IRS revokes a dog club's section 501(c)(7) exemption

Plain-English summary

The IRS revoked a dog club's exemption under IRC section 501(c)(7). The organization held dog shows, obedience trials, sanctioned matches, and other activities in which the general public regularly participated. The examination found that nonmember receipts exceeded the redacted threshold permitted by Public Law 94-568 for at least three years and that the organization did not maintain the required records. The IRS concluded that the club was not substantially supported by member receipts and required Form 1120 filings for the open periods. The examination also addressed, in the alternative, whether income from nonmember and other nonexempt activities would be taxable as unrelated business income under section 511 if the exemption were retained.

Ruling snapshot

• Question: Whether the organization continued to qualify under IRC section 501(c)(7) despite receiving most of its operating revenue from nonmembers.
• Outcome: Revocation of exemption, effective January 1 of the redacted year.
• Key authorities: IRC §§ 501(c)(7), 511, 513, 6014, 6501(g), and 277; Treas. Reg. §§ 1.501(c)(7)-1 and 1.513-1(d)(2); Public Law 94-568; Rev. Ruls. 58-589 and 60-324; Rev. Procs. 71-17 and 84-46.

Full text (IRS public release)

501-07.00

Department of the Treasury
Internal Revenue Service
1100 Commerce Street
Dallas, TX 75242

Release Number: 201317015
Release Date: 4/26/2013

Date: January 14, 2013

Form:

LEGEND Tax Year(s) Ended:

ORG - Organization name

XX - Date Address - address Person to Contact:
Contact Telephone Number:

ORG

ADDRESS

CERTIFIED MAIL

Dear

We have completed our examination of your Form 990 for the periods ended December 31,
20XX. It has been determined that your exempt status should be revoked.

The previous report of examination issued on August 8, 20XX, states the basis for the
revocation. You have concurred with our determination by signing Form 6018-A, Consent to
Proposed Adverse Action, on September 17, 20XX. A copy of which is enclosed. Accordingly,
your exemption from Federal income tax under section 501(c)(7) of the Internal Revenue Code
has been revoked effective January 1, 20XX.

You are required to file Federal income tax return, Form 1120, with the Internal Revenue
Service Center. We have secured the delinquent Forms 1120 for the periods ended December
31, 20XX; December 31, 20XX; December 31, 20XX. When filing future returns, remember the
Internal Revenue Code section 277 may limit your deductions.

You also have the right to contact the Office of the Taxpayer Advocate. However, you should
first contact the person whose name and telephone number are shown above since this person
can access your tax information and can help you get answers. You can call 1-877-777-4778,
and ask for the Taxpayer Advocate assistance or you can contact the Advocate from the site
where this issue was determined by writing to:

Taxpayer Advocate assistance cannot be used as substitute for established IRS procedures,
formal appeals processes, etc. The Taxpayer Advocate is not able to reverse legal or technically
correct tax determination, nor extend the time fixed by law that you have to file a petition in
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. If we do not hear from

you within 30 days of the date of this letter, this determination will be considered final and no
further action will be required.

Please keep a copy of this report with your permanent records.

If you have any questions regarding this matter, please contact the person whose name and
telephone number are shown above.

Sincerely yours,
Nanette M. Downing

Enclosure(s): Director, EO Examination
Publication 892

DEPARTMENT OF THE TREASURY
Internal Revenue Service
TE/GE: EO Examinations
1100 Commerce Street
TAX EXEMPT AND Dallas, TX 75242

GOVERNMENT ENTITIES
DIVISION

August 8, 2012

Taxpayer Identification Number:

ORG Form:

ADDRESS
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.

Sincerely,

Nanette M. Downing
Director, EO Examinations

Enclosures:
Publication 892
Publication 3498
Form 6018
Report of Examination
Envelope

Letter 3610 (04-2002)
Catalog Number 34801V

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

Name of Taxpayer Year/Period Ended
ORG EIN December 12, 20XX

LEGEND
ORG - Organization name XX - Date CO-1 - 1st COMPANY EIN - EIN
August 08, 20XX

ISSUE:

Does ORG continue to qualify as an organization described in the Internal
Revenue Code Section 501(c)(7), even though it receives less than % of its
operating revenue from its members, and substantially all the rest of its revenue from
the general public?

FACTS:

ORG, (the organization) received income tax exemption as described in IRC
501(c)(7) in 19XX, instead of the IRC 501(c)(4) it applied for because it did not meet
the requirements for that Code. Even though the organization appealed that
decision, it has continued to check its Form 990 returns as a 501(c)(4) organization.
The books and records of the organization for the period ending December 31, 20XX
were examined, and it was found that the club is not complying with the
requirements of Public Law 94-568 and Revenue Procedure 71-17. The general
public participates in its events that are carried on, including sanctioned matches, dog
shows, etc., but the organization failed to maintain records of nonmember receipts as
required by Rev. Proc. 71-17.

The organization listed the following objectives in its Constitution: “To further the
advancement of all breeds of pure-bred dogs (all-breed clubs); to do all in its power
to protect and advance the interests of dog shows, obedience trials and to
encourage sportsmanlike competition at such events; and to conduct sanctioned
matches, dog shows and obedience trials under the rules of the CO-1.”

ORG is organized and operating as an organization described in Internal Revenue Code §
501(c)(7) to provide social, recreational and other activities to its members. But in carrying out
its stated objectives above, the general public/nonmembers regularly participate in the Club's
activities and the organization failed to keep records of its nonmember's participation and/or
receipts. Available records of retained copies of returns filed by the Organization for prior years
show that the organization has generated nonmember income in excess of % threshold
permitted in Public Law 94-568 since at least in the last three years analyzed as shown in Exhibit
A below, and failed to file the applicable Form 990-T prior to our examination.

Based on the analysis of the amounts reported on the organization's retained copies
of Form 990 returns and available records, the percentage of gross receipts from
nonmembers are as follows:

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 EIN December 12, 20XX

EXHIBIT: A

ORG - Gross Receipts Per Form 990 Returns

Tax Year
Gross income
Membership dues/income
Nonmember Income
% of nonmember income
% of membership income

20XX12

20XX12

20XX12

Percentage of investment income was as follows: 20XX = .05, 20XX = .03, and 20XX
= .02 of the organization's gross receipts. The above Exhibit shows that the
organization substantially depends on the receipts from the general public or
nonmembers, while maintaining very low membership dues and assessment of $ a
year per interview of the officer and examination of the books and records. It is clear
that the organization will not be able to continue in operation without the revenue
from the public or nonmembers that essentially provide substantial financial benefits
to the members that will otherwise have to bear these costs.

LAW

IRC Section 501(c)(7) states (in specifying attributes for exemption):
“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.”

Revenue Ruling 58-589, 1958-2 C.B. 266, provides that operational costs covered by
nonmember patronage would be an indicator of inurement, provided the club's assets
are distributable to club members upon dissolution. The effect of this Ruling is that a
club can overall experience a loss in any given business year, but inurement can take
the form of any excess of nonmember receipts over direct costs, covering expenses
that the members of the club would have to bear if it were not for the income provided
by nonmember patronage.

Revenue Ruling 1960-324, 1960-2 C.B. 173, weighed the following factors in its
findings that a club that makes its facilities available to the general public on a regular,
recurring basis should no longer be recognized under IRC Section 501(c)(7):

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 EIN December 12, 20XX

percentage of nonmember gross receipts (ranged from - % in this case), gross
profit from the unrelated activities, net profit overall and the number of outside
(unrelated) functions compared to total functions of the club. It was also indicated that
internal analysis of the club showed that if these outside activities were discontinued, a
substantial increase in the amount of annual dues from club members would be
necessary.

Internal Revenue Code Section 501(c)(7) provides for the exemption from Federal
income taxes for Social Clubs. Income Tax Regulation section 1.501(c)(7)-1 states that
if a Social Club makes its social and recreational facilities available to the general public
it will not qualify for tax-exempt status.

However, Revenue Procedure 71-17 as amended by Public Law 94-568 provides
certain gross receipts safe harbors; i.e. Social Clubs may receive up to 35% of their
total gross receipts, including investment income from sources outside of their
membership without jeopardizing their tax exempt status. Within this 35% limit, no
more than 15% of a club's gross receipts may be derived from nonmember use of
the club's facilities and/or services. Reg. 1.501(c)(7)-1(a) states, in part: 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 nonmembers
through the use of club facilities or in connection with club activities. If a club
exceeds the 15/35% test, then it will maintain its exempt status only if it can show
through facts and circumstances that “substantially all” of its activities are for
“pleasure, recreation and other nonprofitable purposes.”

The following are important facts and circumstances to take into account to determine
whether a club may maintain its exemption under IRC 501(c)(7):

• Frequency of use of the club facilities or services by nonmembers. An
unusual or single event (that is, nonrecurring on a year to year basis) that
generates all the nonmember income is viewed more favorably than
nonmember income arising from frequent use or participation by
nonmembers.

• Record of nonmember use over a period of years. A high percentage in one
year by nonmembers, with the other years being within permitted levels, is
viewed more favorably than a consistent pattern of exceeding the limits, even
by relatively small amounts. (See S. Rept. 94-1318, 2d Sess., 1976-2 C.B.
597, 599).

• Purposes for which the club's facilities were made available to nonmembers.

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 EIN December 12, 20XX

• Whether the nonmember income generates net profits for the organization.

TAXPAYER'S POSITION:

Taxpayer has tentatively indicated agreement with the examination findings, but will
have to officially do so by signing and returning the enclosed Form 6018.

GOVERNMENT'S POSITION:

ORG has exceeded the % gross receipts limits for nonmember income on a
continuous basis for at least in the three years. The nonmember receipts are earned
in the organization's regular fundraising activities. There was no one single or
unusual event that caused the club to exceed the % threshold that was not taken into
consideration. It is clear from this examination that the organization has not only
exceeded the % percent legal limit, but also not operating exclusively for exempt
purpose, and should be revoked. It shows that the organization is not substantially
supported by its member receipts as required under this Code. This represents
enormous inurement for the shareholders bared by the IRC 501(a).

The organization's exempt status should be revoked effective January 1, 20XX, the
date the material change in exemption was first noted. Rev. Proc. 84-46, 1984-1
C.B. 541.

As a taxable entity, the organization is required to file Form 1120, U.S. Corporation
Income Tax Return for the periods open under statute. Under 6501(g) these periods
include the years ending December 31, 20XX through December 31, 20XX. These
will replace any Form 990-T returns filed for these years.

Additionally, the organization is reminded of the provisions of IRC 277 concerning
membership organizations which are not exempt organizations.

In accordance with the provisions of Internal Revenue Code Section 6014, copies of
these examination conclusions and consent to the revocation of tax exemption will be
submitted to the State of Florida Revenue Department at the conclusion of the
examination.

Section 501(c)(7), in part, provides for the exemption from federal income tax of clubs
organized for pleasure, recreation, and other nonprofitable purposes, substantially all
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.

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
ORG EIN December 12, 20XX

ALTERNATIVE ISSUE:

In the alternative, if the organization qualifies for exemption under section 501(c)(7),
should the actual net income from nonmembers and other non-exempt activity income
not be taxable as unrelated business income under section 511 of the Code?

BRIEF EXPLANATION OF FACTS

The organization failed to file information and Form 990-T, Exempt Organization
Unrelated Business Income Tax Returns for the prior, current and subsequent years
prior to this examination. The delinquent returns were secured before all the
examination issues were fully developed that led to the decision to propose revocation.

LAW

Section 511(a) of the Code imposes a tax upon the unrelated business taxable income
of organizations exempt from federal income tax.

Section 513(a) defines the term unrelated trade or business as any trade or business
the conduct of which is not substantially related (aside from the need of such
organization for income or funds or the use it makes of the profits derived) to the
exercise or performance by such organization of its exempt functions.

Section 513(c) provides that a trade or business includes any activity which is carried
on for the production of income from the sale of goods. An activity does not lose its
identity as trade or business merely because it is carried on within a larger aggregate of
similar activities or within a larger complex of other endeavors which may not be related
to the exempt purposes of the organization.

Section 1.513-1(d)(2) of the regulations provides that a trade or business is “related” to
exempt purposes only where the conduct of the business activities has a causal
relationship to the achievement of exempt purposes (other than the production of
income). Further, it is “substantially related,” for purposes of section 513 of the Code
only if the causal relationship is a substantial one. For this relationship to exist, the
production or distribution of the goods or the performance of the services from which
the gross income is derived must contribute importantly to the accomplishment of those
exempt purposes.

TAXPAYER POSITION:

Taxpayer has tentatively indicated agreement with the examination findings, but will
have to officially do so by signing and returning the enclosed Form 6018.

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
ORG EIN December 12, 20XX

GOVERNMENT POSITION:

ORG has exceeded the % gross receipts limits for nonmember income on a
continuous basis for at least in the three years. The nonmember receipts are earned
in the organization's regular fundraising activities. There was no one single or
unusual event that caused the club to exceed the % threshold that was not taken into
consideration. It is clear from this examination that the organization has not only
exceeded the % percent legal limit, but also not operating exclusively for exempt
purpose. It shows that the organization is not substantially supported by membership
receipts as required under this Code. This represents enormous inurement for the
shareholders bared by the IRC 501(a). Revocation of exemption status is warranted.

CONCLUSION:

ORG no longer qualifies for exemption under § 501(c)(7) of the Internal Revenue Code as
nonmember income has exceeded the % threshold permitted by Public Law 94-568. Therefore,
your exempt status under § 501(c)(7) of the Internal Revenue Code should be revoked effective
January 01, 20XX. Should this revocation be upheld, Form 1120 must be filed starting with tax
periods ending December 31, 20XX through December 31, 20XX.

Note: If you appeal the proposed revocation, please refer to the enclosed Publication 892.
Appeal should contain statement of facts declared true under penalties of perjury. Please refer
to Publication 892, page 3 for example of statement signed under penalties of perjury.

Our examination of your exempt organization was primarily a compliance audit, and such audit is
conducted to verify your continued compliance with IRC Section 501(c)(7). The Board of
Directors has a fiduciary responsibility to ensure full compliance of the IRC Section 501(c)(7).

Thank you for your cooperation.

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