IRS revoked a social club's tax-exempt status for excessive nonmember activity

Plain-English summary

The IRS Appeals Office considered an organization's appeal of the revocation of its exemption under IRC § 501(c)(7). The organization operated social and recreational facilities, but its nonmember receipts exceeded the applicable safe-harbor limits over multiple years. The IRS concluded that the organization did not qualify under § 501(c)(7) or another subsection of § 501(c), revoked its exemption, and required Form 1120 filings for open years. The examination report also reminded the organization about the rules for membership organizations under § 277.

Ruling snapshot

• Question: Did the organization continue to qualify as a tax-exempt social club under IRC § 501(c)(7)?
• Outcome: Revocation
• Key authorities: IRC §§ 501(c)(7), 6501(g), 277, and 6014

Full text (IRS public release)

Internal Revenue Service

Appeals Office ~ TEGE Programs

Attn: Chris Doerr

Royal Palm One, Suite 350
1000 South Pine Island Road
‘Plantation, FL 33324

Department of the Treasury

Person to Contact:

Employee ID Number:
Tel:

Fax:

Number: 201038021 Refer Reply to:
Release Date: 9/24/2010 AP:A4:T5:CD

In Re: A = Org. Name
Date: July 2, 2010 EIN: C =EIN

UIL: 501.07.05

Year(s): FYE 10/31/ &
A= Org. Name 10/31/

B = Org. Address

To . a,

We have considered your appeal of the revocation of your tax-exempt status under
section 501(c)(7) of the Internal Revenue Code.

Your exemption from Federal income tax under Section 501(c)(7) of the Internal
Revenue Code is hereby revoked. This is a final adverse determination letter.
You are required to file Federal income tax returns on Form 1120 for any years,
which are still open under the statute of limitations.

Consideration was given to whether you qualify for exemption under other
subsections of section 501(c) of the Code; however, we have concluded that you
do not qualify under another subsection.

if you have any questions, please contact the person whose name and telephone
number are shown above.

Sincerely,

Zh FA —

Charles F. Fisher
Appeals Team Manager

Cc:

DEPARTMENT OF THE TREASURY
Internal Revenue Service
30 East 7th Street, #1130-B
St. Paul, MN 55101

TAX EXEMPT AND
GOVERNMENT ENTITIES
DIVISION

August 20, 2008

ORG Taxpayer Identification Number:
, Form:
Tax Year(s) Ended:
ADDRESS Person to Contact/ID Number:
Contact Numbers:
Telephone:
Fax:

CERTIFIED MAIL — RETURN RECEIPT REQUESTED

Dear

We have enclosed a copy of our report of examination explaining why we believe an
adjustment of your organization's exempt status is necessary.

If you do not agree with our position you may appeal your case. The enclosed
Publication 3498, The Examination Process, explains how to appeal an Intemal
Revenue Service (IRS) decision. Publication 3498 also includes information on your
rights as a taxpayer and the IRS collection process.

If you request a conference, we will forward your written statement of protest to the

Appeals Office and they will contact you. For your convenience, an envelope is
enclosed.

If you and Appeals do not agree on some or all of the issues after your Appeals
conference, or if you do not request an Appeals conference, you may file suit in United
States Tax Court, the United States Court of Federal Claims, or United States District

Court, after satisfying procedural and jurisdictional requirements as described in
Publication 3498.

Letter 3610 (04-2002)
Catalog Number 34801V

2

You may also request that we refer this matter for technical advice as explained in
Publication 892, Exempt Organization Appeal Procedures for Unagreed Issues. lf a
determination letter is issued to you based on technical advice, no further
administrative appeal is available to you within the IRS on the issue that was the
subject of the technical advice.

If you accept our findings, please sign and return the enclosed Form 6018, Consent to
Proposed Adverse Action. We will then send you a final letter modifying or revoking
exempt status. If we do not hear from you within 30 days from the date of this letter,
we will process your case on the basis of the recommendations shown in the report of
examination and this letter will become final. In that event, you will be required to file
Federal income tax returns for the tax period(s) shown above. File these retums with
the Ogden Service Center within 60 days from the date of this letter, unless a request
for an extension of time is granted. File returns for later tax years with the appropriate
service center indicated in the instructions for those retums.

You have the right to contact the office of the Taxpayer Advocate. Taxpayer Advocate
assistance is not a substitute for established IRS procedures, such as the formal
appeals process. The Taxpayer Advocate cannot reverse a legally correct tax
determination, or extend the time fixed by law that you have to file a petition in a.
United States 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 may call toll-free 1-877-777-4778 and ask for Taxpayer Advocate
Assistance. If you prefer, you may contact your local Taxpayer Advocate at:

If you have any questions, please call the contact person at the telephone number
shown in the heading of this letter. If you write, please provide a telephone number
and the most convenient time to call if we need to contact you.

Thank you for your cooperation.
Sincerely,

Vicki L. Hansen
Acting Director, EO Examinations

Enclosures:
Publication 892
Publication 3498
Form 6018

Report of Examination

Letter 3610 (04-2002)
Catalog Number 34801V

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

Explanation of Items Exhibit

Name of Taxpayer Year/Period

; Ended
ORG 10/31/20XX

LEGEND
ORG - Organization name XX = Date
ISSUE:

Does the ORG continue to meet the qualifications of an
organization described in Internal Revenue Code Section
501(c) (7)?

FACTS:

ORG received exemption as an organization described in IRC
501(c) (7) in 19xx. The books
and records of the organization for the period ending October
31, 20XX were examined. It was found that the club is
substantially in compliance with Rev. Proc. 71-17. Nonmember
events are carried on throughout the year. The organization
receives nonmember revenue for use of its golf course, pool and
tennis court and from food and beverage sales to nonmembers.
Form 990 was found to be substantially correct as filed.

The organization also filed Form 990-T for the period ending
October 31, 20XX, which was found to be substantially correct.
The organization has had a loss on its nonmember activity for
every year since at least 20xXx.

Inspection of the returns filed by the Club for the prior years
shows that the organization has reported nonmember income in
excess of 15* since at least 20xx.

Based on the amounts reported on the organization's retained
copies of Forms 990, the percent of gross receipts from
nonmember use of facilities was %, %, % and % in the:
years ending October 31, 20XX, 20XX, 20XX and 20xXX,
respectively. See Attachment A.

Investment income in each of these years in less than one
percent of the organization's receipts.

LAW AND DISCUSSION:

Internal Revenue Code section 501(c)(7) provides for the

exemption from Federal income taxes for Social Clubs. Income
Tax Regulation section 1.501(c) (7)-1 states that if a Social
Club makes its social and recreational facilities available to

Department of the Treasury - Internal Revenue Service Form 886-A Page 1

Form 886A Department of the Treasury - Intemmal Revenue Service Schedule No. or —
Explanation of Items - Exhibit
Name of Taxpayer Year/Period
Ended
ORG 10/31/20XX

the general public it will not qualify for tax-exempt status.
However, Revenue Procedure 71-17 as amended by Public Law 94-568
provides certain gross receipts safe harbors; i.e. Social Clubs
May receive up to % of their total gross receipts, including
investment income, from sources outside of their membership
without jeopardizing their tax-exempt status. Within this %
limit, no more than % of a club's gross receipts may be
derived from nonmember use of the club's facilities and/or
services.

If a club exceeds the 15/35% 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):

e 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).

e Purposes for which the club's facilities were
made available to nonmembers.

e Whether the nonmember income generates net profits for
the organization.
TAXPAYER'S POSITION:

The taxpayer's position is unknown at this time.

Department of the Treasury - Internal Revenue Service Form 886-A Page 2

Form 886A Department of the Treasury- Internal Revenue Service -| Schedule No.-or
Explanation of Items Exhibit
Name of Taxpayer Year/Period
Ended
ORG 10/31/20XX

GOVERNMENT'S POSITION:

ORG has exceeded the % gross receipts standard for
nonmember income on a continuous basis for at least four
years. The nonmember receipts are earned
throughout the year. There was no one single or unusual
event that caused the club to exceed the % threshold.
While the organization has reported losses on its
dealings with

nonmembers, some of the expenses contributing to the loss
are interest, property taxes and depreciation. That is,
fixed costs which would otherwise be borne by the members
have been allocated to nonmember revenue, which contributed
to the loss on nonmember activity.

Revocation of its tax-exempt status is warranted,
effective November 1, 20XX.

As a taxable entity, the organization is required to file
Form 1120, U.S. Corporation Income Tax Return for the .
periods open under statute. Under 6501(g) these periods

include the years ending October 31, 20XX and October
31, 20XX.

Additionally, the organization is reminded of the
provisions of IRC 277 concerning membership organizations
which are not exempt organizations.

In accordance with the provisions of Internal Revenue Code
Section 6014, copies of these examination conclusions and
consent to the revocation of tax exemption will be submitted
to the Minnesota Department of Revenue at the conclusion of
the examination.

Department of the Treasury - Internal Revenue Service Form 886-A Page 3