IRS determination 1146022: IRS revokes a social club's exemption for recurring public income

View official IRS release (PDF)

Plain-English summary

The IRS revoked a social club's exemption under IRC § 501(c)(7), effective January 1 of the redacted year. The examination found recurring income from bingo and other charitable gaming with the general public, sales of food, drinks, and ink markers, facility rentals, and donations from the general public. The IRS concluded that these activities produced substantial and recurring income from nonmember sources, and that the club had not maintained records sufficient to establish the member and nonmember portions of its receipts. The document also discusses failures to file required returns and penalties under IRC §§ 6651 and 6662. The club's president signed a consent agreeing to revocation.

Ruling snapshot

• Question: Could the social club continue to qualify under IRC § 501(c)(7) despite recurring nonmember income and related filing and recordkeeping failures?
• Outcome: Revocation.
• Key authorities: IRC §§ 501, 511, 6001, 6033, 6651, 6662, 7428; Treas. Reg. §§ 1.501(c)(7)-1(b), 1.6001-1(a), 1.6001-1(c); Rev. Proc. 71-17; Rev. Rul. 59-95.

Full text (IRS public release)

DEPARTMENT OF THE TREASURY
INTERNAL REVENUE SERVICE

Attn: Mandatory Review, MC 4920 DAL

1100 Commerce St.

Dallas, Texas 75242

TAX EXEMPT AND 501.07-00
GOVERNMENT ENTITIES
DIVISION
Number: 201146022 Date: August 24, 2011

Release Date: 11/18/2011

LEGEND
ORG - Organization name
XX - Date Address - address
ORG Employer Identification Number:
ADDRESS Person to contact/ID Number:
Contact numbers:
Voice:
Fax:

CERTIFIED MAIL — RETURN RECEIPT REQUESTED
Dear

In a determination letter dated July 31, 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 September 23, 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 have filed taxable returns on Forms 1120, U.S. Corporate Income Tax Return, for the years
ended December 31, 20XX, December 31, 20XX, and December 31, 20XX with us. For future
periods, you are required to file Form 1120 with the appropriate service center indicated in the
instructions for the return.

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

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

LEGEND
ORG - Organization name XX - Date Address - address City - city
State - state EIN - EIN CO-1, CO-2, CO-3 & CO-4 - 157, 2™, 37 & 47
COMPANIES
ISSUES

Whether an organization may continue to qualify for exemption under IRC Section 501(c)(7)
when its non-member income consistently exceeds the fifteen percent limitation of total
income?

Whether an organization may continue to qualify for exemption under IRC Section 501(c)(7)
when its sources of income are from conducting bingo activities with the general public,
sales of ink markers, food and drinks to the general public, and rental of its facilities to the
general public? And when the source of income is from donations from the general public?

Whether an organization may continue to qualify for exemption under IRC Section 501(c)(7)
when it fails to correctly file Form 990-EZ and fails to file Form 990-T when due as required
under IRC Section 6033?

Whether an organization no longer exempt under Section 501(c)(7) is liable for filing Form
1120?

Whether the organization is liable for penalties for failure to file tax returns (Form 990-T)
under IRC Section 6651?

Whether the organization is liable for penalties for substantial underpayment of taxes
under IRC Section 6662?

If revocation is not upheld, whether income to an IRC Section 501(c)(7) organization is
taxable as unrelated business income when it is from conducting bingo activities with the
general public, sales of ink markers, food and drinks to the general public and when it is
from rental of its facilities to the general public? And when it is from donations from the
general public?

FACTS

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
December 31,
ORG 20XX, 20XX & 20XX

The ORG (ORG) was incorporated as a State Non-Stock Corporation on December 13, 19XX
according a copy of a certification by the Clerk of the Commission dated February 24, 19XX.
ORG was granted exemption as an IRC Section 501(c)(7) organization on July 31, 19XX. Review
of the State State Corporation website indicated that ORG is an active State Non-stock
Corporation with a status date of May 5, 19XX; the original certificate was issued December 13,
19XX.

A copy of ORG’s Articles of Incorporation were requested, but was not furnished by the
organization.

ORG’s constitution and by-laws (revised March 20XX), which is an operating document, sets
forth its general purposes as follows:

The ORG’s objectives are to operate a civic fraternal organization, to promote the social,
literary and benevolent interests of its members, to acquire and own real estate and
personal property by gift, devise, or purchase, to conduct dances and socials, and to
promote the welfare and civic needs of others.

ORG’s constitution and by-laws (revised March 20XX) defines the composition of and terms of
service for its board of directors and officers as follows:

A board of directors consisting of seven members shall be elected for staggered terms of
one year, two years and three years. The Board of Directors is the official elected body that
directs or supervises some activities and control or govern the affairs of the ORG.

All officers are elected for a term of one year. The President and all officers shall succeed
themselves in office as long as it is the desire of the ORG.

The Service conducted an examination of ORG for the years ending December 31, 20XX,
December 31, 20XX and December 31, 20XX. The examination resulted from an examination of
a related IRC Section 501(c)(3) organization, CO-1 (CO-1).

ORG did not file a Form 990, Return of Organization Exempt from Income Tax for the year
ending December 31, 20XX under its EIN of EIN. Rather, a Form 990 was filed under the EIN
EIN, belonging to CO-1 (CO-1), a related Section 501(c)(3) organization. The consolidated Form
990 combined sources of income and expense from both ORG (Section 501(c)(7) activities) and
CO-1 (Section 501(c)(3) activities) for the year ending December 31, 20XX.

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

Page: -2-

Form 8 86 A Department of the Treasury - Internal Revenue Service Schedule No. or
Explanation of Items Exhibit
Name of Taxpayer Year/Period Ended
December 31,
ORG 20XX, 20XX & 20XX

ORG filed Form 990EZ for the years ending December 31, 20XX and December 31, 20XX
utilizing its own EIN of EIN.

ORG did not file Form 990-T for the years ending December 31, 20XX, December 31, 20XX or
December 31, 20XX.

Audit work showed that both ORG and CO-1 are governed by the same board of directors and
officers for each of the years under examination. The very same individuals that serve as
President and Treasurer for ORG also serve as President and Treasurer for CO-1. The board of
directors for ORG serves as the board of directors for CO-1. Neither organization has a conflict
of interest policy.

The President of ORG/CO-1 stated that ORG owns the building, land and improvements located
at Address, City, State. The building was constructed by members during the late 1950’s and
early 1960’s, per testimony from the President. The building consists of a “private area” with a
flat screen television, booths, tables, chairs and a bar with bar stools. Restrooms are located at
one end, the street side, and a hallway to a kitchen and private office, utilized by ORG officers,
are at the other end. An open doorway leads to a large, open hall with long tables and chairs,
bingo calling board and flat screen televisions make up about 70% of the square footage of the
building. On the opposite end of the large hall from the street are storage areas and
restrooms. A secured room holds the inventory of bingo sheets and sealed cards with sheets
on top of each item, indicating current counts and inventory values of the gaming supplies.

According to testimony from the President of ORG/CO-1, the IRC Section 501(c)(7)’s activities
conducted by ORG include operation of a bar and kitchen for the use of its members and their
guests, Friday night socials, dances and other social activities, rental of the hall to the general
public for baby showers, dances, reunions, parties, repasses, etc. ORG conducts fund raising
activities such as raffles among the members, car shows and sales of doughnuts to the general
public. ORG receives annual donations from CO-2, as well occasionally from other
organizations and individuals. ORG sells food, drinks and ink markers to participants of bingo
games, operated by the related IRC Section 501(c)(3) organization, CO-1 (CO-1). Revenue from
these ORG activities is deposited into the CO-3 Account, number #, which reflects the name of
ORG and EIN of EIN and serves as the primary checking account for ORG. The President of
ORG/CO-1 has signature authority for this checking account, as does another member of ORG.

Audit work showed that in July 20XX, ORG established a checking account at ,
account number #, which serves as a contingency fund for ORG. Proceeds from fundraising
events, as well as a $$ donation received in 20XX were deposited into the contingency fund

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
December 31,
ORG 20XX, 20XX & 20XX

during 20XX. The President of ORG/CO-1 has signatory authority for the account as does
another member of ORG.

The President of ORG/CO-1 stated that CO-1 conducts its IRC Section 501(c)(3) activities in the
building owned by ORG. There is no lease agreement between ORG and CO-1 during the years
under examination.

According to testimony by the President of ORG/CO-1, charitable gaming is the primary fund
raising activity conducted by CO-1. The IRC 501(c)(3) charitable gaming activities are
conducted by the President and Treasurer of ORG/CO-1 and by another member of ORG.
Other members of ORG assist with the selling of sealed cards (pull tabs) from time to time. The
volunteer bookkeeper assists with counting of the gaming proceeds and preparation of the
bank deposit. The President of ORG/CO-1 takes the deposit to the bank. Charitable gaming
proceeds are deposited into the CO-4 Checking Account, account number #. ORG’s name and
EIN were indicated on the CO-4 checking account for the years ending December 31, 20XX and
December 31, 20XX. For the year ending December 31, 20XX, the CO-4 checking account was
changed to reflect the name and EIN of CO-1. The President of ORG/CO-1 has signature
authority for this account, as does another member of ORG.

Commonwealth of State Charitable Gaming Permits indicate that the permit for the time
period of November 1, 20XX through October 31, 20XX was in the name of the IRC Section
501(c)(7) organization, ORG. Below is reflected the name of the organization whose name
appeared on Charitable Gaming Permits for the indicated periods of time:

Period Organization
1/1/20XX — 10/31/20XX CO-1
11/1/20XX — 10/31/20XX ORG.
11/1/20XX — 12/31/20XX CO-1

Gaming receipts and direct costs for each of the years under examination as reported on Form
101 to the State Division of Charitable Gaming are reflected below:

Period Gaming Receipts Direct Costs
1/1/20XX — 12/31/20XX
1/1/20XX — 12/31/20xx
1/1/20XX — 12/31/20XxX

Audit work showed that CO-1 paid for facilities related expenses that were invoiced to ORG
from the CO-4 Checking Account; the checks were signed by the President of ORG/CO-1. These

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
December 31,
ORG 20XX, 20XX & 20XX

expenses included cable television and internet, utilities, insurance, real estate and personal
property taxes, as well as repairs and maintenance. The table below reflects the facilities
related disbursements paid for by CO-1 for the periods ending December 31, 20XX and

December 31, 20XX.

Period
1/1/20XX — 12/31/20XX
1/1/20XX — 12/31/20XX

Facilities Related Expenses

For the period ending December 31, 20XX, the facilities related expenses of S$ were attributed
to ORG. ORG conducted bingo activities and controlled the CO-4 checking account during this

time period.

Testimony provided by the President of ORG/CO-1 indicated that ORG sells drinks, food and ink

markers to the public during charitable gaming sessions conducted by CO-1. Audit work

below:

Period
1/1/20XX — 12/31/20XX
1/1/20XX — 12/31/20XX
1/1/20XX — 12/31/20XX

Sales Cost of Goods Sold

Audit work showed that ORG rents the building and improvements to the public. Rental
income for each of the years under examination is reflected below:

Period
1/1/20XX — 12/31/20XX
1/1/20XX — 12/31/20XX
1/1/20XX — 12/31/20XX

Rental Income

Audit work showed that ORG received donations on an annual basis from individuals and
businesses. Donations received from the general public for each of the years under

examination are shown below:

Period
1/1/20XX — 12/31/20XxX
1/1/20XX — 12/31/20XxX
1/1/20XX — 12/31/20XX

Donation Income

Form 886-A (Rev.4-68)

Department of the Treasury - Internal Revenue Service

Page: -5-

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

Audit work showed that ORG made deposits into its checking account with CO-3 during 20XX in
the amount of $ and during 20XX in the amount of $, for which no identification for the source
of the funds was provided.

Audit work showed that ORG had fundraising income of $$ during 20XX from sales of
doughnuts to the general public and incurred $$ in direct costs.

Audit work determined that for the Form 990EZ filed by ORG for the year ending December 31,
20XX, income was understated by $$. Expenses were understated by $$. Cash in bank was
overstated by $S. Inventory was not reported.

Audit work determined that for the Form 990EZ filed by ORG for the year ending December 31,
20XX, income was understated by $$. Expenses were understated by $$. Inventory was not
reported.

The President of ORG/CO-1 provided a letter addressed to the Service, dated June 29, 20XX,
submitting a plan to address the charitable organization paying a disproportionate amount of
the ORG operating expenses. The letter stated the ORG is used 75 percent of the time by the
charitable organization. Based on the operating expenses of the past 3 years, the charitable
organization will be assessed $$ per month for ORG usage effective July 1, 20XX. This letter is
attached as Exhibit 1.

The President of ORG/CO-1 provided a letter addressed to the Service, dated August 5, 20XX,
which stated the ORG members unanimously voted to terminate its 501(c)(7) tax-exempt
status effective October 1, 20XX. The letter is attached as Exhibit 2.

The Chairman of the Board of the ORG provided to the Service an ORG Resolution, dated
September 1, 20XX. The Resolution states:

“The Board of Directors of the ORG, Address, City, State, hereby acknowledges the
termination of the ORG’s 50(c)(7) tax exempt status as of October 1, 20XX.

Be it resolved, the Board of Directors will work diligently with the ORG’s officers and
persons responsible for reports, to ensure that tax reports and pertinent information
are submitted in a timely manner.

Form 886-A (Rev.4-68) Department of the Treasury - Internal Revenue Service
Page: -6-

Schedule No. or

Form 886 A Department of the Treasury - Internal Revenue Service
Explanation of Items Exhibit
Name of Taxpayer Year/Period Ended
December 31,
ORG 20XX, 20XX & 20XX

The Board of Directors further resolves to work toward the goal of regaining the
501(c)(7) tax exempt status by strict compliance with all requirements of the IRS and
any other agency involved.”

The Resolution is attached as Exhibit 3.

Form 886-A (Rev.4-68)

Department of the Treasury - Internal Revenue Service

Page: -7-

Fotm 886 A Department of the Treasury - Internal Revenue Service Schedule No. or
Explanation of Items Exhibit
Name of Taxpayer Year/Period Ended
December 31,
ORG 20XX, 20XX & 20XX

LAW

Section 501(c)(7) of the Internal Revenue Code provides that ORGs organized and operated
exclusively for pleasure, recreation, and other nonprofitable purposes are exempt from Federal
income tax provided no part of the net earnings inures to the benefit of any private
shareholder.

Section 6001 of the Code addresses notice or regulations requiring records, statements,
and special returns. Every person liable for any tax imposed by this title, or for the
collection thereof, shall keep such records, render such statements, make such returns, and
comply with such rules and regulations as the Secretary may from time to time prescribe.

Section 6033(a)(1) of the Internal Revenue Code provides, except as provided in IRC

Section 6033(a)(2), every organization exempt from tax under section 501(a) shall file an
annual return, stating specifically the items of gross income, receipts and disbursements, and
such other information for the purposes of carrying out the internal revenue laws as the
Secretary may by forms or regulations prescribe, and keep such records, render under oath
such statements, make such other returns, and comply with such rules and regulations as the
Secretary may from time to time prescribe.

Section 6601 of the Code addresses interest on underpayment, nonpayment, or extensions
of time for payment, of tax.
(a) General rule. If any amount of tax imposed by this title (whether required to be
shown on a return, or to be paid by stamp or by some other method) is not paid on or
before the last date prescribed for payment, interest on such amount at the
underpayment rate established under section shall be paid for the period from such last
date to the date paid.

Section 6651 of the Code addresses failure to file tax return or to pay tax.
(a) Addition to the tax. In case of failure--

(1) to file any return required under authority of subchapter A of chapter 61, there
shall be added to the amount required to be shown as tax on such return 5 percent
of the amount of such tax if the failure is for not more than 1 month, with an
additional 5 percent for each additional month or fraction thereof during which such
failure continues, not exceeding 25 percent in the aggregate;

Section 6662(d)(1)(A) of the Code addresses the imposition of accuracy-related penalty on
underpayments of taxes.

Form 886-A (Rev.4-68) Department of the Treasury - Internal Revenue Service
Page: -8-

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

(a) If this section applies to any portion of an underpayment of tax required to be
shown on a return, there shall be added to the tax an amount equal to 20 percent of
the portion of the underpayment to which this section applies.

(d)(1)(A)(/) In general, it there is an understatement of income tax for any taxable year
where the understatement exceed 10 percent of the tax required to be shown on the
tax return for the taxable year, or

(d)(1)(A)(ii) $$

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 Procedure 71-17, 1971-1 C.B. 683.

Section 1.501(c)(7) of the Treasury Regulations provides that, in general, the exemption
extends to social and recreational clubs which are supported by membership fees, dues, and
assessments. However, an ORG otherwise entitled to exemption will not be disqualified merely
because it raises revenue from members through the use of club facilities or in connection with
club activities.

Section 1.501(c)(7)-1(b) of the Treasury Regulations provides "A club which engages in
business, such as making its social and recreational facilities available to the general public...
is not organized and operated exclusively for pleasure, recreation, and other nonprofitable
purposes, and is not exempt under section 501(a)...."

Section 1.6001-1(a) of the Treasury Regulations, in conjunction with Section 1.6001-1(c) of the
Treasury Regulations provides that every organization exempt from tax under IRC § 501(a) and
subject to the tax imposed by IRC § 511 on its unrelated business income must keep such
permanent books or accounts or records, including inventories, as are sufficient to establish
the amount of gross income, deduction, credits, or other matters required to be shown by such
person in any return of such tax. Such organization shall also keep such books and records as
are required to substantiate the information required by IRC § 6033.

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

Page: -9-

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

Revenue Procedure 71-17, 1971-1 C.B. 683 states use of a club's facilities by the general public
is important since it may indicate the existence of a nonexempt purpose or, if not of sufficient
substantiality to result in loss of exemption, it may make the club liable for unrelated business
income tax.

Revenue Procedure 71-17, 1971—1 C.B. 683, and sets forth the record-keeping requirements
for social clubs exempt under IRC section 501(c)(7) with respect to nonmembers use of their
facilities. If records are not maintained in accordance with the Revenue Procedure, all receipts
may be classified as nonmember income

Revenue Ruling 59-95, 1959-1 C.B. 627, concerns an exempt organization that was requested
to produce a financial statement and statement of its operations for a certain year. However,
its records were so incomplete that the organization was unable to furnish such statements.
The Service held that the failure or inability to file the required information return or otherwise
to comply with the provisions of IRC Section 6033 and the regulations which implement it, may
result in the termination of the exempt status of an organization previously held exempt, on
the grounds that the organization has not established that it is observing the conditions
required for the continuation of exempt status.

Revenue Ruling 69-636, 19XX — 2 C.B. 126, demonstrates that when a social club exempt on IRC
section 501(c)(7) permits another organization exempt under IRC Section 501(a) to utilize its
facilities to raise funds for charity and charges the other exempt organization its direct costs
only, the activity will not result in inurement to the club or its members. These charges do not
include any pro rata share of overhead expenses or depreciation. These charges will not
reimburse the club for any portion of the expenses normally incurred in running the club for
members.

Jockey club v. Helvering, 76 F.2d 597, 598 (2d Cir 1935) states that “the court in determining
whether income derived from nonmembers inured to the benefit of members, held that a club
may make a profit on occasion but, taken by and large, the returns from outsiders should do no
more than reimburse the club for its costs. However, if upon computation they are such a
source of income over a substantial period of time so as to justify the conclusion that it is
deliberate, such net earning inure to the benefit of the members, though they are not
distributed.”

Polish American club, Inc. v. Commissioner, 33 T.C.M. (CCH) 925 (1974) T.C. Memo. 1974-207
held that the statutes and regulations require that exempt social clubs be organized and

operated exclusively for pleasure, recreation and other nonprofitable purposes. The case law
has modified this requirement by allowing social clubs to qualify for exemption under section

Form 886-A (Rev.4-68) Department of the Treasury - Internal Revenue Service
Page: -10-

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

501(c)(7) when its outside profits were: (1) strictly incidental to club activities, not as a result of
an outside business; and (2) either negligible or nonrecurring. However, when the outside
income is both substantial and recurring the statutory requirements are not satisfied and the
social club is not exempt from tax.

The Minnequa University club v. Commissioner, 30 TCM (CCH) 1305 — Tax Court 1971 held that
the "exclusively * * * nonprofitable" operation requirement has been tempered somewhat by
regulations and case law. The cases clearly permit generation of some income from
nonmember sources so long as the activity generating such income is merely incidental and the
income is either negligible or nonrecurring. Where outside income is both substantial and
recurring, the statutory requirements are obviously not met and loss of tax-exempt status must
result.

United States v. Fort Worth club of Fort Worth, Texas, 345 F. 2d 52 — Court of Appeals, 5th
Circuit 1965 states under the taxpayer's construction of section 501(c) (7), it would be "a
simple matter to tack a profitable business on to a club that was having difficulty in carrying as
large and luxurious a plant as the members might like without the payment of burdensome
dues". The Fort Worth club cannot deny it has derived substantial and recurrent profit from a
business altogether unrelated to its activities as a social club.

Pittsburgh Press club v. United States, 536 F. 2d 572 — Court of Appeals, 3rd Circuit 1976

It should be noted that tax exemptions are to be strictly construed, and that PPC had an
obligation to maintain records adequate to establish a right to the tax exemption it claimed,
see I.R.C. § 6001 and Rev. Proc. 71-17. In light of these considerations, the club has the burden
of establishing how much of the revenue was attributable to members or nonmembers.

Form 886-A (Rev.4-68) Department of the Treasury - Internal Revenue Service
Page: -11-

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

TAXPAYER’S POSITION

The President of club/CO-1 agreed to club’s revocation of exemption under Section 501(c)(7) of
the Internal Revenue code by signing F6018-A. The President acknowledged the requirement

to file income tax returns; he signed and filed Form 1120 for the years ending December 31,
20XX, December 31, 20XX and December 31, 20XX.

The President paid the income tax liabilities on October 7, 20XX related to the Forms 1120 for
the years ending December 31, 20XX, December 31, 20XX and December 31, 20XxX.

Form 886-A (Rev.4-68) Department of the Treasury - Internal Revenue Service
Page: -12-

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

GOVERNMENT’S POSITION

Exemption Issues

In order to determine whether ORG’s sources of non-member income exceed the allowed 15%,
addressed in Public Law 94-568, the following analysis must be completed.

ORG’s sources of member income are as follows:

Period Member Income Source
1/1/20XX — 12/31/20XX Ss Dues
1/1/20XX — 12/31/20XxX SS Dues

SS Initiation Fees

ss Raffles, Bus Trip

SS Total for 20XX
1/1/20xXX -— 12/31/20XxX Ss Dues

SS Initiation Fees

$s Raffles, Bus Trip

Ss Total for 20XX

ORG’s sources of non-member income are as follows:

Non-member

Period Income Source
1/1/20XX — 12/31/20XxX SS Rent
SS Donations
SS Misc. Income
SS Bar Income
{SS) Cost of Goods Sold
$s Total for 20XX
1/1/20XX — 12/31/20XX Rent
Donations
Bar Income
Cost of Goods Sold

Misc. Income
Bingo Receipts

Form 886-A (Rev.4-68) Department of the Treasury - Internal Revenue Service
Page: -13-

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

Direct Costs
Building Expenses
Total for 20XX

1/1/20XX — 12/31/20XX Rent
Less Refunds
Donations
Doughnut Sales
Cost of Goods Sold
Bar Sales
Cost of Goods Sold
Total for 20XX

ORG’s member and non-member income for each of the three years under examination are
summarized below:

Non-Member %

Period Member Non-member _ of Total Income
1/1/20XX — 12/31/20XxX %
1/1/20XX — 12/31/20XX %
1/1/20XX — 12/31/20XX %

Under The Minnequa University ORG v. Commissioner, where outside income is both
substantial and recurring, the statutory requirements are obviously not met and loss of tax-
exempt status must result. This is consistent with the findings of this examination. Because
ORG’s non-member income is substantial in relation to its other income in all years under
examination and recurs in each of the years, the ORG must lose its exemption under Section
501(c)(7) of the Internal Revenue Code.

Public Law 94-568 specifies that an organization exempt under Section 501(c)(7) may not have
more than 15% of income from non-member sources. ORG fails the test for the year ending
December 31, 20XX where its non-member percentage of total income was 87 percent. ORG
fails the test for the year ending December 31, 20XX where its non-member percentage of
total income was 95 percent. ORG again failed the test for the year ending December 31, 20XX
where its non-member percentage of total income was 91 percent. Because the non-member
income for ORG consistently exceeded the 15 percent limitation, ORG is no longer eligible for
exemption under IRC Sections 501(a) and 501(c)(7) of the internal Revenue Code and said
exemption should be revoked.

Form 886-A (Rev.4-68) Department of the Treasury - Internal Revenue Service
Page: -14-

Form 886 A Department of the Treasury - Internal Revenue Service Schedule No. or
Explanation of Items Exhibit
Name of Taxpayer Year/Period Ended
December 31,
ORG 20XX, 2O0XX & 20XX

Jockey ORG v. Helvering held that if it turns out upon computation that they are such a source
over a substantial enough period to justify the conclusion that this is deliberate, we agree with
the Board that the ORG is making earnings which ‘inure to the benefit’ of the members, though
they are not distributed. The finding in Jockey ORG is consistent with the findings in this
examination. Inurement to the members occurred during 20XX and 20XX. The members of
ORG have during 20XX and 20XX enjoyed the benefit of having the majority of the expenses
associated with operating the building they own paid for by CO-1. These payments were from a
checking account, where checks were signed by the President of ORG/CO-1. ORG has, for the
years under examination, been in control! of CO-1 and thereby the incomes derived from CO-1's
activities. This is demonstrated by payment of facilities related expenses from CO-1 charitable
gaming income. The lack of an independent board of directors and officers has permitted this
control. In addition, officers and board of directors which have authority over both ORG and
CO-1 have facilitated this control, resulting in inurement to the members of ORG. As a result,
ORG’s exemption under IRC 501(c)(7) should be revoked.

Revenue Ruling 69-636 provides the framework that ORG could have followed, but chose not
to. “When a social ORG exempt on IRC section 501(c)(7) permits another organization exempt
under IRC Section 501(a) to utilize its facilities to raise funds for charity and charges the other
exempt organization its direct costs only, the activity will not result in inurement to the ORG or
its members. These charges do not include any pro rata share of overhead expenses or
depreciation. These charges will not reimburse the ORG for any portion of the expenses
normally incurred in running the ORG for members.” Such was not the case in this
examination. CO-1 paid for the majority of all ORG facilities related expenses during 20XX and
20XX. The expenses included utilities, insurance, and taxes, as well as building repairs and
grounds maintenance. The President of ORG/CO-1 signed all of the checks when paying these
expenses. This is a textbook example of inurement to the members of a Section 501(c)(7)
organization, ORG. As a result, ORG’s exemption under IRC 501(c)(7) should be revoked.

Section 501(c)(7) of the Internal Revenue Code provides that ORGs organized and operated
exclusively for pleasure, recreation, and other nonprofitable purposes are exempt from Federal
income tax provided no part of the net earnings inures to the benefit of any private
shareholder. Inurement to the members has permitted ORG to continue to exist. Without the
inurement resulting from the payment of all operating expenses for the building by CO-1 and
its charitable gaming activities, ORG would have had to look to the members to pay the
operating expenses, which ranged from $ in 20XX, to $ in 20XX, and to $ in 20XX. Member
income for 20XX was $$, for 20XX it was $$ and for 20XxX it was $S. It is unlikely that member
income would increase to the level of the building operating expenses. Based upon testimony
by the President, the members of the social ORG pay S$ per month as dues and none of the
members is willing to pay any more than the current rate of $ per month. In this instance, ORG

Form 886-A (Rev.4-68) Department of the Treasury - Internal Revenue Service
Page: -15-

Form 8 86 A Department of the Treasury - Internal Revenue Service Schedule No. or
Explanation of Items Exhibit
Name of Taxpayer Year/Period Ended
December 31,
ORG 20XX, 20XX & 20XX

would need to seek funding from outside of the organization, all of which would lead to the
same conclusion. ORG clearly no longer qualifies for exemption under Sections 501(a) and
501(c)(7) of the Internal Revenue Code and said exemption should be revoked.

IRC sections 6001 and 6033 require that all organizations exempt under IRC section 501(a) file a
return “stating specifically the items of gross income, receipts and disbursements”. ORG did
not correctly file Form 990-EZ for the year ending December 31, 20XX. Total income reported
on Form 990-EZ was $. Total income per the examination was $. Exhibit 5 provides the details
of all adjustments made as the result of the examination of the Form 990-EZ for year ending
December 31, 20XX. ORG failed to meet the filing requirements of IRC Sections 6001 and 6033
to be recognized as exempt from federal income tax under IRC Section 501(c)(7). As such, said
exemption should be revoked.

ORG did not correctly file Form 990-EZ for the year ending December 31, 20XX. Total income
reported on Form 990-EZ was $. Total income per the examination was $. Exhibit 6 provides
the details of all adjustments made as the result of the examination of the Form 990-EZ for the
year ending December 21, 20XX. ORG failed to meet the filing requirements of IRC Sections
6001 and 6033 to be recognized as exempt from federal income tax under

IRC Section 501(c)(7). ORG is therefore no longer eligible for exemption under Section
501(c)(7) of the Internal Revenue Code.

Treasury Regulations Sections 1.6001-1(a), in conjunction with Section 1.6001-1(c) provide that
every organization exempt from tax under IRC Section 501(a) and subject to the tax imposed by
IRC Section 511 on its unrelated business income must maintain permanent records such that
books and records, including inventories, that are sufficient to establish the amount of gross
income, deduction, credits, or other matters required to be shown by such person in any
return of such tax. The requirements of IRC Section 6033 must also be met. ORG failed to file
when due Form 990-T for the years ending December 31, 20XX, 20XX and 20XX. ORG failed to
comply with the filing requirements of Treasury Regulations Sections 1.6001-1(a) and 1.6001-
1(c), and IRC Section 6033, which is required to be recognized as exempt under Section
501(c)(7) of the Internal Revenue Code.

ORG failed to file when due Form 990-T for the years ending December 31, 20XX, 20XX and
20XX. ORG failed to correctly file Form 990-EZ for the years ending December 31, 20XX and
20XX. The failure of ORG to file Forms 990-T and correctly file Forms 990-EZ is consistent with
the findings in Revenue Ruling 59-95, where the Service held that the failure or inability to file
the required information return or otherwise to comply with the provisions of IRC Section 6033
and the regulations which implement it, may result in the termination of the exempt status of
an organization previously held exempt, on the grounds that the organization has not

Form 886-A (Rev.4-68) Department of the Treasury - Internal Revenue Service
Page: -16-

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

established that it is observing the conditions required for the continuation of exempt status.
ORG has consistently failed to comply with the filing requirements of Sections 6001 and 6033
of the Internal Revenue Code and the Treasury Regulations that implement the Code. Asa
result ORG’s exemption under Section 501(c)(7) of the Internal Revenue Code should be
revoked.

Section 6651 of the Internal Revenue Code provides for penalties to be charged for failure to
file returns when due. ORG failed to file Form 990-T for years ending December 31, 20XX, 20XX
and 20XX. As such ORG is liable for IRC Section 6651 penalties for failure to file for all three
years under examination. ORG requested waiver of the penalties under IRC Section 6651 and
the Service accepted the request as reasonable cause, giving due consideration to the fact the
ORG paid the income tax liabilities for Form 1120 for the years ending December 31, 20XX,
December 31, 20XX and December 31, 20XX, as agreed.

Section 6662 of the Internal Revenue Code provides for penalties to be charged for substantial
understatement of taxes. The penalties apply when the amount of tax exceeds 10% of the
amount tax reported. In this case, ORG failed to file Form 990-T for years ending December 31,
20XX, 20XX and 20XX. No taxes were reported. Therefore ORG is liable for penalties for
substantial understatement of taxes for all three years under examination. ORG requested
waiver of the penalties under IRC Section 6662 and the Service accepted the request as
reasonable cause, giving due consideration to the fact the ORG paid the income tax liabilities
for Form 1120 for the years ending December 31, 20XX, December 31, 20XX and December 31,
20XX, as agreed.

ORG has requested termination of its exempt status under IRC Section 501(c)(7) effective
October 1, 20XX based upon the unanimous vote of the members. ORG’s Board of Directors
has issued a board resolution acknowledging termination effective October 1, 20XX. However,
ORG has not provided the required documents for the Service to accept the request. The
Service requires Articles of Dissolution and a statement attesting to the distribution of the
assets. The Service would also require ORG to file Form 990-T for the years ending December
31, 20XX, 20XX and 20XX. ORG must then pay all taxes due. ORG would be required to pay all
failure to file penalties under IRC Section 6651 and all substantial understatement of taxes
under IRC Section 6662. As ORG has not furnished these documents and the payments have
not been made, the Service’s position remains unchanged. Proposed revocation of ORG’s
exempt status under Section 501(c)(7) of the Internal Revenue Code will be pursued.

Attached are Exhibits reflecting income and expenses as reported, adjustments per audit work
performed, and income and expenses as adjusted. The exhibits also reflect the income and
expenses required to be reported on Form 1120 and the related income tax. Exhibit 4 reports

Form 886-A (Rev.4-68) Department of the Treasury - Internal Revenue Service
Page: -17-

Form 8 86 A Department of the Treasury - Internal Revenue Service Schedule No. or
Explanation of Items Exhibit
Name of Taxpayer Year/Period Ended
December 31,
ORG 20XX, 20XX & 20XX

information for the Form 990 and Form 1120 for December 31, 20XX. Exhibit 5 reports
information for the Form 990EZ and Form 1120 for December 31, 20XX. Exhibit 6 reports
information for the Form 990EZ and Form 1120 for December 31, 20XX.

CONCLUSION

ORG no longer qualifies for exemption under Section 501(c)(7) of the Internal Revenue Code,
as non-member income consistently exceeded the 15 percent limitation of total income, in all
three years under examination. Nonmember income sources consisted of the following
activities with the general public: charitable gaming, sales of ink markers, food and drinks,
rental of its facilities, and donations from the general public. Hence, revocation of ORG’s
exemption is proposed effective January 1, 20XX.

It is the Service’s position that the organization failed to meet the reporting requirements
under IRC Sections 6001 and 6033 to be recognized as exempt from federal income tax under
IRC § 501(c)(7). Accordingly, revocation of the organization's exempt status is proposed
effective January 1, 20XX.

ORG is liable for filing Form 1120 returns for the tax periods ending December 31, 20XX and all
subsequent years.

ORG is liable for penalties under Section 6651 of the Internal Revenue Code for failure to file
tax returns when due for all three years under examination.

ORG is liable for penalties under Section 6662 of the Internal Revenue Code for substantial
understatement of tax for each of the three years under examination.

ALTERNATIVE POSITION

Unrelated Business Income Issue
ISSUE

If revocation is not upheld, whether income to an IRC Section 501(c)(7) organization is
taxable as unrelated business income when it is from conducting bingo activities with the
general public, sales of ink markers, food and drinks to the general public and when it is
from rental of its facilities to the general public? And when it is from donations from the
general public?

Form 886-A (Rev.4-68) Department of the Treasury - Internal Revenue Service
Page: -18-

Form 8 86 A Department of the Treasury - Internal Revenue Service Schedule No. or
Explanation of Items Exhibit
Name of Taxpayer Year/Period Ended
December 31,
ORG 20XX, 20XX & 20XX

FACTS

According to testimony by the President of ORG/CO-1, charitable gaming is the primary fund
raising activity conducted by CO-1. The IRC 501(c)(3) charitable gaming activities are
conducted by the President and Treasurer of ORG/CO-1 and by another member of ORG.
Other members of ORG assist with the selling of sealed cards (pull tabs) from time to time. The
volunteer bookkeeper assists with counting of the gaming proceeds and preparation of the
bank deposit. The President of ORG/CO-1 takes the deposit to the bank. Charitable gaming
proceeds are deposited into the CO-4 Checking Account, account number#. ORG’s name and
EIN were indicated on the CO-4 checking account for the years ending December 31, 20XX and
December 31, 20XX. For the year ending December 31, 20XX, the CO-4 checking account was
changed to reflect the name and EIN of CO-1. The President of ORG/CO-1 has signature
authority for this account, as does another member of ORG.

Commonwealth of State Charitable Gaming Permits indicate that the permit for the time
period of November 1, 20XX through October 31, 20XX was in the name of the IRC Section
501(c)(7) organization, ORG. Below is reflected the name of the organization whose name
appeared on Charitable Gaming Permits for the indicated periods of time:

Period Organization
1/1/20XX — 10/31/20XX CO-1
11/1/20XX — 10/31/20XX ORG.
11/1/20XX — 12/31/20xXX CO-1

Gaming receipts and direct costs for each of the years under examination as reported on Form
101 to the State Division of Charitable Gaming are reflected below:

Period Gaming Receipts Direct Costs
1/1/20XxX — 12/31/20XxX
1/1/20XX — 12/31/20XxX
1/1/20XX — 12/31/20XX

Audit work showed that CO-1 paid for facilities related expenses that were invoiced to ORG
from the CO-4 Checking Account; the checks were signed by the President of ORG/CO-1. These
expenses included cable television and internet, utilities, insurance, real estate and personal
property taxes, as well as repairs and maintenance. The table below reflects the facilities
related disbursements paid for by CO-1 for the periods indicated.

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

Page: -19-

Form 886 A Department of the Treasury - Internal Revenue Service Schedule No. or
Explanation of Items Exhibit
Name of Taxpayer Year/Period Ended
December 31,
ORG 20XX, 20XX & 20XX
Period Facilities Related Expenses

1/1/20XX — 12/31/20XX
1/1/20XX — 12/31/20XX

For the period ending December 31, 20XX, the facilities related expenses of $ were attributed
to ORG. ORG conducted bingo activities and controlled the CO-4 checking account during this
time period.

Testimony provided by the President of ORG/CO-1 indicated that ORG sells drinks, food and ink
markers to the public during charitable gaming sessions conducted by CO-1. Audit work
determined sales and cost of goods sold for each of the years under examination as shown
below:

Period Sales Cost of Goods Sold
1/1/20XX — 12/31/20XxX
1/1/20XX — 12/31/20XxX
1/1/20XX — 12/31/20XX

Audit work showed that ORG rents the building and improvements to the public. Rental
income for each of the years under examination is reflected below:

Period Rental Income
1/1/20XX — 12/31/20XxX
1/1/20XX — 12/31/20XX
1/1/20XX — 12/31/20XX

Audit work showed that ORG receives donations on an annual basis from individuals and
businesses. Donations received from the general public for each of the years under
examination are shown below:

Period Donation Income
1/1/20XX — 12/31/20XX SS
1/1/20XX — 12/31/20XxX S$
1/1/20XX — 12/31/20XXx $

Audit work showed that ORG made deposits into its checking account with CO-3 during 20XX in
the amount of $$ and during 20XX in the amount of $$, for which no identification for the
source of the funds was provided.

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

Page: -20-

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

Audit work showed that ORG had fundraising income of SS during 20XX from sales of
doughnuts to the general public and incurred $$ in direct costs.

LAW

Section 501(c)(7) of the Internal Revenue Code provides that clubs organized and operated
exclusively for pleasure, recreation, and other nonprofitable purposes are exempt from Federal
income tax provided no part of the net earnings inures to the benefit of any private
shareholder.

Section 511 of the Code addresses imposition of tax on unrelated business income of
charitable, etc., organizations.
(a) Charitable, etc., organizations taxable at corporation rates.
(2) Organizations subject to tax.
(A) Organizations described in sections 401(a) and 501(c). The tax imposed by
paragraph (1) shall apply in the case of any organization described in section
501(c)(1) which is exempt, by reason of section 501(a).

Section 512(a)(3)(A) of the Code defines unrelated business taxable income for social clubs as
all gross income that is not exempt function income. Furthermore, it provides that the
unrelated taxable income of an organization described in section 501(c)(7) means the gross
income (excluding any exempt function income), less the deductions allowed by Chapter 1 of
the Code which are directly connected with the production of the gross income (excluding
exempt function income).

Section 512(a)(3)(B) of the Code defines exempt function income as “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.”

Section 6001 of the Code addresses notice or regulations requiring records, statements,
and special returns. Every person liable for any tax imposed by this title, or for the
collection thereof, shall keep such records, render such statements, make such returns, and
comply with such rules and regulations as the Secretary may from time to time prescribe.

Section 6033(a)(1) of the Internal Revenue Code provides, except as provided in IRC
Section 6033(a)(2), every organization exempt from tax under section 501(a) shall file an
annual return, stating specifically the items of gross income, receipts and disbursements, and

Form 886-A (Rev.4-68) Department of the Treasury - Internal Revenue Service
Page: -21-

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

such other information for the purposes of carrying out the internal revenue laws as the
Secretary may by forms or regulations prescribe, and keep such records, render under oath
such statements, make such other returns, and comply with such rules and regulations as the

' Secretary may from time to time prescribe.

Section 6601 of the Code addresses interest on underpayment, nonpayment, or extensions

of time for payment, of tax.
(a) General rule. If any amount of tax imposed by this title (whether required to be
shown on a return, or to be paid by stamp or by some other method) is not paid on or
before the last date prescribed for payment, interest on such amount at the |
underpayment rate established under section shall be paid for the period from such last
date to the date paid. |

|

Section 6651 of the Code addresses failure to file tax return or to pay tax.
(a) Addition to the tax. In case of failure--

(1) to file any return required under authority of subchapter A of chapter 61, there
shall be added to the amount required to be shown as tax on such return 5 percent
of the amount of such tax if the failure is for not more than 1 month, with an
additional 5 percent for each additional month or fraction thereof during which such
failure continues, not exceeding 25 percent in the aggregate

Section 6662 of the Code addresses the imposition of accuracy-related penalty on
underpayments of taxes.
(a) Imposition of penalty. If this section applies to any portion of an underpayment of tax
required to be shown on a return, there shall be added to the tax an amount equal to 20
percent of the portion of the underpayment to which this section applies.
(d)(1)(A)(/) In general, it there is an understatement of income tax for any taxable year
where the understatement exceed 10 percent of the tax required to be shown on the tax
return for the taxable year...

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:

(b) 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

Form 886-A (Rev.4-68) Department of the Treasury - Internal Revenue Service
Page: -22-

Form 8 86 A Department of the Treasury - Internal Revenue Service Schedule No. or
Explanation of Items Exhibit
Name of Taxpayer Year/Period Ended
December 31,
ORG 20XX, 20XX & 20XX

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.
Section 1.501(c)(7) of the Income Tax Regulations provides that, in general, the exemption
extends to social and recreational clubs which are supported by membership fees, dues, and
assessments.

Section 1.501(c)(7)-1(b) of the Regulations provides "A club which engages in business, such as
making its social and recreational facilities available to the general public . . . is not organized
and operated exclusively for pleasure, recreation, and other nonprofitable purposes, and is not
exempt under section 501(a)...."

Revenue Procedure 71-17, 1971-1 C.B. 683 states use of a club's facilities by the general public
is important since it may indicate the existence of a nonexempt purpose or, if not of sufficient
substantiality to result in loss of exemption, it may make the club liable for unrelated business
income tax.

Revenue Procedure 71-17, 1971—1 C.B. 683, and sets forth the record-keeping requirements
for social clubs exempt under IRC section 501(c)(7) with respect to nonmembers use of their
facilities. If records are not maintained in accordance with the Revenue Procedure, all receipts
may be classified as nonmember income

Revenue Ruling 69-636, 19XX — 2 C.B. 126, demonstrates that when a social club exempt on IRC
section 501(c)(7) permits another organization exempt under IRC Section 501(a) to utilize its
facilities to raise funds for charity and charges the other exempt organization its direct costs
only, the activity will not result in inurement to the club or its members. These charges do not
include any pro rata share of overhead expenses or depreciation. These charges will not
reimburse the club for any portion of the expenses normally incurred in running the club for
members.

Pittsburgh Press club v. United States, 536 F. 2d 572 — Court of Appeals, 3rd Circuit 1976

It should be noted that tax exemptions are to be strictly construed, and that PPC had an
obligation to maintain records adequate to establish a right to the tax exemption it claimed,
see I.R.C. § 6001 and Rev. Proc. 71-17. In light of these considerations, the club has the burden
of establishing how much of the revenue was attributable to members or nonmembers.

United States v. Fort Worth club of Fort Worth, Texas, 345 F. 2d 52 — Court of Appeals, 5th
Circuit 1965 states under the taxpayer's construction of section 501(c) (7), it would be "a
simple matter to tack a profitable business on to a club that was having difficulty in carrying as
large and luxurious a plant as the members might like without the payment of burdensome

Form 886-A (Rev.4-68) Department of the Treasury - Internal Revenue Service
Page: -23-

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

dues". The Fort Worth club cannot deny it has derived substantial and recurrent profit from a
business altogether unrelated to its activities as a social club.
GOVERNMENT’S POSITION

The State Division of Charitable Gaming issued a charitable gaming permit to ORG for the time
period of November 1, 20XX through October 31, 20XX. The CO-4 checking account where the
gaming proceeds were deposited carried the name of the ORG and carried the EIN of EIN,
belonging to ORG. Officers and members of ORG conducted the charitable gaming activities
with the general public. When ORG conducted charitable gaming activities with the general
public it violated Section 1.501(c)(7)-1(b) of the Regulations. The income of $$ from the public
gaming activities is not exempt function income as defined in IRC Sections 512(a)(3)(A) and
512(a)(B) of the Internal Revenue Code in that the income is derived from activities conducted
by members with the general public and not from activities conducted by members with
members of the ORG. This income is therefore unrelated business income and taxable under
IRC Section 511 of the Internal Revenue Code.

ORG sold drinks, food, and ink markers to the general public during charitable gaming
activities. ORG also sold these same items to its members and guests. Under Pittsburgh Press
club v. United States, and Revenue Procedure 71-17, the ORG has the burden of establishing
how much of the revenue was attributable to members or nonmembers. ORG did not furnish
records differentiating between sales to members and sales to non-members. As such all sales
are deemed to be from non-members and are by definition unrelated business income. ORG is
therefore subject to taxation on its unrelated business income under IRC Section 511 of the
Internal Revenue Code.

ORG rented its facilities to the general public during each year of the examination. Rental
income was $$ in 20XX, $$ in 20XX and $ in 20XX. Such rental income is not exempt function
income for a Section 501(c)(7) organization as defined in IRC Section 512(a)(3)(B) in that the
source of income is not from members. The income is substantial in relation to its other
income in 20XX and 20XX and has been ongoing throughout the years under examination. The
rental income is therefore taxable as unrelated business income under Section 511 of the
Internal Revenue Code.

ORG received donations from the general public for each of the years under examination.
Section 512(a)(3)(A) of the Code defines unrelated business taxable income for social ORGs as
all gross income that is not exempt function income. Section 512(a)(3)(B) of the Code defines
exempt function income as “gross income from dues, fees, charges, or similar amounts paid by
members...” In that donations from the public are not paid by members, such income is not
exempt function income. The donation income from the general public, and not members, is

Form 886-A (Rev.4-68) Department of the Treasury - Internal Revenue Service
Page: -24-

Form 8 86 A Department of the Treasury - Internal Revenue Service Schedule No. or
Explanation of Items Exhibit
Name of Taxpayer Year/ Period Ended
December 31,
ORG 20XX, 20XX & 20XX

therefore taxable as unrelated business income under Section 511 of the Internal Revenue
Code.

The findings under United States v. Fort Worth ORG of Fort Worth, Texas are not unlike what
ORG has experienced. The Fort Worth ORG cannot deny it has derived substantial and
recurrent profit from a business altogether unrelated to its activities as a social ORG. ORG
conducted gaming activities with the public during twelve of the thirty-six months under
examination. ORG regularly rents its facilities to the general public. ORG regularly receives
donations from the general public. ORG regularly sells food, drinks and ink markers to the
general public. Each of these activities resulted in recurrent profit from business altogether
unrelated to its activities as a social ORG. As such, the income associated with each of these
activities is taxable as unrelated business income under Section 511 of the Internal Revenue
Code.

Section 6651(a)(1) of the Internal Revenue Code provides for penalties to be charged for failure
to file returns when due. ORG failed to file Form 990-T for years ending December 31, 20XX,
20XX and 20XX. As such ORG is liable for IRC Section 6651 penalties for failure to file for all
three years under examination.

Section 6662 of the Internal Revenue Code provides for penalties to be charged for substantial
understatement of taxes. The penalties apply when the amount of tax exceeds 10% of the
amount tax reported. In this case, ORG failed to file Form 990-T for years ending December 31,
20XX, 20XX and 20XX. No taxes were reported. Therefore ORG is liable for penalties for
substantial understatement of taxes for all three years under examination.

Attached are Exhibits reflecting income and expenses as reported, adjustments per audit work
performed, and income and expenses as adjusted. The exhibits also reflect the income and
expenses required to be reported on Form 990-T and the related income tax. Exhibit 7 reports
information for the Form 990 and Form 990-T for December 31, 20XX. Exhibit 8 reports
information for the Form 990EZ and Form 990-T for December 31, 20XX. Exhibit 9 reports
information for the Form 990EZ and Form 990-T for December 31, 20XX.

CONCLUSION

ORG is liable for unrelated business income on the following activities:

e Gaming activities conducted with the general public
e Sales of food, drinks, and ink markers to the general public
e Rental of the facilities to the general public
e Donation income from the general public
Form 886-A (Rev.4-68) Department of the Treasury - Internal Revenue Service

Page: -25-

Form 8 86 A Department of the Treasury - Internal Revenue Service Schedule No. or
Explanation of Items Exhibit
Name of Taxpayer Year/Period Ended
December 31,
ORG 20XX, 20XX & 20XX

ORG is liable for filing Form 990-T for the years ending December 31, 20XX, 20XX and 20XX.

ORG is liable for penalties under Section 6651 of the Internal Revenue Code for failure file tax
returns when due for all three years under examination.

ORG is liable for penalties under Section 6662 of the Internal Revenue Code for substantial
understatement of tax for each of the three years under examination.

Form 886-A (Rev.4-68) Department of the Treasury - Internal Revenue Service
Page: -26-