IRS determination 1344010: Social club exemption revoked for excessive nonmember income

Plain-English summary

The IRS revoked a social club's exemption under section 501(c)(7) after finding that recurring nonmember income exceeded the applicable 15 percent limitation. The income came from nonmember use of facilities and related sales, including golf, food and beverages, and other activities described in the examination report. The IRS concluded that the club was not operated exclusively for exempt social and recreational purposes and required it to file Form 1120 returns for the affected and later periods. The package also discusses unrelated business income under sections 511 through 513 and reminds the organization of section 277.

Ruling snapshot

• Question: Whether the organization continued to qualify as a tax-exempt social club under IRC § 501(c)(7).
• Outcome: Revocation
• Key authorities: IRC §§ 501(c)(7), 511, 512, 513, and 277; Rev. Proc. 71-17; Rev. Ruls. 58-589 and 60-324

Full text (IRS public release)

DEPARTMENT OF THE TREASURY
Internal Revenue Service
TEGE EO Examinations

Date: May 20, 2009

TAX EXEMPT AND
GOVERNMENT ENTITIES
DIVISION

Number: 201344010

Release Date: 11/1/2013
UIL: 501.07-01

Taxpayer Identification
Legend: Person to Contact:
ORG = Name of Organization
Address = Address of Organization
Year = xx Telephone Number:
FAX Number:

CERTIFIED MAIL — RETURN RECEIPT REQUESTED

Dear

In a determination letter dated November 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 adverse determination letter with regard to your status
under section 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 the Taxpayer Advocate, as well
as your appeal rights. On February 17, 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 have filed taxable returns on Form[s] 1120, for the year[s] ended September 30, 20xx, 20xx & 20xx with us.
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:

Taxpayer Advocate Service

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

Sincerely,

Sunita B. Lough
Director, EO Examinations

DEPARTMENT OF THE TREASURY
Internal Revenue Service

TAX EXEMPT AND
GOVERNMENT ENTITIES
DIVISION

January 20, 2009

Taxpayer Identification Number:

LEGEND:

ORG = Name of Organization Form:

Address = Address of Organization

Year = xx 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. lf 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 34801 V

Thank you for your cooperation.

Sincerely,

Renee B. Wells
Acting Director, EO Examinations

Enclosures:
Publication 892
Publication 3498
Form 6018

Report of Examination
Envelope

Letter 3610 (04-2002)
Catalog Number 34801V

Form 886-A | |Schedule No.
| EXPLANATION OF ITEMS |
| |

Name of Taxpayer |Years/Period Ended
ORG |

+

LEGEND :

ORG = Name of Organization

YEAR = xx

ISSUE:

Does the ORG continue to meet the qualifications of an
organization described in Internal Revenue Code Section
501 (c) (7)?

FACTS:

ORG received exemption as an organization described in IRC
501(c) (7) in 19xx. The records available for the organization
for the periods ending September 30, 20xx and 20xx were
examined. It was found that the club is not in compliance with
Rev. Proc. 71-17. Nonmember events are carried on throughout
the year. The organization receives nonmember revenue for use of
its golf course, golf cart rental, pool and tennis court and
from food and beverage sales to nonmembers. The exempt
organization failed to file form 990T

to report their nonmember income

Inspection of the returns filed by the Club for the prior years
shows that the organization has not reported their nonmember
income in excess of 15% on form 990T since 20xx.

Based on the amounts reported on the organizations income
statement for tax year ending September 30, 20xx, the percent of
gross receipts estimated from nonmember use of facilities
exceeds the allowed 15%. Information regarding nonmember
portion of proceeds for tax year ending September 30, 20xx was
solicited but not provided.

Department of the Treasury - Internal Revenue Service Form 886-A
Page 1

Form 886-A | |Schedule No.
| EXPLANATION OF ITEMS |
| | .
Name of Taxpayer |Years/Period Ended
ORG |

LAW AND DISCUSSION:

IRC Section 501(c) 7 states:

Internal Revenue Code section 501(c) (7) provides for the exemption
from Federal income taxes for Social Clubs with these specifying
attributes for exemption “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
the net earnings of which inures to the benefit of any private
shareholder.” “IRC 501(c) (7)

Treasury Regulation Section 1.501(c)7-1:

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 non profitable purposes, but does not apply to any club if
any part of 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 non profitable 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 the club
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.

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

Department of the Treasury - Internal Revenue Service Form 886-A
Page 2

Form 886-A | |Schedule No.
| EXPLANATION OF ITEMS |
| |
Name of Taxpayer |Years/Period Ended
ORG |

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 bare 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): percentage of nonmember gross receipts (ranged from 12-
17% 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.

Revenue Procedure 1971-17, 1971-1, CB 683,

sets forth the guidelines for determining the gross receipts from
the use of a social club’s facilities by the general public. The
Revenue Procedure also provides that in situations where a club
makes its facilities available to the general public to a
substantial degree, the club is not operated exclusively for
pleasure, recreation, or other non profitable purposes. The
definition of items includable in the gross receipts tests is
established in this Revenue Procedure. Also contained in this
Revenue Procedure are the rules under which the host-guest

relationship will be established.

U.S. Court of Appeals:

Pittsburgh Press Club v. USA, 536 F.2d 572, (1976).

Case stated there are factors to be considered when considering
the effects of a social club’s nonmember receipts, including the
percentage of gross receipts from nonmembers, profit from non-
member receipts, the purpose for which a social club’s facilities
are made available to nonmember groups, and the frequency of use
of club facilities made by nonmembers.

Public Law —PL 94-568(October 20, 1976):

This Public Law defines limitations of nonmember gross receipts as 15% of total gross receipts.

Department of the Treasury - Internal Revenue Service Form 886-A
Page 3

Form 886-A | |Schedule No.
| EXPLANATION OF ITEMS |
| |
Name of Taxpayer |Years/Period Ended
ORG |

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 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 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 the club’s facilities were made
available to nonmembers.

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

TAXPAYER'S POSITION:
The taxpayer has indicated that they are in agreement with this
decision. However, I do not have a signed form 6018.

GOVERNMENT'S POSITION:

Social Clubs are required to follow Revenue Procedure 1971-17.
This Procedure provides guidelines Social Clubs should follow when
they engage in business with non-members. One of the requirements
that this Procedure mandates is that Social Clubs document their
levels of non-member income in various situations. Social Club
did not follow this required Procedure which is why the analysis
had to be performed based on organization’s own partial
estimation. It is unclear whether or not the organization has the
records available to provide an estimation of non-member receipts.

Department of the Treasury - Internal Revenue Service Form 886-A
Page 4

Form 886-A | |Schedule No.
| EXPLANATION OF ITEMS |
| |
Name of Taxpayer |Years/Period Ended
ORG |

The 15% limitation is, however a threshold. The facts and
circumstances are also required to be examined when reviewing the
exempt status of an organization exempt under IRC Section

501(c) (7).

In the terms of the facts and circumstances tests described in
Revenue Rulings 1960-324 and Pittsburgh Press Club v. USA, the
organization exceeding the gross receipts tests by either

percentage is unfavorable. In Revenue Ruling 1960-324, the club
in that case only exceeded the percentage by two percent at the
most (12-17% of nonmember income over several years). The Social

Club described in Revenue Ruling 1960-324 had their exemption
revoked.

Based on the data that has been provided the green fees and cart
rentals are an on-going activities and the organization has been
operating without deficit for the years in question. The
analysis shows that the Gross Receipts from non-members subsidizes
the club, and has helped the organization cover expenditures that
the members would have to bear alone.

Overall neither the facts and circumstances nor the Gross Receipts
Test fall to the benefit of the Social Club. The primary factor
is the Gross Receipts Test. The percentage, coupled with the
fact that there are other areas that would make this percentage
higher, is far outside the range that was intended for even the
facts and circumstances to come into play.

ORG has exceeded 15% the permissible levels of non-member income
to a substantial degree on a continuous basis. The nonmember
receipts are earned throughout the year. There was no one single
or unusual event that caused the club to exceed the 15% threshold.

Social Clubs receiving more then 15% of their receipts, per PL 94-
568 and Revenue Procedure 1971-17, from nonmember usage of
facilities are not operating in an exempt fashion per the rules
and regulations governing organizations exempt under IRC Section
501(c) (7), with limited exceptions. No precedent was noted that
discussed facts and circumstances of a Social Club’s continued
exemption, where nonmember patronage was not within a few
percentage points of 15%. It has thus been determined that the
organization has not met the requirements for continued exemption

Department of the Treasury - Internal Revenue Service Form 886-A
Page 5

Form 886-A {Schedule No.
| ' EXPLANATION OF ITEMS |
| |
Name of Taxpayer |Years/Period Ended
ORG |

as a 501(c) (7) organization. Theses rules are provided to Social
Clubs when they received their exemption, as evidenced by the
Social Club’s determination letter which was issued to them.

Revocation of its tax-exempt status is warranted, effective
October 1, 20xx.

As a taxable entity, the organization is required to file Form
1120, U.S. Corporation Income Tax Return the tax periods ending
on or after September 30, 20xx and all subsequent years.

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

Department of the Treasury - Internal Revenue Service Form 886-A
Page 6