Determination 1219032: IRS denies section 501(c)(7) exemption to a craft guild

Plain-English summary

The IRS denied tax exemption to a nonprofit craft guild that held public craft shows and paid members the proceeds from their product sales. The organization argued that its shows, meetings, scholarships, donations, and community programs supported exemption under IRC § 501(c)(7). The IRS concluded that the guild primarily operated a business that promoted and sold members' products, earned more than 90 percent of its revenue from nonmembers, and allowed earnings to inure to members. The denial became final after the organization did not file a protest within 30 days.

Ruling snapshot

• Question: Did the craft guild qualify for exemption as a social club under IRC § 501(c)(7)?
• Outcome: Denied
• Key authorities: IRC §§ 501(c)(7), 6110(k)(3), and 4946(a); Treas. Reg. § 1.501(c)(7)-1; Rev. Ruls. 69-527 and 69-635; Public Law 94-568

Full text (IRS public release)

DEPARTMENT OF THE TREASURY
INTERNAL REVENUE SERVICE
WASHINGTON, D.C. 20224

TAX EXEMPT AND
GOVERNMENT ENTITIES
DIVISION

Release Number: 201219032 Contact Person:
Release Date: 5/11/2012
Date: February 17, 2012 Identification Number:
UIL Code: 501.07-00
501.07-05 Contact Number:
501.07-06
501.32-00 Employer Identification Number:
Form Required To Be Filed:
Tax Years:

Dear

This is our final determination that you do not qualify for exemption from federal income
tax as an organization described in Internal Revenue Code section 501(c)(7). Recently,
we sent you a letter in response to your application that proposed an adverse
determination. The letter explained the facts, law and rationale, and gave you 30 days
to file a protest. Since we did not receive a protest within the requisite 30 days, the
proposed adverse determination is now final.

You must file federal income tax returns on the form and for the years listed above
within 30 days of this letter, unless you request an extension of time to file.

We will make this letter and our proposed adverse determination letter available for
public inspection under Code section 6110, after deleting certain identifying information.
Please read the enclosed Notice 437, Notice of Intention to Disclose, and review the
two attached letters that show our proposed deletions. If you disagree with our
proposed deletions, you should follow the instructions in Notice 437. If you agree with
our deletions, you do not need to take any further action.

If you have any questions about this letter, please contact the person whose name and
telephone number are shown in the heading of this letter. If you have any questions
about your federal income tax status and responsibilities, please contact IRS Customer
Service at

Letter 4040(CG) (11-2005)
Catalog Number 476352

2

1-800-829-1040 or the IRS Customer Service number for businesses, 1-800-829-4933.
The IRS Customer Service number for people with hearing impairments is 1-800-829-
4059.

Sincerely,

Lois G. Lerner
Director, Exempt Organizations

Enclosure
Notice 437
Redacted Proposed Adverse Determination Letter
Redacted Final Adverse Determination Letter

Letter 4040(CG) (11-2005)
Catalog Number 476352

DEPARTMENT OF THE TREASURY
INTERNAL REVENUE SERVICE
WASHINGTON, D.C. 20224

TAX EXEMPT AND
GOVERNMENT ENTITIES

DIVISION

Date: January 12, 2012 Contact Person:
Identification Number:
Contact Number:
FAX Number:
Employer Identification Number:
LEGEND: UIL:
501.07-00
B = state 501.07-05
C = date 501.07-06
D = area 501.32-00
E = cities
F = river
G = area

h = dollar amount

Dear

We have considered your application for recognition of exemption from federal income
tax under Internal Revenue Code section 501(a). Based on the information provided,
we have concluded that you do not qualify for exemption under Code section 501(c)(7).
The basis for our conclusion is set forth below.

Issues

Do you qualify for exemption under section 501(c)(7) of the Code? No, for the reasons
described below.

Facts

You are a B nonprofit corporation incorporated on C. Your Restated Articles of

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Incorporation provide that you are:

(1) a non-profit corporation or guild for artistic or educational purposes, no part
of the net earnings of which inures to the benefit of any private shareholder or
individual or member,

(2) a club for pleasure, recreation, and other nonprofit purposes, substantially all
of the activities of which are for such purposes and no part of net earnings of
which inures to the benefit of any private shareholder or member, pursuant to the
requirements of 26 U.S.C. § 501(c)(7).

You describe yourself as the longest, continuous craft guild west of the F, providing a
creative outlet for people living in the G area. Your members work year round to create
unique and interesting crafts for sale at your bi-annual craft show and sale. You state
your primary purpose to be the promotion of your membership.

You are operated on a membership basis, with your governing board being elected from
your membership. You have four classes of members: general, associate, life and
honorary. Members are required to stay current on dues. As you have indicated in your
newsletters to members, those who do not pay current dues could lose voting rights,
may not be able to show at the annual shows, and may not be included in the directory
given out at the shows. This directory is a roster, on paper and via your web site, that
includes each member's name and contact, business name and respective medium
(painting, sewing, woodcrafts, etc). The member roster is presented at each annual
show. In addition to this benefit, members may also pay an extra fee to have their
businesses linked directly through the online roster available on your web site, enabling
visitors to click through to their business web site through yours.

You listed the following activities (with the approximate percentage of the organization's
time listed next to the activity):

Shows and Meetings — 85%

You conduct monthly membership meetings which include a business meeting,
training sessions for upcoming shows, and speakers of interest. The meetings also offer
a venue for the sharing of ideas and materials, education, refreshments, and fellowship
with other members.

You conduct two annual craft shows in which your members display and sell their crafts.
All sales are processed through you, with each member receiving their portion of sales
proceeds after the event, minus a 15% commission to cover operating costs. Admission
to the events is free and the events are open to the public.

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You rent the building, pay for advertising through flyers and radio, secure insurance,
provide necessary materials and supplies and pay any applicable taxes. In return,
members work necessary positions during the shows to ensure the event runs smoothly
while bringing in “high quality handcrafted items for display and sale.”

You have a waiver form members must complete prior to show sales. This form
stipulates members agree that all funds received from you are contractor fees and each
member is responsible for reporting said income and paying applicable taxes. This
waiver also describes the various positions members are required to fill at each show,
methods for determining prices of merchandise, and for tracking and maintaining
inventory. Members are instructed to “not discuss guild business while working the
show”.

You control and manage inventory and proceeds of sales in the following manner. Each
item for sale has a price tag with a personalized member number and corresponding
inventory sheet. When purchased, the tag is removed and retained by you. After the
show, the tags are separated by member, and sales totaled. You retain 15%, and your
treasurer then writes each member a check for the remainder of their individual sales.

Programs and Community Presentations — 5%

You have a monthly meeting nine times annually. After the business portion of each
meeting, you permit individuals from the community to participate in presentations on
topics of relevance to the community. Past programs have included discussions on
home break-ins and mail theft, how to make the community a safer environment, future
road developments, identity theft, and how to prepare for a dry summer.

You plan to initiate a “Crafter of the Month” program in which one member will be
featured each month to briefly discuss their special crafting talents. The member will
offer a short presentation on how they do what they do.

Community Donations — 4%

You distribute funds and goods to local charitable organizations and to individuals in
need, such as local fire departments and Boy Scout troops.

Scholarships — 3%
You award one h dollars scholarship annually to a graduating senior in the local area.

Selections are based on community involvement, school participation, and academic
performance.

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Community Events — 3%

Your members are often invited to participate in numerous craft fairs, community
functions, and events around the city. These are usually hosted by local schools,
churches and charities. Portions of profits are often donated to the host entity by
participating members.

Revenue for the last four completed fiscal years and the total percentage of all revenue
over that period includes the following (numbers approximated):

Member dues and fees: $13000 2.6%
Sales: $480000 96%
Advertising: $5000 1%
Gifts/other: $2000 4%

Over that same period approximately 78% of your total expenses consisted of payments
back to members for sales. The remainder was attributable mostly to show expenses,
taxes and advertising.

Law

Section 501(c)(7) of the Code provides for the exemption from federal income tax of
clubs organized for pleasure, recreation, and other nonprofitable purposes, substantially
all of the activities of which are for such purposes and no part of the net earnings of
which inures to the benefit of any private shareholder.

Section 1.501(c)(7)-1(a) of the Regulations states that the exemption provided by
section 501(a) of the Code for an organization described in section 501(c)(7) of the
Code 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.

Section 1.501(c)(7)-1(b) of the Regulations states that 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) of the Code. Solicitation by advertisement or otherwise for public
patronage of its facilities is prima facie evidence that the club is engaging in business

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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.

Rev. Rul. 69-527, 1969-2 C.B. 125

A social club formed to assist its members in their business endeavors through study
and discussion of problems and other activities at weekly luncheon meetings does not
qualify for exemption under section 501(c)(7) of the Code. The organization was formed
and has been operated to study and discuss business and financial problems; to
interchange among its membership business and financial information in order to create
and encourage efficiency in business and finance; to assist its members in the
expansion and development of their individual trades, businesses, and professions by
encouraging the direct interchange of patronage among members; and to assist its
members in extending and establishing new trade, business, and professional contacts.

Rev. Rul. 69-635, 1969-2 C.B. 126

An automobile club whose principal activity is rendering automobile services
to its members but has no significant social activities does not qualify for
exemption under section 501(c)(7). The principal activity of this organization is the
rendering of automobile services to its members. Most of the services offered are of a
type generally available to motorists on a commercial basis. The rendition of such
services is not in the nature of pleasure or recreation within the meaning of the statute.

Public Law 94-568, 1976-2 C.B. 596, provides that a social club may receive up to 35
percent of its gross receipts, including investment income, from sources outside its
membership without losing exemption. 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.

Application of Law

You do not meet the requirements of section 501(c)(7) of the Code, because
substantially all of your activities are not for pleasure, recreation, or other nonprofitable
purposes. You are formed primarily to benefit individual members by facilitating the sale
of their products through the conduct of two annual craft shows, open and advertised to
the general public. As seen in Section 1.501(c)(7)-1(b) of the Regulations, when a club
engages in business it is not organized and operated exclusively for pleasure,
recreation and other nonprofitable purposes. Your sales activities are more than
incidental and, therefore, preclude exemption under section 501(c)(7) of the Code.

Your income results from business done with the general public and you are not
supported solely by membership fees, dues, assessments, or income derived from the
social activities of your members. By receiving over 90% of your revenue from
nonmembers in the four tax years preceding the submittal of your application for tax

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exemption, you fail the membership income tests set forth by Public Law 94-568. You
do not meet the facts and circumstances exception for this income test as this source of
income is regular and substantial.

By collecting and afterward distributing sales proceeds to your members based on the
sales of their show items your income is inuring directly to insiders. Per Section
1.501(c)(7)-1(a) of the Regulations exemption under 501(c)(7) does not apply to any
club if any part of its net earnings inure to the benefit of any private shareholder.

Similar to the organizations in Revenue Rulings 69-527 and 69-635, you are formed and
operated not for social and recreational purposes, but as a service to your members in
helping them promote, market and sell their products. While you hold monthly meetings
among your members, which does constitute a level of commingling, you describe your
purpose as the promotion of your membership. Members are treated as contractors for
the purposes of selling their items at your shows and receive direct benefits of being
included in a directory detailing their products and including business contact
information. Nearly all of your income is derived not from member dues but from sales
to the general public, with a significant portion given back to members. You list no
scheduled social or recreational events outside of monthly meetings and there is no
requirement for members to attend these meetings, paying dues is the only
requirement of members to stay in good standing. Your two annual shows provide a
convenience to your members to sell their products while retaining a significant portion
of the proceeds, you do not primarily serve a social or recreational but a business
purpose and do not meet the qualifications under 501(c)(7).

Applicant's Position

You state that your income does not inure to the benefit of its members. You state that
the shows give you the net income necessary to meet your expenses and support your
scholarship fund.

Service Response to Applicant's Position

When funds received by an organization are turned over to insiders, in this case your
members, in a more than insubstantial or material manner, this constitutes inurement.
Members directly benefit from your earnings by retaining portions of sales minus your
commission and from payment of advertising of their products through your two shows.

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Conclusion

Based on the facts provided above, we hold that you do not meet the requirements for
tax exemption under Section 501(c)(7) of the Code. You are formed to promote your
members and their products while operating primarily for business rather than social or
recreational purposes. You lack a significant level of commingling among members and
your net earnings inure to insiders. Further, nearly all of your income is derived from
non-members, failing the membership income test for a 501(c)(7) club.

You have the right to file a protest if you believe this determination is incorrect. To
protest, you must submit a statement of your views and fully explain your reasoning.
You must submit the statement, signed by one of your officers, within 30 days from the
date of this letter.

We will consider your statement and decide if that information affects our determination.
If your statement does not provide a basis to reconsider our determination, we will
forward your case to our Appeals Office. You can find more information about the role
of the Appeals Office in Publication 892, Exempt Organization Appeal Procedures for
Unagreed Issues.

Types of information that should be included in your appeal can be found on page 2 of
Publication 892, under the heading “Regional Office Appeal”. The statement of facts
(item 4) must be declared true under penalties of perjury. This may be done by adding
to the appeal the following signed declaration:

“Under penalties of perjury, I declare that I have examined the statement of facts
presented in this appeal and in any accompanying schedules and statements and, to the
best of my knowledge and belief, they are true, correct, and complete.”

Your appeal will be considered incomplete without this statement.

If an organization's representative submits the appeal, a substitute declaration must be
included stating that the representative prepared the appeal and accompanying
documents; and whether the representative knows personally that the statements of
facts contained in the appeal and accompanying documents are true and correct.

An attorney, certified public accountant, or an individual enrolled to practice before the
Internal Revenue Service may represent you during the appeal process. To be
represented during the appeal process, you must file a proper power of attorney, Form
2848, Power of Attorney and Declaration of Representative, if you have not already
done so. For more information about representation, see Publication 947, Practice
Before the IRS and Power of Attorney. All forms and publications mentioned in this
letter can be found at www.irs.gov, Forms and Publications.

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If you do not intend to protest this determination, you do not need to take any further
action. If we do not hear from you within 30 days, we will issue a final adverse
determination letter to you. That letter will provide information about filing tax returns
and other matters.

Please send your protest statement, Form 2848 and any supporting documents to the
applicable address:

Mail to: Deliver to:
Internal Revenue Service Internal Revenue Service
EO Determinations Quality Assurance EO Determinations Quality Assurance
Room 7-008 550 Main Street, Room 7-008
P.O. Box 2508 Cincinnati, OH 45202

Cincinnati, OH 45201
You may also fax your statement using the fax number shown in the heading of this
letter. If you fax your statement, please call the person identified in the heading of this
letter to confirm that he or she received your fax.

If you have any questions, please contact the person whose name and
telephone number are shown in the heading of this letter.

Sincerely,

Lois G. Lerner
Director, Exempt Organizations

Enclosure, Publication 892

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