Other 1318021: IRS revokes a members-only organization's exemption

Plain-English summary

The IRS revoked a members-only organization's exemption under section 501(c)(4). The organization operated a bar and function hall, provided member benefits, and donated some income to local schools and charitable organizations. The IRS concluded that the bar was the organization's primary activity and did not promote the common good and general welfare of the community. The IRS also concluded that the organization did not qualify under sections 501(c)(7) or 501(c)(8), because it provided sick and death benefits, could not establish compliance with the nonmember-income limit, and did not operate under a lodge system.

Ruling snapshot

• Question: Whether the organization qualified under section 501(c)(4) or an alternative exemption provision.
• Outcome: Revocation.
• Key authorities: IRC §§ 501(c)(4), 501(c)(7), 501(c)(8); Treas. Reg. §§ 1.501(c)(4)-1(a)(2)(i), 1.501(c)(4)-1(a)(2)(ii), 1.501(c)(8)-1(a); Allied Trades Club, Inc. v. Commissioner, 23 T.C. 1017 (1955); Rev. Rul. 63-190; Rev. Rul. 66-179.

Full text (IRS public release)

DEPARTMENT OF THE TREASURY
Internal Revenue Service
10 Causeway Street, Room 581
Boston, MA 02222

TAX EXEMPT AND
GOVERNMENT ENTITIES
DIVISION

July 31, 2007

Taxpayer Identification Number:
Number: 201318021

Release Date: 5/3/2013 Form:
Tax Year(s) Ended:
ORG
ADDRESS Person to Contact/ID Number:
UIL: 501.04-00 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. Ifa
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,

Marsha A. Ramirez
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 20XX12

LEGEND
ORG - Organization name XX - Date Country - country Church —
church CO-1 - 1°* COMPANY
Issues

1. Should the tax exempt status of a 501(c)(4) members only organization which operates a bar
   be revoked?

2. Would the organization qualify under an alternate section of the IRC, such as 501(c)(7) as a
   social club or 501(c)(8) or 501(c)(10) as a fraternal organization operating under the lodge

system?

Explanation of Facts

The organization listed above received exemption in 1941 as a membership organization
described in 501(c)(4) of the Code. According to its Articles of Incorporation, the primary
purpose of the organization is to “establish and maintain a place for reading rooms and social
meetings.” Membership is open to men of Country descent, over the age of 21, who are
members of a Church. Per a Charter located on the wall of the function hall, prior to receiving its
individual exemption under 501(c)(4), the organization was a subordinate to a national
organization, the CO-1.

Benefits of membership with ORG include use of the organization’s bar and function hall,
death/sick benefits and life insurance. Life insurance is offered through the CO-1 (CO-1). ORG
directs any fees received from members regarding the life insurance to CO-1, and does not record
the transaction in their financial records.

Revenue and expenses of the organization are mainly associated with the operation of the bar.,
with % of its revenue generated through bar sales, and % from video games located in the bar
area. Hall rentals to the public provided only $ of revenue for 20XX. It is unclear how much
income is derived from non-member bar sales, as separate records are not kept. The organization
donates $ (% of its income) to local schools and charitable organizations. All other expenses are
associated with general administration and the operation of the bar.

Issue 1:
Should the tax exempt status of a 501(c)(4) members only organization which operates a bar be
revoked?

Law

Form 886-A crev.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 20XX12

Section 501(c)(4) of the Code provides, in part, for the exemption from Federal income tax of
civic leagues or organizations not organized for profit but operated exclusively for the promotion
of social welfare.

Section 1.501(c)(4)-1(a)(2)(i) of the Regulations states 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 people of the community. An organization
embraced within this section is one which is operated primarily for the purpose of bringing about
civic betterment and social improvements.

Rev. Rul. 66-179, 1966-1 CB 139, states that social activities for the benefit, pleasure, and
recreation of members do not preclude exemption under section 501(c)(4) of the Code.
However, section 1.501(c)(4)-1(a)(2)(ii) of the regulations provides that an organization will not
qualify for exemption as a civic organization described in section 501(c)(4) of the Code if its
primary activity is the operation of a social club.

Taxpayer’s Position
During the original exit interview, reasons for revocation were discussed with the Chairman

(President). The organization was in agreement that they no longer qualify for exemption under
501(c)(4) of the Code. The Form 6018-A is being requested to document their position.

Government’s Position

Based on the facts of the examination, the organization does not qualify for exemption under
501(c)(4) of the Code as the operation of a members only bar is not promoting the common good
and general welfare of the community. Rev. Rul. 66-179 states that although social activities for
members will not preclude exemption, the operation of a social club as the primary activity will.
Although a portion of their revenue is donated to community organizations, the primary activity
remains the operation of the bar.

Conclusion
Based on the reasons stated above, the organization does not qualify for exemption under
501(c)(4) of the Internal Revenue Code, and its exemption should be revoked.

Issue 2:

Would the organization qualify under an alternate section of the IRC, such as 501(c)(7) as a
social club or 501(c)(8) or 501(c)(10) as a fraternal organization operating under the lodge
system?

Law
Section 501(c)(7) of the Code provides for the exemption from Federal income tax of clubs
organized for pleasure, recreation, and other non-profitable purposes, substantially all of the

Form 886-Acrev.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 20XX12

activities of which are for such purposes and no part of the net earnings of which inures to the
benefit of any private shareholder.

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. This
means that an exempt social club may receive up to 35 percent of its gross receipts from a
combination of investment income and receipts from nonmembers so long as the latter do not
represent more than 15 percent of the total receipts.

Allied Trades Club, Inc. v. Commissioner, 23 T.C. 1017 (1955) states that the payment of sick
and death benefits is not a function of a social club exempt under 501(c)(7).

Section 501(c)(8) of the Code provides for the exemption from Federal income tax of fraternal
organizations operated under the lodge system who provide payment of sick, death, life or other
benefits to their members.

Section 501(c)(8)-1(a) states that a fraternal beneficiary society is exempt from tax only if
operated under the lodge system or for the exclusive benefit of the members so operating.
Operating under the lodge system means carrying on its activities under a form of organization
that comprises local branches, chartered by a parent organization and largely self-governing,
called lodges, chapters, or the like. In order to be exempt it is also necessary that the society have
an established system for the payment to its members or their dependents of life, sick, accident,
or other benefits.

Rev. Rul. 63-190, 1963-2 CB 212, states that a nonprofit organization (not operated under the
lodge system), which maintains a social club for members and also provides sick and death
benefits for members, does not qualify for exemption as a social club under section 501(c)(7), a
civic league under section 501(c)(4), or a fraternal beneficiary society under section 501(c)(8).

Taxpayer’s Position
During the original exit interview, the reasons the organization would not qualify under a

different subsection were discussed with the Chairman (President). The organization was in
agreement that their activities were not within the scope of another subsection.

Government’s Position

Based on the facts of the examination, the organization does not qualify under 501(c)(4),
501(c)(7) or 501(c)(8) of the Internal Revenue Code. Basis for revocation under 501(c)(4) is
discussed in Issue 1. The organization does not qualify for 501(c)(7) as they offer death benefits
to its members. The organization does not keep separate records of its non-member bar sales, so

Form 886-Acev.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 20XX12

its eligibility for 501(c)(7) based on the 35% non-member income limit could not be determined.
The organization is not operated under a lodge system, and therefore is not a fraternal
organization as described in 501(c)(8) of the Code.

Conclusion

Based on the reasons stated above, the organization does not qualify for exemption under
501(c)(4), 501(c)(7) or 501(c)(8) of the Code.

Form 886-Arev.4-68)

Department of the Treasury - Internal Revenue Service

Page: -4-