501(c)(7) social club loses exemption because investment income repeatedly exceeded the 35% limit

Plain-English summary

The IRS revoked the tax exemption of a social club that had been recognized under section 501(c)(7). Social clubs (think recreation associations supported by member dues) get their exemption on the condition that substantially all of their activity is for pleasure, recreation, and similar member purposes. A 1976 law (Public Law 94-568) set a bright-line cushion: a 501(c)(7) club may take in up to 35 percent of its gross receipts from outside its membership, including investment income, without losing exemption. On audit, this club's income came mostly from professionally managed investment accounts and interest, and its investment income exceeded the 35 percent threshold year after year. Because it was no longer operating substantially for recreational purposes, the IRS concluded it did not qualify as a social club and revoked the exemption, effective the stated date, requiring it to file exempt-organization business income tax returns (and, if revocation stands, to begin filing the applicable returns for later periods). This matters to any dues-funded club sitting on a large investment portfolio: passive earnings that dwarf member receipts can tip it out of 501(c)(7) status.

Ruling snapshot

• Question: Does a social club still qualify under IRC § 501(c)(7) when its investment income has repeatedly exceeded the 35% investment-income limit?
• Outcome: Revocation (proposed and finalized; exemption revoked)
• Key authorities: IRC § 501(c)(7); Treas. Reg. § 1.501(c)(7)-1; Public Law 94-568 (Senate Report No. 94-1318); Rev. Rul. 66-149

Full text (IRS public release)

(Scanned document; OCR-proofread. Obvious scan misreads were corrected; wording is preserved verbatim, and redaction gaps left by the IRS appear as blank spaces or underscores.)

Department of the Treasury
Internal Revenue Service                                   Date: July 28, 2022
IRS Tax Exempt and Government Entities

Release Number: 202305013
Release Date: 2/3/2023
UIL Code: 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 organized and operated substantially for an exempt purpose within the meaning of IRC
Section 501(c)(7). Your gross receipts from investments have consistently exceeded the      % threshold as
outlined in Public Law 94-568. As a result, you are not operating substantially for pleasure, recreation, or other
non-profitable purposes.

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,
       A. Brinkley
Acting Director, Exempt Organizations Examinations

Enclosures:
Publication 1
Publication 594
Publication 892

Letter 6337 (12-2020)
Catalog Number 74808E


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Department of the Treasury
Internal Revenue Service                                   Date: 1/26/2022
IRS Tax Exempt and Government Entities

Response due date: February 24, 2022

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.

   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).

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

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


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Form 886-A                Explanations of Items

ISSUE
Has         met the requirements of the Internal Revenue Code (IRC)
Section 501(c)(7) and Treasury Regulation 1.501(c)(7)-1 if their investment income has repeatedly
exceeded the      % investment income limitation?

FACTS
        is exempt as an organization described in IRC § 501(c)(7) to
provide social, recreational, and other activities to its members. The organization was formed in
        in the         Court of         in       . Their primary
purpose, per their Form      , is to foster good         among         and         , preserve
        and all forms of         , aid in the distribution and         of         , and to
do all other acts consistent with the         ,         , and the Association.
On       , the Revenue Agent held a phone conference with         , the
organization's         . Through the conference it was discovered that the EO's
activities includes         and parties and work weekends to maintain and improve the
        . It was also revealed that majority of the organization's income is generated from
investments. These investments include professionally managed investment accounts with
        and         . The organization also has a         which generates interest
income and         in the form of         .
The organization reported investment income on Form      , Exempt Organization Business
Income Tax Return, for the periods       -       , as follows:

   Form      :
   Total Investment Income:     $        $        $        $
   Gross Receipts:              $        $        $        $
   Percentage of investment income:   %      %      %      %

The organization's total investment income has consistently exceeded the      % investment income
limitation.

LAW
IRC § 501(c)(7) exempts from federal income tax clubs organized for pleasure, recreation, and
other non-profitable 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) 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:

   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.

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.

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
Taxpayer's position has not been provided.

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 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.

The organization's investment income makes up      % of its gross receipts for the year under audit.
Over the last      tax years, investment income has consistently exceeded      % of its gross
receipts, exceeding the      percent limitation on investment income for a 501(c)(7) organization.

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

CONCLUSION
        does not qualify for exemption under section 501(c)(7) of the Code
as their investment income has exceeded the      limitations on a continuing basis. Therefore, it is
proposed that your exempt status under § 501(c)(7) of the Code be revoked 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      .
If you disagree please submit a statement of your position.

Form 886-A (Rev. 5-2017)  Catalog Number 20810W