Determination 1338050: IRS revokes social club exemption over private services for members’ homes

Plain-English summary

The IRS revoked a social club’s exemption under IRC § 501(c)(7). The club’s employees performed maintenance, repair, trash collection, and water services for members’ personally owned homes, and the members paid the club for those services. The IRS concluded that these activities provided private benefits and were substantial, recurring business activities unrelated to social or recreational purposes. The taxpayer agreed to revocation effective January 1 of the redacted year.

Ruling snapshot

• Question: Did the organization continue to qualify as a tax-exempt social club under IRC § 501(c)(7)?
• Outcome: Revocation. The IRS concluded that the club operated substantial nontraditional business activities for members’ private residences.
• Key authorities: IRC §§ 501(a), 501(c)(7); Treas. Reg. §§ 1.501(c)(7)-1, 1.501(c)(7)-1(b); Rev. Ruls. 58-589, 63-190, 68-168, 68-535; Rev. Proc. 71-17.

Full text (IRS public release)

Department of the Treasury
Internal Revenue Service
TE/GE EO Examinations 501.07-00
1100 Commerce Street
Dallas, Texas 75242

Date: October 10, 2010
TAX EXEMPT AND
GOVERNMENT ENTITIES
DIVISION

Taxpayer Identification Number:
Number: 201338050 Form:
Release Date: 9/20/2013

ORG Tax Year(s) Ended:

ADDRESS Person to Contact/ID Number:
Contact Numbers:
Telephone:
Fax:

Dear
:

In a determination letter dated June 8, 19XX you were held to be exempt from
Federal income tax under 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
January 1, 20XX.

This is a final adverse determination letter with regard to your status under
501(c)(7) 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 Taxpayer Advocate, as well as your appeal rights. On
November 16, 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 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, or unless an examiner’s report of income tax liability
was issued to you with other instructions. File returns for later years with the

appropriate service center indicated in the instructions for those returns.

You have the right to contact Office of the Taxpayer Advocate. Taxpayer
Advocate assistance is not a substitute for established IRS procedures, such as
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 Tax
payer Advocate Assistance. If you prefer, you may contact your local Taxpayer
Advocate at:

If you have any questions, please contact the person whose name and telephone
number are shown at the beginning of this letter.

Sincerely,

Reviewer’s Name
EO Exam Reviewer

Department of the Treasury
Internal Revenue Service
TE/GE EO Examinations

100 South Clinton Street Room 1109

Syracuse, NY 13261

TAX EXEMPT AND
GOVERNMENT ENTITIES

DIVISION
December 14, 2010
ORG
ADDRESS Taxpayer Identification Number:
Form:
Tax Year(s) Ended:
Person to Contact/ID Number:
Contact Telephone Number:
Contact Fax Number:
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 accept our findings, please sign and return the enclosed Form 6018-A, Consent to
Proposed Action. We will then send you a final letter modifying or 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 the event of revocation, you will be required to file Federal income tax
returns for the tax period(s) shown above. If you have not yet filed these returns, please file
them with the examiner as soon as possible, unless a report of income tax liability was
issued to you with other instructions. File returns for later tax years with the appropriate
service center indicated in the instructions for those returns.

In lieu of Letter 3610

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. Please note that Fast Tract
Mediation Services referred to in Publication 3498, do not apply to Exempt
Organizations.

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 the
United States Tax Court, the United States Court of Federal Claims, or the 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 Organizations 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.

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:

In lieu of Letter 3610

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,

Nannette M. Downing
Director, EO Examinations

Enclosures:

Publication 892

Publication 3498

Form 6018-A

Report of Examination

Envelope

In lieu of Letter 3610

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 City - city State - state

Island - island

ISSUES:

1. Whether ORG (Organization) is a social club as described under Internal
   Revenue Code (IRC)501(c)(7).

FACTS:

The organization is exempt from income tax pursuant to Internal Revenue Code (IRC) §
501(a) because it is described as a social club in IRC § 501(c)(7).

The organization was incorporated in the city of City, State of State for the purposes of
the following, “to act as a neighborhood improvement association and as such, to own,
hire and lease lands and buildings upon the island of Island and in other places
necessary for the betterment of the neighborhood or neighborhoods of members and
such to build, repair and maintain streets and ways, build , repair and maintain private
water supply systems, carry on the operation of social clubs, societies, places of
recreation, sport, amusement and instruction for the benefit and entertainment of its
members and their nominees, build, repair and maintain wharves or landings for the
use of its members and buy, sell, maintain and rent boats of all sorts to its members
and their nominees, to conduct any of its corporate objects in any of the states of the
United States and have 1 or more officers therein; provided, however, that nothing
herein contained shall be construed to authorize the corporation to transact business in
any state contrary to the provisions of the Laws of such state’.”

The original application for exemption, dated June 8, 19XX, stated that “The
organization was formed to coordinate mutual interests of several members of the
summer colony at Island, State, by a pooling of caretaking and utility services and by
providing social functions’.

“Each year the corporation leases property at ORG containing various buildings and
facilities, including those for water and electricity, which it operates for the benefit of
some of its members. For rent the corporation agrees to maintain the property and pay
a sum equal the real estate taxes and premiums for fire and liability insurance on the
premises. It employs a caretaker who does work for the benefit of the corporation and
also for the benefit of the individual members. Members pay an annual membership fee
of $$ and an assessment fee if any major repairs are needed that year. The individual
work is specially billed to the members on a cost basis. Members are also assessed $
to take care of general expenses”.

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 20XX12

The care taker and three other employees supply maintenance and repair services for
the organization and individual member homes. Traditional activities that the employees
do include hauling and launching member boats, supplying fresh water on the docks,
taking care of all of the maintenance for the dock area, boat house, water system, gas
house, picking up trash for the organization and maintaining the swimming pool and the
tennis court areas. Prohibited non traditional activities that the organization does
includes picking up all the trash for member homes, supplying water service to member
homes and performing maintenance and repairs on member homes. The organization
also supplies water service for its use and also for individual members use for their
homes. The members pay on a per household basis. There are 14 or 15 users in all
including the organization. During the year under audit the organization received the
following prohibited non traditional revenue from these home owners. These non
traditional activities have been conducted for many years. $ in labor, $ for material used
for maintenance & repairs on member homes, $ rubbish revenue for picking up trash at
their homes, $ for water service.

The homes are personally owned by the members. When a member needs repairs
done on their home they contact the organization which schedule’s an appointment to
provide the service. Upon completing the repairs, the member is billed. Payment for
such repairs are paid directly to the organization.

LAW:

IRC 501(c)(7) provides that clubs are exempt from tax that are organized for pleasure,
recreation, and other non-profitable 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.

§1.501(c)(7)-1. Social clubs

(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 that clubs are exempt from tax that are organized for pleasure,
recreation, and other non-profitable 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. .

§1.501(c)(7)-1(b) of the regulations provides that a club which engages in business, such as
selling real estate, is not organized and operated exclusively for pleasure, recreation, and other
nonprofitable purposes and is not exempt under section 501(a) of the Code.

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 20XX12

Santa Barbara Club v. Commissioner, 68 T.C. 200 (1974). “In that case, the Tax
Court had to determine whether a social club's status as a tax-exempt organization
under IRC 501(c)(7) could be revoked because the club sold liquor to its members for
consumption away from the club's premises. In determining whether the activity was
substantial, the Tax Court based its decision on the amount of gross receipts generated
from the liquor sales, which was in excess of 25% of gross receipts from all sources.”
Thus, the Tax Court held that the organization was not exempt because the activity did
not further any social club purposes, was recurrent, and the gross receipts were in
excess of 25% of total gross receipts.

Revenue Ruling 58-589, 1958-2 CB 266 states;

“where a club engages in income producing transactions which are not a part of the
club purposes, exemption will not be denied because of incidental, trivial or
nonrecurrent activities such as sales of property no longer adapted to club purposes.
Santee Club v. White, 87 Fed. (2d) 5. In order to retain exemption a club must not enter
into outside activities with the purpose of deriving profit. Section 1.501(c)(7)-1 of the
Income Tax Regulations and Santee Club v. White, supra. If such income producing
activities are other than incidental, trivial or nonrecurrent, it will be considered that they
are designed to produce income and will defeat exemption.”

Revenue Ruling 68-168, 1968-1 CB 269 reads:
“A nonprofit organization that leases building lots to its members on a long-term basis is not
exempt from Federal income tax under section 501(c)(7) of the Internal Revenue Code of 1954.”

In the text of Revenue Ruling 68-168 it states “Although the revenues from this activity are
derived from the organization’s members only, the revenues are not raised from the members’
use of recreational facilities, or in connection with the organization’s recreational activities. The
conduct of such real estate activity, whether with members only or with the general public, is not
incidental to or in furtherance of any purpose covered by section 501(c)(7) of the Code.
Accordingly, the organization does not qualify for exemption from Federal income tax under that
section.”

Revenue Ruling 68-535, 1968-2 CB 219, (Jan. 01, 1968):

“A social club that regularly sells liquor to its members for consumption off its premises is not
entitled to exemption under section 501(c)(7) of the Code.”

In the text of Rev Ruling 68-535 it states:

“ the regular sale of liquor under the circumstances in the instant case is a service to the members
that is neither related to nor in furtherance of a social club’s exempt purposes. Since such
activity is neither social nor recreational, the club is not operated exclusively for pleasure,
recreation, and other nonprofitable purposes within the meaning of section 501(c)(7) of the Code.

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 20XX12

Accordingly, the social club described above is not entitled to exemption from Federal income
tax under section 501(c)(7) of the Code.”

Revenue Ruling 63-190, 1963-2 CB 212

“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 and their beneficiaries, does
not qualify for exemption from Federal income tax either as a social club under section 501(c)(7)
of the Internal Revenue Code of 1954.”

Revenue Ruling 75-494, 1975-2 CB 214, (Jan. 01, 1975)

Qualification; homeowner associations as social clubs.--

“A club providing social and recreational facilities, whose membership is limited to
homeowners of a housing development, will be precluded from qualifying for exemption
under section 501(c)(7) of the Code by owning and maintaining residential streets,
enforcing restrictive covenants, or providing residential fire and police protection and
trash collection service.”

Rev. Proc. 71-17, 1971-1 C.B. 683, sets forth guidelines for determining the effect of gross
receipts derived from nonmember use of a social club's facilities on the club's exemption under
Code §501(c)(7). In §3.02 this Revenue Procedure defines the term ‘total gross receipts’. Total
gross receipts means receipts from normal and usual activities of the club including charges,
admissions, membership fees, dues, and assessments. Excluded for this purpose are (a) initiation
fees and capital contributions, (b) interest, dividends, rents, and similar receipts, and (c) unusual
amounts of income such as amounts derived from nonrecurring sales of club assets.

Public Law 94-568, amended §501(c)(7) to provide for exemption from federal income tax
clubs organized for pleasure, recreation, and other non-profitable purposes, substantially all of
the activities of which are for such purposes and no part of net earnings of which inures to the
benefit of any private shareholder.

The Committee Report (S. Rep. No.94 - 1318, 94th Cong., 2nd Sess.1976) that accompanied
P.L. 94-568, provides congressional intent to the limitations on revenue from outside
membership. The report reads in part as follows:

“It is intended that a social club, or any other organization exempt under Code §501(c)(7), may
receive the full 35-percent amount of its gross receipts from investment income sources (reduced
by any amount of nonmember income)... in the case where a social club permits nonmembers to
use its club facilities and receives 15 percent of its gross receipts from these nonmember sources,
it may receive only up to 20 percent of its income from investment sources.”

TAXPAYER’S POSITION:

The taxpayer has agreed to revocation of their tax exempt status as of January 1,
20XX.

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 20XX12
GOVERNMENT’S POSITION

Based on the facts of the examination, we conclude that you do not meet the
requirements for exempt status under section 501(c)(7) of the code. Section 501(c)(7)
of the Code provides that a club be organized and operated exclusively for pleasure,
recreation, and other nonprofitable purposes is exempt from Federal income tax,
provided no part of its net earnings inures to the benefit of any private shareholder.
Maintenance and repair services provided to members for work done on their personal
residences is a private benefit to its members. This organization, in carrying out its
purposes in the manner described above, is not being operated exclusively for pleasure
and recreation of its members. Accordingly, it does not qualify for exemption under
section 501(c)(7) of the Code.

The organization did over % of prohibited non traditional exempt activities. According to
Revenue Ruling 58-589, 1958-2 CB 266, an organization that performs incidental, trivial
or nonrecurrent activities, exemption will not be denied. These prohibited non traditional
activities were not trivial or incidental and they have occurred for many years. In the tax
court case Santa Barbara Club v. Commissioner, 68 T.C. 200 (1974), non exempt
activity was % and exempt status was revoked.

Revenue Ruling 68-535 and Revenue Ruling 63-190 (stated above), are two revenue
rulings where non traditional exempt activities were involved and exempt status was
revoked. Even though these activities were done by members, these activities were
neither social nor recreational, are considered nontraditional activities and if substantial
and recurring, tax exempt status should be revoked. Exempt social clubs are not
permitted to receive income from activities not conducted in furtherance of their exempt
purposes. Revenue ruling 71-17, Pub law 94-568 and the report that accompanied
P.L.94-568 ,(S. Rep. No.94 - 1318, 94th Cong., 2nd Sess.1976), give further evidence
that income from the active conduct of businesses not traditionally carried on by these
organizations is not authorized and exemption should be revoked.

Conclusion:

Accordingly, we conclude that you do not meet the requirements for exempt status
under section 501(c)(7) of the code and propose to deny your exemption under that
section. We have determined you fail to qualify for exempt status under any other
subsection of IRC 501(c). After the proposed revocation becomes final, you will be
responsible for filing F1120s in the future.

Form 886-A rev.4-68) Department of the Treasury - Internal Revenue Service
Page: -5-