Other 1318010: IRS revokes section 501(c)(4) status but finds section 501(c)(7) qualification

Plain-English summary

The IRS revoked the organization’s exemption under section 501(c)(4), effective January 1, 20XX. The organization hosted social events for residents of a residential tower complex, but did not invite the general public. The IRS concluded that the tower residents did not constitute a qualifying community for section 501(c)(4) purposes. It separately concluded that the organization qualified under section 501(c)(7) because its activities were substantially for pleasure and recreation, and its investment and nonmember income remained within the stated limits.

Ruling snapshot

• Question: Whether the organization qualified under section 501(c)(4) as a community service organization or under section 501(c)(7) as a social club.
• Outcome: Section 501(c)(4) status revoked; section 501(c)(7) qualification found.
• Key authorities: IRC §§ 501(c)(4), 501(c)(7); Treas. Reg. §§ 1.501(c)(4)-1(a)(1), 1.501(c)(4)-1(a)(2)(i), 1.501(c)(7)-1; Rev. Rul. 72-102; Rev. Rul. 74-99; Pub. L. 94-568.

Full text (IRS public release)

GOVERNMENT ENTITIES

DEPARTMENT OF THE TREASURY
INTERNAL REVENUE SERVICE
TE/GE EO Examinations
MS:4957:DAL 501.04-00
1100 Commerce Street
Dallas, TX 75242

TAX EXEMPT AND

DIVISION Date: 12/11/2012

Number: 201318010
Release Date: 5/3/2013

LEGEND

ORG - Organization name
XX - Date Address - address Employer Identification Number:

Person to Contact/ID Number:

ORG Contact Numbers:
ADDRESS Telephone:
Fax:

CERTIFIED MAIL - RETURN RECEIPT REQUESTED

Dear

In a determination letter July 9, 20XX, you were held to be exempt from Federal income
tax under section 501(c)(4) of the Internal Revenue Code (the Code).

Based upon recent information received, we have determined you have not operated in
accordance with the provisions of section 501(c)(4) 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)(4) 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 January 18,
20XX, you signed Form 6018-A, Consent to Proposed Action, agreeing to the revocation
of your exempt status under section 501(c)(4) of the Code.

You are therefore required to file Form 1120 U.S. Corporation Income Tax Return for the
year(s) ended December 31, 20XX with the Ogden Service Center. 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 call the contact person whose name telephone
number shown at the beginning of this letter.

Sincerely,

Nan Downing
Director, EO Examinations

Internal Revenue Service Department of the Treasury

Taxpayer Identification Number:

Date: May 4, 2010

Form:

ORG Tax Year(s) Ended:
ADDRESS
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 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.

Letter 3610 (Rev. 11-2003)
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 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 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 ina
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.

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 (Rev. 11-2003)
Catalog Number: 34801V

Form 886A Department of the Treasury - Internal Revenue Service Schedule No. or
Explanation of Items Exhibit
Name of Taxpayer Year/ Period Ended
ORG December 31,
20XX
December 31,
20XX
LEGEND
ORG —- Organization name XX - Date State - state RA - RA co-1,
& CO-2 —- 1st & 2nd" COMPANIES Event-1 & Event-2 - 1st & 2nd Event
Issue:

Does ORG meet the requirements for exemption under Section 501(c)(4) as a community service
organization?

Does ORG meet the requirements for exemption under Section 501(c)(7) as a private club?

Facts:

ORG (ORG) was incorporated as a non-profit corporation in December, 20XX, in the State of
State. In February, 20XX ORG applied for exemption of federal income taxes under Internal
Revenue Code Section 501(c)(4) as a social welfare organization. The application for exemption
was signed by RA, principal of CO-1, developer of the CO-2.

As part of its application for exemption (Form 1024, dated February 2, 20XX) ORG stated that
ORG “was formed to promote the common good and general welfare of the residents in the CO-2
and the general public through civic betterments and social improvements by providing
recreational activities as well as other services to the residents and visitors of the CO-2.”

ORG receives funding from two sources. The first source of income is from an assessment made
at the time of sale of any residential unit in the towers. This assessment is equal to one
fourth of one percent (%). The assessment is made on original sales and subsequent sales of
units.

The second source of income is from returns on investments. During the years under examination
the organization reported $ in 20XX12 and $ in 20XX12. This represents % and % of total
returns respectively.

During 20XX the program activities consisted of 6 events planned and hosted by ORG. These
events were a winter holiday event, a wine & cheese event, a movie night event, a Event-1, and a
Event-2. These events were, basically, theme parties. The purpose of each event was to provide
an opportunity for the residents of the towers to commingle and enjoy food and refreshments
provided by ORG. Live music was provided by ORG during at least one of the events. While all
of the residents of the towers were invited to the events the general public was not invited.

The direct costs of the six events totaled $. Indirect costs of these events including contract
management, on-site management, and supplies were $. The total program activity costs were $.

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 December 31,
20XX
December 31,
20XX

Law:

IRC Section 501(c)(4) provides for an exemption of federal income taxes for social welfare
organization operated exclusively for the promotion of social welfare.

Reg. 1.501(c)(4)-1(a)(1) states “In general. A civic league or organization may be exempt as an
organization described in section 501(c)(4) if-It is not organized or operated for profit; and. It is
operated exclusively for the promotion of social welfare.

Reg. 1.501(c)(4)-1(a)(2)(i) provides that an organization is operated exclusively for the
promotion of social welfare if it is primarily engaged in promoting in some way the common
good and general welfare of the community.

Rev. Rul. 74-99, 1974-1 C.B. 132 states in part, “One misconception generated by Rev. Rul. 72-
102 is that the ruling appears unqualifiedly to equate a housing development with the term
“community” within the meaning of section 501(c)(4) of the Code, thereby giving rise to the
implication that any housing development may qualify as a community for exemption purposes
regardless of any other attendant facts and circumstances in the case. Rev. Rul. 72-102 is hereby
modified to reject its apparent acceptance of such a narrow definition of “community” for
purposes of section 501(c)(4).

A community within the meaning of the section 501(c)(4) of the Code and the regulations
is not simply an aggregation of homeowners bound together in a structured unit formed as an
integral part of a plan for the development of a real estate subdivision and the sale and purchase
of homes therein. Although an exact delineation of the boundaries of a “community”
contemplated by section 501(c)(4) is not possible, the term as used in that section has
traditionally been construed as having reference to a geographical unit bearing a reasonably
recognizable relationship to an area ordinarily identified as a governmental subdivision or a unit
or district thereof.

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

Reg. 1.501(c)(7)-1 provides “In general, this exemption extends to social and recreation clubs
which are supported solely by membership fees, dues, and assessments.”

Public Law 94-568 states that it is intended that social clubs should be permitted to receive up to
35 percent of their gross income, including investment income from sources outside of their

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 December 31,
20XX
December 31,
20XX

membership without losing their exempt status. Within this 35 percent amount, not more that 15
percent of the gross receipts should be derived from the use of the social club’s facilities or
services by the general public. Thus a social club may receive investment income up to the full
35 percent amount of gross receipts.

Taxpayer Position:

Conclusion:

During the year under examination (20XX12) ORG hosted events for the residents of the CO-2
on six occasions. These events were for the benefit of the residents. Members of the general
public including people in the immediate vicinity were not invited or welcome.

Code Section 501(c)(4) provides for an exemption for community service organizations primarily
engaged in promoting in some way the common good and general welfare of the community.

The question becomes what makes up the community?

Rev. Rul. 74-99, 1974-1 C.B. 132 rejects the narrow definition of Community found in Rev. Rul.
72-102 that equates a housing development with a community and substitutes the broader
definition that has traditionally been construed as having reference to a geographical unit bearing
a reasonably recognizable relationship to an area ordinarily identified as a governmental
subdivision or a unit or district thereof.

For purposes of Code Section 501(c)(4) the residents of the towers do not constitute a
community. Because only residents of the towers are invited and allowed to attend the events and
no members of the general public are allowed this organization does not serve a community as
defined for purposes of this code section. As such the organization does not meet the
requirements for exemption under this code section.

The possibility that this organization could meet the requirements for exemption as a social club
under Section 501(c)(7) was considered.

All of this organization’s activities are directed towards the pleasure and entertainment of the
residents. All of the activities include commingling and fellowship in public areas of the
residential towers. These activities typically include live music, food and beverages for the
benefit of the residents and inherently are a social forum. Entertainment comes in the form of
movies, or live music.

During the 20XX12 year there was no income from nonmember use of facilities and investment
income totaled approximately % and _ percent of the total revenues. This is within the
limitations provided by PL 94-568.

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 December 31,
20XX
December 31,
20XX

During the examination it was observed that substantially all of the organization’s activities were
for the purposes of pleasure and recreation. Less than _ percent of the total revenue was from
investment income and nonmember sources. Assessments related to the sale of condominiums

made up more than __ percent of total revenue in each year.

At no point did any income inure to the benefit of private shareholders.

It was concluded that the organization does qualify for exemption under IRC Section 501(c)(7).

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

Page: -4-