IRS revokes a country club’s exemption after public use exceeds the nonmember-income limit

Plain-English summary

The IRS revoked a country club’s exemption under IRC section 501(c)(7), effective October 1 of a redacted year. The club had opened its golf course, restaurant, bar, and other facilities to the public after membership declined. Its nonmember income was 28.3 percent and 27 percent of gross receipts in the two periods examined, above the 15 percent limit for public use of club facilities. The club also did not maintain the records required by Rev. Proc. 71-17, and agreed with the IRS position that it would file Form 1120.

Ruling snapshot

• Question: Does a social club continue to qualify for exemption when public use of its facilities produces nonmember income above the applicable limit?
• Outcome: Revocation
• Key authorities: IRC § 501(c)(7); Treas. Reg. § 1.501(c)(7)-1; Rev. Ruls. 58-589, 60-325, 68-638, and 69-219; Rev. Proc. 71-17

Full text (IRS public release)

DEPARTMENT OF THE TREASURY

INTERNAL REVENUE SERVICE
Attn: Mandatory Review, MC 4920 DAL 501.07-00
1100 Commerce St.
TAX EXEMPT AND Dallas, TX 75242
GOVERNMENT ENTITIES
DIVISION Date: April 13, 2012
Number: 201240027
Release Date: 10/5/2012 Employer Identification Number:
Person to Contact/ID Number:
ORG Contact Numbers:
ADDRESS Voice
Fax

CERTIFIED MAIL — RETURN RECEIPT REQUESTED
Dear

In a determination letter dated August 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
October 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 February 2, 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 Form 1120 U. S. Corporation Income Tax Return. You have
filed Form 1120 U. S. Corporation Income Tax Return for the years ended September
30, 20XX, September 30, 20XX and September 30, 20XX with us. In addition, 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

Internal Revenue Service Tax Exempt and Government Entities Division
Exempt Organizations: Examinations

1100 Commerce Street

MS:4957:DAL

Dallas, TX 75242-1100

Taxpayer Identification Number:
Form:

Date: November 17, 2011 Tax Year(s) Ended:
Person to Contact/ID Number:

ID Number:
Contact Numbers:
Telephone:

Fax:
ORG
ADDRESS

Certified Mail-Return Receipt Requested

Dear

We have enclosed a copy of our report of examination explaining why we believe revocation 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.

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-A, Consent to
Proposed Adverse Action. We will then send you a final letter revoking your 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

Letter 3610 (Rev 11-2003)

Fax: 214-413-5492
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 1-877-777-4778 and ask for
Taxpayer Advocate Assistance. If you prefer, you may contact your local Taxpayer Advocate

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

Thank you for your cooperation.

Sincerely,

Nanette M. Downing
Director, EO Examinations

Enclosures:
Publication 892
Publication 3498
Form 6018-A

Report of Examination
Envelope

2 Letter 3610 (Rev 11-2003)
Catalog Number 34801 V

Form 886-A Department of the Treasury - Internal Revenue Service Schedule No. or
Explanation of Items Exhibit
Name of Taxpayer Year/Period Ended
ORG September 30,
20XX
September 30,
20XX
LEGEND
ORG - Organization name XX - Date State - state CO-1 - 1st COMPANY
ISSUE:

Whether ORG continues to qualify for tax exempt status under Section 501(c)(7) of the
Internal Revenue Code of 19XX?

FACTS:

ORG was organized as a “non-profit corporation as approved by the Secretary of State, State
of State, as set in the Articles of Incorporation filed with the Secretary of State November 15,
19XX.” The corporation is made up of several classes of membership. The Articles of
Incorporation also states that "the purposes for which the corporation is organized are: To
provide social, fraternal and athletic facilities within the purview and meaning of Article 2.01 (A)
of the StateNon Profit Corporation Act including but not limited to the establishment and
maintenance of facilities for fishing, hunting, swimming, boating, golf, tennis, club house
facilities to accommodate social activities of the membership hereof; to protect, preserve and
propagate fish and game; to purchase and own such lands and bodies of water as may be
desirable in connection therewith; to erect suitable improvements thereon; as well as any other
purposes normally incidental to and consistent with the normal operation of a private country
club. "

Article Eight (8): "Membership in said corporation, and the classes thereof, shall be as
authorized under the By-Laws of said corporation as the same may be from time to time
promulgated by the board of directors acting under proper delegation of authority from a
majority vote of the then voting membership. "

Article I, Section 1 of the By-Laws, states: "The ORGs affairs are managed by a Board of
Directors. Article II of the By-Laws states: "The Board is comprised of nine (9) members, who
are Class A members and active members in good standing, elected by ballot at the annual
Class A membership meeting to serve terms of three (3) years."

ORG conducts various activities for the pleasure and enjoyment of their members, but is now
open to the public. There are still some amenities afforded to members only such as, fishing,
swimming, voting, and use of the lake. ORG distributes a newsletter with monthly club news,
names of the current board, monthly sales information from the café, restaurant hours, calendar
of events, and solicited advertising on the back page. They have opened, and advertise open
to the public, because of the decline in membership. ORG had around 450 members in early
20XX, but has only 85 at the present time, thus making it difficult to survive without nonmember
income.

ORG has contracted out its kitchen and banquet facilities to CO-1, who books events such as
wedding receptions, reunions, and parties. ORG receives the following from CO-1:

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
ORG September 30,
20XX
September 30,
20XX

1. 5% of gross sales from the 19th hole or Café

2. 5% of gross sales of food for catered events

3. 25% of gross sales of all alcoholic beverages from bar or catering events

4. In addition, 5% of the gross sales of #1 & #2 will be held by CO-1 to be used only on
   kitchen repairs, and or upgrades and maintenance of ORG’s equipment, including
   signed for inventory.

ORG operates an 18-hole golf course open to members and the public. The income received
by ORG includes membership dues, greens fees, cart rentals, pro shop sales, and a
percentage of restaurant & bar sales, and miscellaneous income including interest and rebates
received on credit cards.

The exact income attributable to non-members is unknown because ORG did not comply with
the record keeping requirements of Revenue Procedure 71-17. Per Revenue Procedure 71-17,
without records of non-member sales, all income from cart rentals, restaurant & bar, and pro-
shop sales can be assumed to be from nonmembers. However, ORG and agent agreed on a
method to determine a reasonable nonmember percentage.

As a result, the analysis of nonmember percentage based on a two year period is noted below:

Year/Period % of Gross Receipts Total % Investment
Ended from nonmember use nonmember income
September, 20XX 28.3% (Exhibit A) 28.3%
September, 20XX 27% (Exhibit B) 27%
LAW:

Internal Revenue Code section 501(c)(7) exempts from federal income tax those organizations
or 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 of the Income Tax Regulations provides that, in general, the exemption
extends to social and recreation clubs supported solely by membership fees, dues, and
assessments. However, a club which engages in a 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.

Also, Public Law 94-568 was intended to permit organizations to receive up to 15% of its gross
receipts from the use of a social club’s facilities or services by the general public without
jeopardizing its exempt status. Gross receipts are defined for this purpose as those receipts

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

Form 886-A Department of the Treasury - Internal Revenue Service Schedule No. or
Explanation of Items Exhibit
Name of Taxpayer Year/Period Ended
ORG September 30,
20XX
September 30,
20XX

from normal and usual activities of ORG including charges, admissions, membership fees,
dues, assessments, and investment income, dividends and rents.

Furthermore, Revenue Ruling 68-638 states that a country club that annually host a golf
tournament to which the general public is admitted for a charge and uses the net income
thereof for club purposes does not qualify for exemption under section 501(c)(7) of the Internal
Revenue Code. Revenue Ruling 69-219 states a social club that regularly holds its golf course
open to the general public, charging established green fees that are used for maintenance and
improvement of club facilities, is not exempt under section 501(c)(7) of the Code. Revenue
Ruling 58-589 states solicitation by advertisement or otherwise for public patronage of its
facilities is prima facie evidence that ORG is engaging in business and is not being operated
exclusively for pleasure, recreation or social purposes. And finally, Revenue Ruling 60-325
states a social club which has been granted exemption from Federal income tax under section
501(c)(7) of the Internal Revenue Code of 1954 may lose its exemption if it makes its club
facilities available to the general public on a regular, recurring basis since it may then no longer
be considered to be organized and operated exclusively for its exempt purpose.

Revenue Procedure 71-17 sets forth guidelines for determining the effect of gross receipts
derived from nonmember use of a social club’s facilities on exemption under Internal Revenue
Code Section 501(c)(7) and recordkeeping requirements. Failure to maintain such records or
make them available to the Service for examination will preclude use of the minimum gross
receipts standard and audit assumptions set forth in this Revenue Procedure.

TAXPAYERS POSITION:
The organization agreed with the IRS Position and will submit Forms 1120.

IRS POSITION:

Based on the examination, the Organization does not qualify for exemption as a social club
described in IRC 501(c)(7). An Organization exempt from federal income taxes as described
in IRC section 501(c)(7) must meet the gross receipts test in order to maintain its exemption.
In order to meet the gross receipts test, an organization can receive up to thirty-five percent
(35%) of its gross receipts, including investment income, from sources outside its membership
without losing its tax exempt status. Within this 35% amount, not more than fifteen (15%) of the
gross receipts should be derived from the use of the social club’s facilities or services by
nonmembers.

The Organization has exceeded the 15% gross receipts standard for nonmember income on a
continuous basis for at least two (2) years. ORG received a large percentage of gross
nonmember income 28.3% for the period ended September 30, 20XX, and 27% for the period
ended September 30, 20XX, which exceeds the limitation of 15% as set forth by IRC 501(c)
(7). Nonmember income is received from the cart rentals, restaurant and bar sales, and pro

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
ORG September 30,
20XX
September 30,
20XX

shop sales, but the exact amount of income from these activities is indeterminable because
they did not comply with the record keeping requirements of Revenue Procedure 71-17. ORG
is advertising it is open to the public and has many amenities to offer residents in the area. The
facts of the case show that it is operating in a manner consistent with a for-profit business.

CONCLUSION:

As a result of our examination of your Form 990 for the periods ending September 30, 20XX,
and September 30, 20XX, we have determined that your Organization no longer qualifies as an
exempt social and recreational club described in IRC 501(c)(7). Therefore, we are proposing
revocation of your exempt status under IRC Section 501(c)(7) effective October 1, 20XX.

As a taxable entity, you are required to file Form 1120, U.S. Corporation Income Tax Return for
the periods open, September 30, 20XX through September 30, 20XX, and subsequent years.

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