IRS revokes a social club's exemption because it lacked social activities and retained nonmember income

Plain-English summary

The IRS issued a final adverse determination revoking an organization's exemption under IRC § 501(c)(7). The organization held title to and maintained a building used by four fraternal organizations, but it did not conduct or organize social functions and received substantial nonmember investment income. The IRS also concluded that the organization did not qualify under § 501(c)(2) because its purposes extended beyond title holding and it retained income instead of turning it over to an exempt parent organization. The organization was required to file Form 1120 income tax returns for the stated tax period and later years.

Ruling snapshot

• Question: Did the organization qualify as a social club under IRC § 501(c)(7) or as a title-holding corporation under § 501(c)(2)?
• Outcome: Revocation
• Key authorities: IRC §§ 501(a), 501(c)(2), 501(c)(7), and 6110; Treas. Reg. § 1.501(c)(2)-1(b); Rev. Rul. 66-149 and Rev. Rul. 58-566

Full text (IRS public release)

Internal Revenue Service Department of the Treasury

Appeals Office

San Jose Appeals, HQ-7100
55 S. Market St., Suite 516
San Jose, CA 95113

Taxpayer Identification Number:
Person to Contact:
Employee ID Number:
Tel:
Fax:
Contact Hours:
Tax Period(s) Ended:

Release Number: 201241018
Release Date: 10/12/2012

Date: July 19, 2012

UIL:
0501.07-00
0511.02-00

Dear

This is a final determination that you do not qualify for exemption from Federal income tax under Internal
Revenue Code (the “Code”) section 501(a) as an organization described in Code section 501(c)(7).

The revocation of your exempt status under Code section 501(c)(7) because you have not conducted any
social functions for members and your non-member income in the form of dividend and interest has
exceeded the allowable percentage under said section.

You also do not qualify under Code section 501(c)(2) because you are not organized as a title holding
company and you have not turned over excess income, which has been accumulated year after year, to
your member organizations.

You are required to file Federal income tax returns on Forms 1120 for the tax period stated in the heading of
this letter and for all tax years thereafter. File your return with the appropriate Internal Revenue Service
Center per the instructions of the return. For further instructions, forms, and information please visit

www.irs.gov.

Please show your employer identification number on all returns you file and in all correspondence with
Internal Revenue Service.

You also 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 tax matters that
may not have been resolved through normal channels get prompt and proper handling. If you want
Taxpayer Advocate assistance, please contact the Taxpayer Advocate for the IRS office that issued this
letter. You may call toll-free, 1-877-777-4778, for the Taxpayer Advocate or visit www.irs.gov/advocate for
more information.

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.

Sincerely Yours,

Karen A Skinder
Appeals Team Manager

cc:

DEPARTMENT OF THE TREASURY
Internal Revenue Service
Mail Code 4900DAL
1100 Commerce St.
Dallas, TX 75242

GOVERNMENT ENTITIES
DIVISION

June 15, 2010

Taxpayer Identification Number:

ORG
ADDRESS
Form:

Tax Year(s) Ended:

Person to Contact/ID Number:

Contact Numbers:
Telephone:
Fax:

CERTIFIED MAIL - RETURN RECEIPT REQUESTED

Dear

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

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

If you request a conference, we will forward your written statement of protest to the
Appeals Office and they will contact you. For your convenience, an envelope is
enclosed.

If you and Appeals do not agree on some or all of the issues after your Appeals
conference, or if you do not request an Appeals conference, you may file suit in United
States Tax Court, the United States Court of Federal Claims, or United States District
Court, after satisfying procedural and jurisdictional requirements as described in
Publication 3498.

Letter 3610 (04-2002)
Catalog Number 34801V

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

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

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

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

Letter 3610 (04-2002)
Catalog Number 34801V

Thank you for your cooperation.

Enclosures:
Publication 892
Publication 3498
Form 6018

Report of Examination
Envelope

Sincerely,

Nanette M. Downing
Director, EO Examinations

Letter 3610 (04-2002)
Catalog Number 34801V

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

Explanation of Items Exhibit
Year/Period Ended

Name of Taxpayer
ORG December 31,
20XX

LEGEND
ORG - Organization name XX - Date CO-1, CO-2, CO-3 & CO-4 = 1st, 2nd,
3rd & 4th companies

ISSUES

1. Should the tax exempt status of an organization exempt under 501(c)(7) of the Code
   be revoked, whose primary function is holding title to and providing upkeep for a
   building used by several fraternal organizations?

2. Does the organization qualify under 501(c)(2) of the Code as a title holding
   company?

FACTS

The organization listed above received exemption in 19XX as a social club described in
501(c)(7) of the Code. According to its Bylaws, the organization was formed for the
purposes of:

“receiving subscriptions, donations and bequests of money and other property, real and
personal, and of holding, managing, controlling, expending and incumbering the same
to secure loans and erecting, finishing, furnishing, controlling and managing a building
or buildings for the use of CO-1; CO-2, CO-3, CO-4,...”

The ORG, Inc. (ORG) is a membership organization comprised of four
fraternal/Masonic organizations. The ORG holds title to the property and handles the
day to day operations of the facility, ultimately insuring the building is usable by the
member organizations. All social functions that take place at the facility are run by the
member organizations. ORG does not participate or organize these functions.

The main sources of income for the ORG are membership dues and rents (from the
member organizations) and investment income. The organization does not have a
“parent” organization and retains earnings and income from year to year.

ISSUE 1

Should the tax exempt status of an organization exempt under 501(c)(7) of the Code be
revoked, whose primary function is holding title to and providing upkeep for a building
used by several fraternal organizations?

LAW

Section 501(c)(7) of the Code exempts from federal income tax 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 explain that exemption provided by section
501(a) for organizations described in section 501(c)(7) applies only to clubs which are
organized and operated exclusively for pleasure, recreation, and other nonprofitable
purposes, but does not apply to any club if any part of its net earnings inures to the
benefit of any private shareholder. In general, this exemption extends to social and
recreation clubs which are supported solely by membership fees, dues, and
assessments.

Rev. Rul. 66-149, 1966-1 C.B. 146, states that a social club is not exempt from Federal
income tax as an organization described in section 501(c)(7) of the Internal Revenue
Code where it regularly derives a substantial part of its income from nonmember
sources such as, for example, dividends and interest on investments which it owns.

TAXPAYER’S POSITION

The taxpayer's position has not been determined at this time.

GOVERNMENT'S POSITION

ORG is not eligible for exemption under 501(c)(7) of the Code as a social club. Section
501(c)(7) of the Code exempts from federal income tax clubs organized for pleasure,
recreation, and other non-profitable purposes. The organization does not meet the
criteria as there are no social activities.

The purpose of the organization is to “secure loans and erecting, finishing, furnishing,
controlling and managing a building or buildings for the use of the four Masonic
bodies...” The scope of their stated mission is outside that allowed for social clubs
exempt under 501(c)(7) of the Code. As their organizing document does not meet the
organizational test required for exemption under 501(c)(7) of the Code, the organization
does not qualify for exemption under this code section.

Rev. Rul. 66-149, 1966-1 C.B. 146, states that a social club is not exempt from Federal
income tax as an organization described in section 501(c)(7) of the Internal Revenue
Code where it regularly derives a substantial part of its income from nonmember
sources such as, for example, dividends and interest on investments which it owns.
ORG's main source of income is dividends and interest.

CONCLUSION

As ORG is not organized as a social club, has no recreational activities and receives a
substantial amount of its revenue from non-member sources, including investment
income, they do not qualify for exemption under 501(c)(7) of the Code.

ISSUE 2

Does the organization qualify under 501(c)(2) of the Code as a title holding company?

LAW

Section 501(c)(2) of the Code exempts from federal income tax corporations organized
for the exclusive purpose of holding title to property, collecting income therefrom, and
turning over the entire amount thereof, less expenses, to an organization which itself is
exempt under this section.

Treas. Reg. § 1.501(c)(2)-1(b) explains that a corporation described in section 501(c)(2)
cannot accumulate income and retain its exemption, but it must turn over the entire
amount of such income, less expenses, to an organization which is itself exempt from
tax under section 501(a).

Rev. Rul. 58-566, 1958-2 C.B. 261 states that in part, an organization incorporated with
broad powers and business purposes beyond the scope of those necessary to a
holding company, did not qualify for exemption under 501(c)(2) of the Code.

Santa Cruz Building Associations v. United States of America, 411 F.Supp. 871, 37
A.F.T.R.2d 76-1314, 76-1 USTC P 9374, found that a building association did not
qualify for exemption under 501(c)(2) of the Code that retained more income than
needed to cover normal operational expenses.

TAXPAYER POSITION

The taxpayer's position has not been determined at this time.

GOVERNMENT’S POSITION

Section 501(c)(2) of the Code exempts from federal income tax corporations organized
for the exclusive purpose of holding title to property, collecting income therefrom, and
turning over the entire amount thereof, less expenses, to an organization which itself is
exempt under this section (subsection a). ORG does not turn its income over to
another organization.

Treas. Reg. § 1.501(c)(2)-1(b) explains that a corporation described in section 501(c)(2)
cannot accumulate income and retain its exemption, but it must turn over the entire
amount of such income, less expenses, to an organization which is itself exempt from
tax under section 501(a). ORG accumulates its income in a savings account. The
20XX end of year cash in a savings account was $. This amount was indicated as the
beginning year balance for 20XX, and accumulated to an end of year balance of $.

Rev. Rul. 58-566, 1958-2 C.B. 261 states that in part, an organization incorporated with
broad powers and business purposes beyond the scope of those necessary to a
holding company, did not qualify for exemption under 501(c)(2) of the Code. The
purpose of ORG as stated in their organizing document is for “receiving subscriptions,
donations and bequests of money and other property, real and personal, and of
holding, managing, controlling, expending and incumbering the same to secure loans
and erecting, finishing, furnishing, controlling and managing a building or buildings...”
These purposes and powers are beyond the scope of holding title to property, collecting
income thereof and turning over this income to a parent organization.

CONCLUSION

As ORG does not turn over its income to another organization exempt under 501(a) of
the Code, accumulates income in a savings account and was organized with purposes
beyond the scope of a title holding company, they do not qualify for exemption under
501(c)(2) of the Code.

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