelated Business

Income tax after subtracting expenses.

During the examination, it was determined that the complied with the recordkeeping
requirements of Revenue Procedure 71-17, 1971-1 C.B. 683. The however received and
continues to receive the majority of its gross income from the outside catering corporation which
was classified as nonmember income and Unrelated Business Income. Based on an
examination of the Form return for the period ended and review
of their books and records, the percent of gross receipts from nonmember use of facilities far
exceeded % for the year of the exam. The agent reviewed the prior and subsequent years,
however did not examine these years as the nonmember income derived from the outside
catering corporation also far exceeded % for the prior and subsequent years. These receipts
are noted in the following chart:

Year/Period Ended | % of gross receipts from nonmember use | % of gross receipts from investment income | Total % investment income / nonmember income
[redacted table entries]

Form 886-A (Rev.4-68) Department of the Treasury - Internal Revenue Service

Page: -1-

Form 886-A Department of the Treasury - Internal Revenue Service Schedule No. or
Explanation of Items Exhibit
Name of Taxpayer Year/Period Ended
The examination year, year ended , reflected gross receipts from
nonmember use of $ as a result of the income received from the outside catering
organization and total gross revenue for the year of $ which resulted in

percent from non member use.
LAW:

Organizations exempt from federal taxes as described in IRC Section 501(c)(7) include 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 of the Income Tax Regulations, relating to the requirements of exemption
of such clubs under section 501(a), reads in part as follows:

(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
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.

Prior to its amendment in 1976, IRC Section 501(c)(7) required that social clubs be operated
exclusively for pleasure, recreation, and other non-profitable purposes. Public Law 94-568
amended the “exclusive” provision to read “substantially” in order to allow a section 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 further state:

(a) Within this 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. These percentages
supersede those provided in Revenue Ruling 71-17, 1971-1 C.B. 683.

Form 886-A (Rev.4-68) Department of the Treasury - Internal Revenue Service
Page: -2-

Form 886-A Department of the Treasury - Internal Revenue Service Schedule No. or
Explanation of Items Exhibit

Name of Taxpayer Year/Period Ended

(b) Thus, a social club may receive investment income up to the full 35 percent of its gross
receipts if no income is received from non-members’ use of club facilities.

(c) In addition, the Committee Reports state 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.

(d) The Senate report also indicates that even though gross receipts from the general public
exceed this standard, it does not necessarily establish that there is a nonexempt
purpose. A conclusion that there is a nonexempt purpose will be based on all the facts
and circumstances including, but not limited to, the gross receipts factor.

Revenue Ruling 58-589 sets forth the criteria for exemption under section 501(c)(7) of the Code,
and provides that a club must have an established membership of individuals, personal
contacts, and fellowship. It also provides that, while the regulations indicate that a club may
lose its exemption if it makes its facilities available to the general public, this does not mean that
any dealings with nonmembers will automatically cause a club to lose its exemption. A club
may receive some income from the general public, that is, persons other than members and
their bona fide guests, or permit the general public to participate in its affairs, provided that such
participation is incidental to and in furtherance of the club’s exempt purposes, such dealings
with the general public and the receipt of income therefrom does not indicate the existence of a
club purpose to make a profit, and the income does not inure to club members.

Revenue Ruling 60-324 provides that a social club that made its social facilities available to the
general public through its member-sponsorship arrangement can not be treated as being
operated exclusively for pleasure, recreation, or other nonprofitable purposes and the club no
longer qualified for exemption under 501(c)(7) of the Code.

Revenue Ruling 66-149 provides that a social club is not exempt from federal income tax as an
organization described in section 501(c)(7) of the code if it regularly derives a substantial part of
its income from non-member sources such as, for example, dividends and interest on
investments.

Revenue Ruling 68-119 provides that a club will not necessarily lose its exemption if it derives
income from transactions with other than bona fide members and their guests, or if the general
public on occasion is permitted to participate in its affairs, provided such participation is
incidental to and in furtherance of its general club purposes and the income therefrom does not
inure to members.

Revenue Procedure 71-17 sets forth guidelines for determining the effect of gross receipts
derived from nonmember use of a social club’s facilities on exemption under Internal Revenue
Code Section 501(c)(7) and recordkeeping requirements. Failure to maintain such records or
make them available to the Service for examination will preclude use of the minimum gross
receipts standard and audit assumptions set forth in this Revenue Procedure.

Form 886-A (Rev.4-68) Department of the Treasury - Internal Revenue Service
Page: -3-

Form 886-A Department of the Treasury - Internal Revenue Service Schedule No. or
Explanation of Items Exhibit
Name of Taxpayer Year/Period Ended
If a club exceeds the % test, then it will maintain its exempt status only if it can show

through facts and circumstances that “substantially all” of its activities are for “pleasure,
recreation and other nonprofitable purposes.”

The following are important facts and circumstances to take into account to determine whether a
club may maintain its exemption under IRC 501(c)(7):

• The actual percentage of nonmember receipts and/or investment income.

• Frequency of use of the club facilities or services by nonmembers. An unusual or
single event (that is, nonrecurring on a year to year basis) that generates all the
nonmember income is viewed more favorably than nonmember income arising from
frequent use by nonmembers.

• Record of nonmember use over a period of years. A high percentage in one year by
nonmembers, with the other years being within permitted levels, is viewed more
favorably than a consistent pattern of exceeding the limits, even by relatively small
amounts. (See S. Rept. 94-1318, 2d Sess., 1976-2 C.B. 597,599).

• Purposes for which the club’s facilities were made available to nonmembers.

• Whether the nonmember income generates net profits for the organization. Profits
derived from nonmembers, unless set aside, subsidize the club’s activities for
members and result in inurement within the meaning of IRC 501(c)(7).

TAXPAYER'S POSITION:

The has agreed to the proposed revocation of their tax exempt status as described in
IRC section 501(c)(7).

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 thirty-five 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 facilities or services by non-members.

has far exceeded the % gross receipts standard for nonmember income
for the examination year. A review of the prior and subsequent years indicated that
also far exceeded the % gross receipt test for nonmember income. The
nonmember receipts are earned throughout the year on a monthly basis for the examination
year as well as the prior and subsequent years. There was no one single or unusual event
that caused the club to exceed the % threshold.

Form 886-A (Rev.4-68) Department of the Treasury - Internal Revenue Service
Page: -4-

Form 886-A Department of the Treasury - Internal Revenue Service Schedule No. or
Explanation of Items Exhibit

Name of Taxpayer Year/Period Ended

Based on the large percentages of gross nonmember income to total gross receipts of the

, (i.e., as noted in the above table), which exceeded the limitation of % as set forth by
IRC 501(c)(7) for each of these years, it is the Government's position that the is no
longer operated exclusively for the pleasure and recreation of it’s members and is not
exempt under section 501(c)(7).

CONCLUSION:
The IRC Section 501(c)(7) tax exempt status of should be revoked since the
nonmember income received by the exceeded % of the total gross receipts for

the year under examination.

no longer meets the requirements to qualify as exempt from federal income tax
under IRC section 501(a) as described in section 501(c)(7). Therefore, your exempt status
under 501(c)(7) of the Internal Revenue Code will be revoked effective .

As a taxable entity, the organization is required to file Form , U.S. Corporation Income
Tax Return for the periods open under statute. Under 6501(g) these periods include the year
ended and subsequent tax years.

Form 886-A (Rev.4-68) Department of the Treasury - Internal Revenue Service
Page: -5-