IRS determination 1107030: Social club tax exemption revoked

Plain-English summary

The IRS revoked a social club's exemption under section 501(c)(7), effective on the stated January 1 date. The examination materials concluded that the organization exceeded the 15 percent gross-receipts limit for nonmember income for three consecutive years. The organization had consented to the proposed revocation, and the IRS required it to file federal income tax returns for the affected periods. The attached report also explains how member and nonmember income and expenses should be reported after revocation.

Ruling snapshot

• Question: Did the organization continue to qualify for exemption as a section 501(c)(7) social club?
• Outcome: Revocation
• Key authorities: IRC § 501(c)(7); IRC § 277; Treas. Reg. § 1.501(c)(7)-1

Full text (IRS public release)

DEPARTMENT OF THE TREASURY
INTERNAL REVENUE SERVICE

1100 Commerce, MC 4920 DAL 501.07-00
Dallas, TX 75242

TAX EXEMPT AND
GOVERNMENT ENTITIES November 24, 2010

DIVISION

Release Number: 201107030
Release Date: 2/18/11

LEGEND Taxpayer Identification Number:
ORG - Organization name Form:
XX = Date Address = address Tax Year(s) Ended:

Person to Contact/ID Number:
Contact Numbers:

ORG Telephone:

ADDRESS Fax:

CERTIFIED MAIL —- RETURN RECEIPT REQUESTED
Dear

In a determination letter dated January 19XX, you were held to be exempt from Federal
income tax under section 501(c)(7) of the Internal Revenue Code (the Code).

Based on recent information received, we have determined you have not operated in
accordance with the provisions of section 501(c)(7) of the Code. Accordingly, your
exemption from Federal income tax is revoked effective January 1, 20XX. This is a final
adverse determination letter with regard to your status under section 501(c)(7) of the
Code.

We previously provided you a report of examination explaining why we believe
revocation of your exempt status is necessary. At that time, we informed you of your
right to contact the Taxpayer Advocate, as well as your appeal rights. On June 22,
20XX, you signed Form 6018-A, Consent to Proposed Action, agreeing to the
revocation of your exempt status under section 501(c)(7) of the Code.

You are required to file Federal income tax returns for the tax period(s) shown above. If
you have not yet filed these returns, please file them with the Ogden Service Center
within 60 days from the date of this letter, unless a request for an extension of time is
granted, or unless an examiner's report for income tax liability was issued to you with
other instructions. File returns for later tax years with the appropriate service center
indicated in the instructions for those returns.

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 contact the person whose name and telephone
number are shown at the beginning of this letter.

Sincerely,

Nanette M. Downing
Director, EO Examinations

DEPARTMENT OF THE TREASURY
Internal Revenue Service
1616 Capitol St Ste 450 Stop 47100MA
Omaha, NE 68102-4923

TAX EXEMPT AND
GOVERNMENT ENTITIES

June 15, 2010
Taxpayer Identification Number:
ORG
ADDRESS Form:

Tax Year(s) Ended:
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 Internal
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

You may also request that we refer this matter for technical advice as explained in
Publication 892, Exempt Organization Appeal Procedures for Unagreed Issues. If 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 returns 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 returns.

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 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.

Letter 3610 (04-2002)
Catalog Number 34801 V

Thank you for your cooperation.

Enclosures:
Publication 892
Publication 3498
Form 6018

Report of Examination
Envelope

Sincerely,

Nanette M. Downing
Director, EO Examinations

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 20XX/12
EIN: EIN
LEGEND
ORG = Organization name XX = Date City = city State = state
Issue:

Whether ORG qualifies for exemption under Section 501(c)(7) of the Internal Revenue
Code?

Facts:

Article

The articles were filed 7-27-19XX. The articles stated the purpose was to manage and
control without profit to the stockholders, for social and charitable purposes a golf course
in City, State. There was not a discriminatory statement to violate their exempt status.

Activities

The club is bound together for the common purpose of golfing. The Club manager
operates the bar and restaurant. During the 20XX period, they remodeled the bar and
increased the business for the rental facility. The club’s income is from membership dues,
hall rental, green fees, cart and shed rental and cart lease rental. The membership
consists of family, single, social, couples and students.

The Club House is open from April to Oct from 9:00AM to 5:30PM Sunday to Saturday.
The course is open from approximately 7AM to Sunset 5-5:30PM. The hours are flexible
according to the weather, sunrise and sunset. Tuesdays and Wednesdays are league
days. They may have 3-4 tournaments per year. There are invoices recorded for all
golfing, rentals and bar/food sales. The Taxpayer did follow Rev. Proc. 71-17, 1971-1
C.B. 683.

The Power of Attorney (POA) advised me how to distinguish between member, non-
member income and combined member and non-member income categories. The green
fees and cart rental was non-member income only; cart lease and shed rental is member
only income. For the 12/31/20XX tax period, I recorded the actual member and non-
member income from the event invoices. I totaled all the identified combined
member/non-member income from the invoices. The POA informed me since forever a
historical 33% was used to determine the non-member income. The formula used to
categorize member/non-member is: I identified the combined mem/non-member income,
then subtracted the actual member and non-member income=remainder income (if any)
is then multiplied by the 33% historical figure used by the POA. I tried to compute a
more reasonable percentage by taking all the percentage’s derived from the various non-
member/total incomes but the average totaled 54% and did not seem appropriate for the
daily traffic, so I used the 33% historical figure. Using the 33% non-member income
figure is more than 15% gross receipts test and will result in an inevitable amount of
being over the 15% gross receipts test.

The profit and loss statements were used to compute the 12/31/20XX and the
12/31/20XX unrelated business income (UBI) gross receipts test. The Form 990 for the
12/31/20XX period was used to determine the UBI gross receipts test. The percentage for
the UBI gross receipts test for 20XX to 20XX are as follows: 31%, 36% and 40%
worksheets attached. Because the unrelated business income (UBI) gross receipts is over

Form 886-A (Rev. 4-68) Department of the Treasury - Internal Revenue Service
Page: -1-

Form 886A Department of the Treasury - Internal Revenue Service Schedule No. or
Explanation of Items Exhibit
Name of Taxpayer Year/Period Ended
ORG 20XN/12
EIN: EIN

the 15% for non-member income for three years, revocation was recommend effective
January 1, 20XxX.

Law:

IRC § 501(c)(7) 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.

REGS, §1.501(c)(7)-1. Social clubs (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 any part of 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.
(Reg. §1.501(c)(7)-1.]

IRC § 277. DEDUCTIONS INCURRED BY CERTAIN MEMBERSHIP ORGANIZATIONS
IN TRANSACTIONS WITH MEMBERS.

IRC § 277(a) GENERAL RULE. —In the case of a social club or other membership organization
which is operated primarily to furnish services or goods to members and which is not
exempt from taxation, deductions for the taxable year attributable to furnishing services,
insurance, goods, or other items of value to members shall be allowed only to the extent of
income derived during such year from members or transactions with members (including
income derived during such year from institutes and trade shows which are primarily for the
education of members). If for any taxable year such deductions exceed such income, the
excess shall be treated as a deduction attributable to furnishing services, insurance, goods,
or other items of value to members paid or incurred in the succeeding taxable year. The
deductions provided by sections 243, 244, and 245 (relating to dividends received by
corporations) shall not be allowed to any organization to which this section applies for the
taxable year.

Revenue Procedure 71-17, 1971-1 C.B. 683, describes the record-keeping requirements
for social clubs exempt under IRC 501(c)(7) with respect to nonmember use of their
facilities; it sets forth guidelines for determining the effect of gross receipts derived from
public use of the club’s facilities on exemption and liability for unrelated business income
tax.

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

Form 886A | Department of the Treasury - Internal Revenue Service Schedule No. or
ee | Explanation of Items Exhibit
Name of Taxpayer Year/Period Ended
ORG 20XX/12
EIN: EIN

Gross Receipts Test / Public Law 94-568

Section 501(c)(7) was amended in 1976 by Public Law 94-568 to provide that section
501(c)(7) organizations could receive some outside income without losing their exempt
status. Senate Report No. 94-1318 (1976), 2d Session, 1976-2 C.B. 597, explains that a
social club is permitted to receive up to 35 percent of its gross receipts, including
investment income, from sources outside of its membership without losing its tax-exempt
status. It is also intended that 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 (nonmembers). In effect, the latter modification increases from 5 percent
(Rev. Proc. 71-17, 1971-1 C.B. 683) to 15 percent the proportion of gross receipts a club
may receive from making its club facilities available to the general public without losing its
tax exempt status.

The Senate Report also states that it is not intended that these organizations should be
permitted to receive, within the 15 percent or 35 percent allowances, income from the
active conduct of businesses not traditionally carried on by these organizations. In cases
where an organization's nontraditional income would cause the organization to exceed the
15 or 35 percent allowances, consideration should be given as to whether the organization
continues to be substantially operated for IRC § 501(c)(7) purposes.

According to the Committee Reports, where a club receives income from other sources (non-
traditional or unusual), including income from the sale of its clubhouse or similar facility,
that income is not to be included in the formula; that is, such income is not to be included
in either the numerator or the denominator for purposes of computing the 35 or 15 percent
allowances.

The Committee Reports provide that gross receipts include, charges, admissions,
membership fees, dues, assessments, investment income (such as dividends, rents, and
similar receipts), and normal recurring capital gains on investments, but excluding
initiation fees and capital contributions.

Where college fraternities or sororities charge membership initiation fees but not normal
dues, such fees will be included in their gross receipts, notwithstanding that initiation fees
are ordinarily excluded (Senate Report 94-1318, 2d Session, 1976-2 C.B. 599.).

Taxpayer's Position:

Discussed the issue with the POA and the Taxpayer and they agreed the non-member
income exceeded the gross receipts limitations. POA has been compliant and sent in
converted Forms 1120 for the December 31, 20XX, 20XX and 20XX tax periods.

Government's Position:

Based on the facts of the examination, the organization does not qualify for exemption
since the operations were more than substantial for non-members. The Public Law 94-
568 and Senate Report No. 1318 amended IRC 501(c)(7) as of October 20, 19XX. Those

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

Form 886A Department of the Treasury - Internal Revenue Service Schedule No. or
Explanation of Items Exhibit
Name of Taxpayer Year/Period Ended
ORG 20XX/12
EIN: EIN

documents limited the non-member income to be received by social clubs. This
organization substantially exceeded the 15% limitation from non-member income for
three consecutive years.

Conclusion: Based on the foregoing reasons, the organization does not qualify for
exemption under section 501(c)(7) and its tax exempt status should be revoked.
Accordingly, the organization's exempt status is revoked effective January 1, 20XX.

Per Section 277 of the Internal Revenue Code (Code), a non-exempt organization that is a
membership organization is allowed a deduction for expenses that relate to the operation of
the organization for its members. Section 277(a) states that “In the case of a social club or
other membership organization which is operated primarily to furnish services or goods to
members, and which is not exempt from taxation, deductions for the taxable year
attributable to furnishing services, insurance, goods, or other items of value to members
shall be allowed only to the extent of income derived during such year from members or
transactions with members (including income derived during such year from institutes and
trade shows which are primarily for the education of members)”.

When completing the Form 1120 the organization must divide the income and expenses
between the member and non-member activities. If there is a loss from the membership
activity it cannot be used to offset the income from the non-member activities. A loss on
the member activity can be carried forward to a later year to be taken against member
income,

Form 1120 returns should be filed for the tax periods ending on or after December 31,
20XX.

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