IRS revokes a social club's tax exemption after excessive nonmember income

Plain-English summary

The IRS revoked a social club's exemption under IRC § 501(c)(7). The organization received substantial income from nonmember use of its facilities and from oil, gas, and mineral royalties, and it did not maintain the records required to apply the applicable gross-receipts standards. The examination report concluded that the organization exceeded the limits for nonmember receipts and was not operated exclusively for members' pleasure and recreation. The revocation was made effective October 1 of the redacted year, and the organization was instructed to file corporate income tax returns for open periods.

Ruling snapshot

• Question: Did the organization continue to qualify as an exempt social club under IRC § 501(c)(7)?
• Outcome: Revocation, effective October 1 of the redacted year.
• Key authorities: IRC § 501(c)(7); Treas. Reg. § 1.501(c)(7)-1; Rev. Proc. 71-17; IRC §§ 277 and 6110(k)(3).

Full text (IRS public release)

DEPARTMENT OF THE TREASURY
INTERNAL REVENUE SERVICE
WASHINGTON, D.C. 20224

501-07.00
TAX EXEMPT AND
GOVERNMENT ENTITIES
DIVISION March 13, 2013
Release Number: 201333019
Release Date: 8/16/2013
LEGEND
ORG - Organization name Taxpayer Identification Number:
XX - Date Address - address Form:
Tax Year(s) Ended:
Person to Contact/ID Number:
Contact Number:
ORG Group Manager Contact Number:
ADDRESS

CERTIFIED MAIL — RETURN RECEIPT REQUESTED
Dear

In a determination letter dated March 25, 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 letter with regard to your exempt status.

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 24,
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 Federal income tax returns for the for tax period(s) shown
above. If you have not yet filed these returns, please file them 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.
Thank you for your cooperation.

Sincerely,

Nanette M. Downing
Director, EO Examinations

Enclosure:
Publication 892

Internal Revenue Service Department of the Treasury
Tax Exempt and Government Entities Division

Exempt Organizations: Examinations

801 Tom Martin Drive

Room 263. -

Birmingham, AL 35211

Date: November 30, 2012 Taxpayer Identification Number:
Form:
Tax Year(s) Ended:
Person to Contact/ID Number:

ORG Contact Numbers:
ADDRESS 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.

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
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.

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

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.

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 34801V

Schedule number or exhibit

Form 886-A
(Rev. January 1994) EXPLANATIONS OF ITEMS 4

Name of taxpayer Tax Identification Number Year/Period ended
Oct. XX-Sept. XX
ORG EIN Oct. XX-Sept. XX
LEGEND
ORG - Organization name EIN - ein XX - Date City - city President -
president Co-1 - 18* COMPANY
Issue:

1. Whether or not ORG will continue to qualify as an exempt organization under Internal Revenue
   Code (IRC) section 501(c)(7)?

Facts:

The ORG (ORG) was granted exemption as a social club exempt from Federal income tax under Internal
Revenue Code section 501(c)(7) pursuant to a ruling issued on March 25, 19XX. Its purposes as stated in
its Articles of Incorporation are: “provide for its members facilities and operating for them the sport
commonly known as clay-bird shooting, in all of its aspect, and to that end the acquisition and maintenance
and operation of the gun club and shooting grounds, and the equipment therefore, for clay-bird shooting;
and the operation of local practice shoots, local registered shoots, state shoots, and any other shooting
activities deemed by the Board of Directors to be in the interest of ORG.”

ORG’s principal activity is to encourage the sport of trapshooting and to provide the necessary facilities to
its members. ORG holds specialty shoots and provides shooting lessons to both members and non-
members. Skeet, trap, 5 stand non-members fees are $, and $ for members, sporting clays 100 are $ for
non-members and $ for members.

In the fiscal year ending (FYE) September 30, 20XX, ORG derived most of its income from the sales of oil,
gas, and mineral royalties. ORG received $ from exempt function income and $ from oil, gas and mineral
royalties, $ from advertising, and $ from non-member use of the facility in FYE September 30, 20XX. There
was a written contract provided for the oil, gas and mineral lease.

Board meeting minutes dated September 28, 20XX included a resolution of the board of directors stating:
“Be it resolved by the board of directors of the ORG November 24, 20XX that President, President is
hereby authorized to act on behalf of ORG and execute oil and gas leases whose terms are no less than $
(dollars) per acre and % (percent) royalty.”Oil, gas and mineral lease dated January 22, 20XX between the
ORG, and CO-1 stated that the lessee may use the land for purposes of investigating, prospecting, drilling,
mining and exploring (including exclusive rights to conduct geophysical/seismic operations and other
related activities) for and producing oil, gas, and all other minerals, laying pipe lines, building drill sites,
access roads, tanks, power stations, telephone lines, and other structures thereon to produce, save, take
care of, teat, transport and own said products and for dredging and maintaining canals, constructing roads
and bridges, and building houses for its employees, and, in general, for all appliances, structures,
equipment, servitudes and privileges which may be necessary, useful or convenient to or | connection with
any such operations conducted by Lessee thereon, or on any lands pooled therewith the following
described land in City, to will:” The lease shall be for a term of 5 years and for a total amount of 48.30 acres
of land. See the attached lease for more specific details.

During the examination, it was determined that ORG receives income from outside its membership and did
not comply with the record- keeping requirements of Revenue Procedure 71-17, 1971-1 C.B. 683. Based
on examination of ORG’s Form 990 for the period ending September 30, 20XX, and 20XX, and Form 990-

Form 886-A (1-1994) Catalog Number 20810W Page_1 publish.no.irs.gov Department of the Treasury-Internal Revenue Service

Schedule number or exhibit

Form 886-A
(Rev. January 1994) EXPLANATIONS OF ITEMS 1

Name of taxpayer Tax Identification Number Year/Period ended
Oct. XX-Sept. XX
ORG EIN Oct. XX-Sept. XX

T for the period ending September 30, 20XX and 20XX and a review of their books and records, the
percent of nonmember use of facilities exceeded % of its total gross receipts and more than % of its gross
receipts are from non-member sources for the years under exam as well as the subsequent year. These
receipts are noted in the following chart:

: % of gross receipts Total % investment
0
Year/Period Ended % of gross receipts from investment income / nonmember
from nonmember use income income
September 30, 20XX 0%
September 30, 20XX 0%

TABLE DELETED

LAW:

Organizations exempt from federal taxes as described in IRC Section 501(c)(7) include 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, relating to the requirements of exemption of such
clubs under section 501(a), reads in part as follows:

(a) The 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 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. However, a club otherwise entitled
to exemption will not be disqualified because it raises revenue from members through the use of
club facilities or in connection with club activities.

(b) A club which engages in business, such as making its social and recreational facilities available to
the general public or by selling real estate, timber or other products, is not organized and operated
exclusively for pleasure, recreation, and other nonprofitable purposes and is not exempt under
section 501(a). 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. However, an incidental sale of property will not deprive a
club of its exemption.

Prior to its amendment in 1976, IRC Section 501(c)(7) required that social clubs be operated exclusively for
pleasure, recreation, and other non-profitable purposes. Public Law 94-568 amended the “exclusive”
provision to read “substantially” in order to allow a section 501(c)(7) organization to receive up to 35
percent of its gross receipts, including investment income, from sources outside its membership without
losing its tax exempt status. The Committee Reports for Public Law 94-568 further state:

Form 886-A (1-1994) Catalog Number 20810W Page 2 publish.no.irs.gov Department of the Treasury-Internal Revenue Service

Schedule number or exhibit

Form 886-A
(Rev. January 1994) EXPLANATIONS OF ITEMS 1

Name of taxpayer Tax Identification Number Year/Period ended
Oct. XX-Sept. XX
ORG EIN Oct. XX-Sept. XX

(a) 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 non-members, so long as the latter do not represent more
than 15 percent of total receipts. These percentages supersede those provided in Revenue Ruling
71-17, 1971-1 C.B. 683.

(b) Thus, a social club may receive investment income up to the full 35 percent of its gross receipts if
no income is received from non-members’ use of club facilities.

(c) In addition, the Committee Reports state that where a club receives unusual amounts of income,
such as from the sale of its clubhouse or similar facilities, that income is not to be included in the 35
percent formula.

(d) The Senate report also indicates that even though gross receipts from the general public exceed
this standard, it does not necessarily establish that there is a nonexempt purpose. A conclusion
that there is a nonexempt purpose will be based on all the facts and circumstances including, but
not limited to, the gross receipts factor.

Revenue Ruling 58-589 sets forth the criteria for exemption under section 501(c)(7) of the Code, and
provides that a club must have an established membership of individuals, personal contacts, and
fellowship. It also provides that, while the regulations indicate that a club may lose its exemption if it makes
its facilities available to the general public, this does not mean that any dealings with nonmembers will
automatically cause a club to lose its exemption. A club may receive some income from the general public,
that is, persons other than members and their bona fide guests, or permit the general public to participate
in its affairs, provided that such participation is incidental to and in furtherance of ORG’s exempt purposes,
such dealings with the general public and the receipt of income therefrom does not indicate the existence
of a club purpose to make a profit, and the income does not inure to club members.

Revenue Ruling 60-324 provides that a social club that made its social facilities available to the general
public through its member-sponsorship arrangement can not be treated as being operated exclusively for
pleasure, recreation, or other nonprofitable purposes and ORG no longer qualified for exemption under
501(c)(7) of the Code.

Revenue Ruling 66-149 provides that a social club is not exempt from federal income tax as an
organization described in section 501(c)(7) of the code if it regularly derives a substantial part of its income
from non-member sources such as, for example, dividends and interest on investments.

Revenue Ruling 68-119 provides that a club will not necessarily lose its exemption if it derives income from
transactions with other than bona fide members and their guests, or if the general public on occasion is
permitted to participate in its affairs, provided such participation is incidental to and in furtherance of its
general club purposes and the income therefrom does not inure to members.

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

Department of the Treasury-Internal Revenue Service

Form 886-A (1-1994) Catalog Number 20810W Page 3 publish.no.irs.gov

Schedule number or exhibit

Form 886-A
(Rev. January 1994) EXPLANATIONS OF ITEMS 1

Name of taxpayer Tax Identification Number Year/Period ended
Oct. XX-Sept. XX
ORG EIN Oct. XX-Sept. XX

for examination will preclude use of the minimum gross receipts standard and audit assumptions set forth
in this Revenue Procedure.

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):

e The actual percentage of nonmember receipts and/or investment income.

e Frequency of use of ORG 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 by nonmembers.

e 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).

e Purposes for which ORG’s facilities were made available to nonmembers.

e Whether the nonmember income generates net profits for the organization. Profits derived from
nonmembers, unless set aside, subsidize ORG’s activities for members and result in inurement
within the meaning of IRC 501(c)(7).

TAXPAYER'S POSITION:

The ORG Inc. will have an opportunity to respond once this report is received.

GOVERNMENT'S POSITION:

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 (%) 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 percent (%) of the gross receipts should be derived from the use of a social club’s
facilities or services by non-members.

ORG, has exceeded the % gross receipts standard for nonmember income on a continuous basis for at
least two years. The nonmember receipts are earned throughout the year. During the fiscal year ending
September 30, 20XX there was a single unusual event that occurred but even without the gas, oil,
mineral lease ORG still exceeded the 15% threshold and therefore no longer qualifies for exemption as
a 501(c)(7) organization.

Form 886-A (1-1994) Catalog Number 20810W Page_4 —_publish.no.irs.gov Department of the Treasury-Internal Revenue Service

Schedule number or exhibit

Form 886-A
(Rev. January 1994) EXPLANATIONS OF ITEMS

Name of taxpayer Tax Identification Number Year/Period ended
Oct. XX-Sept. XX
ORG EIN Oct. XX-Sept. XX

Based on the large percentages of gross nonmember income to total gross receipts of ORG, (i.e., % for
20XX09 and % 20XX09 as noted in the above table), which exceeds the limitation of % as set forth by
IRC 501(c)(7) for each of these years and the fact that the organization is not keeping adequate records
to account for non-member income and advertises the use of their facilities to the general public, it is the
Government’s position that ORG is no longer operated exclusively for the pleasure and recreation of it’s
members and is not exempt under section 501(c)(7).

CONCLUSION:

The IRC Section 501(c)(7) tax exempt status of ORG __. should be revoked since the nonmember income
received by ORG exceeded 15% of ORG’s total gross receipts for the years under examination. Further, it
advertises the use of their facilities to the general public reflecting evidence that ORG is engaged in a
business and is not being “operated exclusively for pleasure, recreation, or social purposes.”

ORG __ .no longer meets the requirements to qualify as exempt from federal income tax under IRC
section 501(a) as described in section 501(c)(7). Therefore, your exempt status under 501(c)(7) of the
Internal Revenue Code will be revoked effective October 1, 20XX.

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 September
30, 20XX and subsequent tax years.

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

Form 886-A (1-1994) Catalog Number 20810W — Page_5 publish.no.irs.gov Department of the Treasury-Internal Revenue Service