Other 1344011: IRS revokes a social club's exempt status after recurring public bingo income

View official IRS release (PDF)

Plain-English summary

The IRS issued a final determination revoking a social club's exemption under IRC § 501(c)(7). The organization operated charitable bingo open to the general public, including traditional and electronic video bingo, and sold food, drinks, and ink markers during those activities. The determination says nonmember income exceeded the applicable limitation in two years and that the organization was not primarily engaged in social welfare for purposes of § 501(c)(4). It also concludes that video bingo, public bingo, and related sales produced unrelated business income and required Form 990-T. The document is redacted, so amounts and dates appear as placeholders.

Ruling snapshot

• Question: Did the organization retain exemption under IRC § 501(c)(7), or qualify under § 501(c)(4), despite recurring public bingo income and related sales?
• Outcome: Revocation
• Key authorities: IRC §§ 501(c)(4), 501(c)(7), 511, 512, and 513; Treas. Reg. §§ 1.501(c)(7)-1(b), 1.513-1(d), and 1.513-5(d)

Full text (IRS public release)

internal Revenue Service Department of the Treasury
Appeals Office
8701 S. Gessner, Suite 750, MC 8000 H-AL Employer Identification Number:
Houston, TX 77074 EIN
Person to Contact:
Number: 201344011
Release Date: 11/1/2013

Employee ID Number:

Tel:
Date: August 7, 2013 Fax:
ORG- Tax Period(s) Ended:
ADDRESS
UIL: 512.09-03
Certified Mail
Dear

This is a final determination that you do not qualify for exemption from Federal income tax under Internal
Revenue Code (the “Code”) section 501(a) as an organization described in Code section 501(c)(7).

The revocation of your exempt status was made for the following reason(s):

Non-member income consistently exceeded the 15 percent limitation of total income, in the two years
under examination. Nonmember income sources consisted of the following activities with the general
public: charitable gaming, sales of ink markers, and sales of food and drink. Hence revocation of your
exempt status is proposed effective July 1,20 . Additionally you do not qualify for exemption under
section 501(c)(4) of the Internal Revenue Code because the organization is not engaged primarily in
social welfare activities within the meaning of the statute.

You are required to file Federal income tax returns on Forms 1120 for the tax periods stated in the
heading of this letter and for all tax years thereafter. File your return with the appropriate Internal
Revenue Service Center per the instructions of the return. For further instructions, forms, and information
please visit www.irs.gov.

Please show your employer identification number on all returns you file and in all correspondence with
Internal Revenue Service.

We will make this letter and the proposed adverse determination letter available for public inspection
under Code section 6110 after deleting certain identifying information. We have provided to you, ina
separate mailing, Notice 437, Notice of Intention to Disclose. Please review the Notice 437 and the
documents attached that show our proposed deletions. If you disagree with our proposed deletions, follow
the instructions in Notice 437.

You also 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 matters
that may not have been resolved through normal channels get prompt and proper handling. If you want
Taxpayer Advocate assistance, please contact the Taxpayer Advocate for the IRS office that issued this
letter. You may call toll-free, 1-877-777-4778, for the Taxpayer Advocate or visit www.irs.gov/advocate
for more information.

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

Sincerely Yours,

Timothy D. Jarvis
Acting Appeals Team Manager

cc: POA

Enclosure: Publication 892 and/or 556

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

Division Exempt Organizations: Examinations

1122 Town & Country Commons Drive

Chesterfield, MO 63317

Date: APR 4 208 Taxpayer Identification Number:
Tax Year(s) Ended:
Person to Contact/ID Number:
Contact Numbers:

ORG Telephone:
ADDRESS 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, 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)

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

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.

Thank you for your cooperation.

Sincerely,

Nanette M. Downing
Director, EO Examinations

Enclosures:
Publication 892
Publication 3498
Form 6018

Report of Examination
Envelope

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

Department of the Treasury - Internal Revenue Schedule No. or
Form 886A .
Servicé Exhibit 1, Exhibit 2
Unagreed Revocation with Alternative Form 1120
Issue Fom90T
Name of Taxpayer YeaPaiodEndad
ORG EIN June 30, 20XX and
June 30, 20XX

LEGEND
ORG - Organization name EIN - ein XX - Date Address - address

City ~- city State - state Festival - festival CO-1 & CO-2 - 1% &
2°° COMPANIES

ISSUE

1. Whether ORG may continue to qualify for exemption under IRC 501(c) (7) when its
   non-member income consistently exceeds the % limitation of total income?

2. Whether ORG may continue to qualify for exemption under IRC Section 501(c)(7)
   when its sources of income are from conducting bingo activities with the general public,
   sales of ink markers, food and drinks to the general public?

3. Whether ORG is no longer exempt under Section 501(c) (7) is liable for filing
   Form 1120?

FACTS

On June 30, 19XX, the Internal Revenue Service issued a determination letter recognizing ORG
as being exempt under section 501(c) (7) under group exemption for ORG in City, State,
EIN EIN. The ORG chapter of ORG was granted exemption under the group ruling in 19XX as a
501(c)(7), 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.

ORG college fraternity is incorporated in the State of State. Their Constitution and By-

Laws, Article II hold that the purpose for which ORG was formed is:
to maintain, manage and administer real estate situated at Address, City, State

to be responsible for all the fund raising efforts to accomplish this purpose

to provide scholarships to undergraduate members
to fund other activities that will strengthen the chapter and/or further the purpose of the

ORG national fraternity

VVVV

ORG activities include associate member education, quarterly meetings, a crawfish boil,
a homecoming event, a formal dinner party/dance (where the officers are elected), and
the Festival.

The Alumni Association oversees the associate member education program by attending weekly

Form 886-A(Rev.4-68) Department of the Treasury - Internal Revenue Service
Page: -1-

meetings, providing lectures and workshops on issues to encourage growth of the chapter, and
by providing an associate member education program, known as " ". All of these
functions are funded primarily by the annual dues paid to the Alumni Association, with the
exception of the Festival and the bingo.

Form 886A Department of the Treasury - Internal Revenue Service Schedule No. or
Unagreed Revocation with Alternative Exhibit 1, Exhibit 2
Issue Form 1120
Fom0T YewPaiod Ended
Name of Taxpayer dre AKXand
ORG EIN June 30, 20XX

The primary non-member fund-raising activity of ORG is charitable bingo. The proceeds
from the bingo are used to make donations to other charitable organizations.

Income

The ORG fraternal residence has a total of 14 rooms available for students to rent in the house
for $ per semester for four semesters. ORG charges $ for dues for the undergraduate
members. ORG Alumni Association pays annual dues of $ and oversees the finances of the
house. The member income for the period ending June 30, 20XX is $, with associated total
house expenses for the period of $.

The Festival occurs one time per year in State, and many of the students from the University use
this to raise funds. The students rent a booth; make food to sell; and distribute information about
their college fraternity upon request. The income for this activity for fiscal year ending June 30,
20XX was $ and $$ for fiscal year ending June 30, 20XX.

The members of ORG also conduct bingo games (traditional bingo and video bingo), at the
CO-1 in City, State. The CO-1 is an unrelated for-profit organization. The State of State
allows non-profit organizations to rent a portion of the facility for conducting charitable
bingo. ORG rents space at the CO-1 to conduct the bingo games. According to the gaming
laws for State, exempt organizations are required to participate in 15 sessions per month at a
minimum.

The bingo activity is the majority of ORG's income and expenses. A member of ORG
conducts the bingo games, sells ink markers, bingo cards, food and drinks. A distributor
oversees the operations of the bingo games and does the pay out for the bingo prizes. ORG
received % of the video bingo proceeds from this activity. The number of people attending
the bingo exceeds the number of members of ORG.

In a separate room, there are video bingo machines that resemble slot machines. The same
distributor pays out the winnings on these machines. At the end of the session, a member from
ORG counts the gaming proceeds with the distributor, prepares the deposit, and takes the
deposit to the bank. The proceeds from the bingo are kept in a separate bank account from the
operating account for ORG, per the State of State.

Form 886-A(Rev.4-68) Department of the Treasury - Internal Revenue Service
Page: -2-

Form 886A Department of the Treasury - Intemal Revenue Service Schedule No. or
Unagreed Revocation with Alternative Exhibit 1, Exhibit 2
Issue Form 1120
Fon90T Yeatriodeinkd
Name of Taxpayer UretKXadl
ORG EIN June 30, 20XX
LAW
Section 501(c) (7) Law

IRC §501(c)(7) provides the following definition; 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.

Section 501(c)(7) was amended in 1976 by Private Letter Ruling 94-568 to provide that section
501(c)(7) organizations could receive some outside income, including investment income,
without losing their exempt status. Prior to passage of this law in 1976, section 501(c) (7) of the
Code provided exemption for social clubs organized exclusively for pleasure, recreation, and
other non-profitable purposes. Private Letter Ruling 94-568 substitutes the work "substantially"
for "exclusively".

Both Senate and the House Committee Reports show that this wording change was intended to
make it clear that social clubs may receive outside income, without losing their exempt status.
However, the Committee reports also specified clearly defined limits on this outside income,
which if exceeded then invoke the application of a facts and circumstances test. The laws allows
social clubs to receive up to % of their gross receipts, including investment income, from sources
outside their membership without losing their exempt status. Within this %, no more than % of
their gross receipts may be derived from non-member use of club facilities and/or services. (S.
Report No. 94-1318 (1976), 2d Sess., 1976-1 C.B. 597; H. Report No. 94-1353, to accompany
H. Report 1144 (Public Law 94-568, 3-4, 8 (1976)).

The percentage of nonmember income allowed for a section 501(c) (7) is % and not more
than % of the gross receipts derived from the use of the fraternity's facilities or services by

the general public.

Revenue Procedure 71-17, 1971-1 C.B. 683, provides guidelines for determining the effect of
gross receipts derived from nonmember use of a social club's facilities on the club's exemption
under section 501(c)(7) of the Code. Rev. Proc. 71-17 sets as an audit standard that if the annual
gross receipts from the general public for use of a club's facilities are five percent or less of the
club's total gross receipts, the Service will consider that the existence of gross receipts from the
general public does not indicate a nonexempt purpose. If the annual gross receipts from the
general public exceed this audit standard, this will be considered as one factor among all facts
and circumstances examined to determine whether there is a nonexempt purpose.

Form 886-A(Rev.4-68) Department of the Treasury - Internal Revenue Service
Page: -3-

Form 838 6 A Department of the Treasury - Intemal Revenue Service Schedule No. or
Unagreed Revocation with Alternative Exhibit 1, Exhibit 2
Issue Form 1120
Fon $001 YeaPundEindkd
Name of Taxpayer eA kXad
ORG EIN June 30, 20XX

Revenue Procedure 71-17, 1971-1 CB 683, is the audit standard used by the Internal
Revenue Service to determine the effect of gross receipts derived from nonmember use of a
social club's facilities on their exempt status under 501(c)(7) of the Code. It defines the term
"general public" to mean persons other than members of a club or their dependents or guests.
(The member's spouse is treated as a member).

Treasury Regulation § 1.501(c) (7)-1(b) provides that, in general, the exemption extends to
social and recreational clubs supported solely by membership fees, dues, and assessments.
However, a club which engages in business, such as making its social and recreational facilities
available to the general public, is not organized and operated exclusively for pleasure,
recreation, and other non-profitable purposes, and is not exempt under section 501(a).

Treasury Regulation §1.513-5(d) defines a bingo game as "a game of chance played with cards
that are generally printed with five rows of five squares each. Participants place markers over
randomly called numbers on the cards in an attempt to form a preselected pattern such as a
horizontal, vertical, or diagonal line, or all four corners. The first participant to form the
preselected pattern wins the game. As used in this section, the term "bingo game" means any
game of bingo of the type described above in which wagers are placed, winners are
determined, and prizes or other property is distributed in the presence of all persons placing
wagers in that game. The term "bingo game" does not refer to any game of chance (including,
but not limited to, keno games, dice games, card games, and lotteries) other than the type of
game described in this paragraph."

Treasury Regulation §1.513-1(d) (1) states that income is derived from an unrelated trade or
business "if the conduct of the trade or business which produces the income is not substantially
related to the purposes for which exemption is granted". This requires a relationship between the
business activity and the accomplishment of the organization's exempt purpose.

Treasury Regulation §1.513-1(d)(2) provides that a trade or business is "related" to the
organization's exempt purpose if the conduct of the business activity has a causal relationship
to the achievement of the exempt purpose. When the business activity does not contribute
importantly to the accomplishment of the organization's exempt purpose, the activity is not
considered a related trade or business.

Rev. Rul. 60-324, 1960-2 C.B. 173, states that a social club which has been granted exemption
from Federal income tax under section 501(c) (7) of the Internal Revenue Code of 1954 may lose
its exemption if it makes club facilities available to the general public on a regular, recurring,
basis since it may then no longer be considered to be organized and operated exclusively for its
exempt purpose. Since the bingo operations are open to the public on a regular basis, this does

Form886-A4RevA-B) Depextmentofthe Theeary-IntanaReeneSavie

Page: -4-

Form 886A Department of the Treasury - Internal Revenue Service Schedule No. or
Unagreed Revocation with Alternative Exhibit 1, Exhibit
Issue 2 Form 1120
Form 990-T
Name of Taxpayer Year/Period Ended
ORG EIN June 30, 20XX
and June 30,

2Z0XX

not meet the purposes of operating on a nonprofit basis for the pleasure and recreation of its
members and their guests.

Jockey Club v. Helvering, 76 F2d 597, 598 (2d Cir 1935) states that "the court in determining
whether income derived from nonmembers inured to the benefit of members, held that a club
may make a profit on occasion but, taken by and large, the returns from outsiders should do no
more than reimburse the club for its costs. However, if upon computation they are such a source
of income over a substantial period of time so as to justify the conclusion that it is deliberate,
such net earning inure to the benefit of the members, though they are not distributed.

Polish American Club, Inc. v. Commissioner, 33 T.C.M. (CCH) 925 (1974) T.C. Memo. 1974-
207 held that the statutes and regulations require that exempt social clubs be organized and
operated exclusively for pleasure, recreation and other non-profitable purposes. The case law has
modified this requirement by allowing social clubs to qualify for exemption under section 501(c)
(7) when its outside profits were: (1) strictly incidental to club activities, not as a result of an
outside business; and (2) either negligible or nonrecurring. However, when the outside income is
both substantial and recurring the statutory requirements are not satisfied and the social club is
not exempt from tax.

The Minnequa University Club v. Commissioner, 30 TCM (CCH) 1305 — Tax Court 1971
held that the "exclusively * * * non-profitable" operation requirement has been tempered
somewhat by regulations and case law. The cases clearly permit generation of some income
from nonmember sources so long as the activity generating such income is both substantial
and recurring, the statutory requirements are obviously not met and loss of tax-exempt status
must result.

IRC §513(f) defines certain bingo games as not meeting the definition of an unrelated trade or
business. Certain bingo games include any games of bingo, where a wager is placed, and a
winner is determined, and a distribution of a prize is made in the presence of all persons placing
a wager.

IRC §512(a) (3) provides special rules used in determining unrelated business taxable income for
certain organizations, including those exempt under IRC §501(c) (7). For covered organizations,
the term" unrelated business taxable income "means gross income (excluding "exempt function
income "as defined in IRC §512(a) (3) (B) less allowable deductions and with certain
modifications. In general, exempt function income means income from payments by members as
consideration for the organization providing members, their dependents, or guests, goods,
facilities, or services furthering exempt purposes. Exempt function income also includes all
income (except income from unrelated trade or business computed under IRC §512(a) (1)) which
is set aside for a purpose specified in IRC §170(c) (4).

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

Form 886A Department of the Treasury - Internal Revenue Service Schedule No. or
Unagreed Revocation with Alternative Exhibit 1, Exhibit
Issue 2 Form 1120

. Form 990-T

Name of Taxpayer Year/Period Ended

ORG EIN June 30, 20XX

and June 30,
2ZOXX

Section 501(c) (4) Law

Section 501(c) (4) of the Internal Revenue Code grants exemption to:

"Civic leagues or organizations not organized for profit but operated exclusively for the

promotion of social welfare, or local association of employees, the membership of which is
limited to the employees of a designated person or persons in a particular municipality and
the net earnings of which are devoted exclusively to charitable, educational, or recreational

purposes."

The regulations describe the promotion of social welfare as promoting in some way the
common good and general welfare of the people of the community, such as bringing about civic

betterment and social improvements.

Erie Endowment v. United States, 62-1 U.S.T.C. 9173, the court defined "civic" as pertaining to
a city or citizen; relating to the community. The court provides that a civic league or
organization embodies the idea of citizens of a community cooperating to promote the common
good and general welfare of people of the community. Erie Endowment v. United States, 316
F.2d 151 (1063) affirming the conclusion of the District Court, held that the concept of social
welfare suggests benefits affecting a whole community of people rather than a private group of
citizens. It held that a corporation formed to carry out the purposes of an irrevocable inter vivos
trust does not qualify under § 501(c) (4) as a civic organization because it was not a community
movement designed to accomplish community ends.

People's Educational Camp Society, Inc. v Commissioner, 331 F.2d 923(1964) held in
exceptional cases, an organization whose services are made available solely to its members
will, by the nature of the services and the group receiving them, be considered as benefiting the
community as a whole. In such exceptional cases, it must be clearly established that making the
service available to the particular group benefits the community as a whole.

Revenue Ruling 68-46, 1968-1 C.B., 260 held although an organization carried on veterans’
programs and other benevolent, patriotic, and civic activities, its business activities involving
rental of its office building and providing food and bar catering services exceeded all of its
other activities. It was held not exempt under section 501(c) (4) of the Code as its social welfare

programs were not its primary activity.

Form 886-A(Rev.4-68) Department of the Treasury - Internal Revenue Service
Page: -6-

Department of the Treasury - Internal Revenue Service Schedule No. or
Form 886A Unagreed Revocation with Alternative Exhibit 1, Exhibit 2
Issue Form 1120
Fom900-T YearPerind Ended

Name of Taxpayer . June 30, 20XX

ORG EIN and June 30,
20XX

TAXPAYER'S POSITION

The taxpayer is protesting revocation of its exempt status. The organization requests to be
reclassified as a 501(c) (4).

The second argument the taxpayer raised is that the Service should have included the gross
receipts of the national fraternity in the calculation of the % / % test.

The third argument the taxpayer raised is that the Service consider the facts and circumstances
test per IRM 4.76.16.6(d).

The fourth argument raised by the taxpayer is that charitable bingo is not considered an unrelated
trade or business, first under the general exception of Internal Revenue Code 513(a)(1) where
"substantially all the work in carrying on such trade or business is performed by the organization
without compensation" and second under the express exception of Internal Revenue Code 513(f)
that "[t]he term ‘unrelated trade or business' does not include-any trade or business which consists
of conducting bingo games." Section 513(f) goes on and defines bingo games to mean:

"The term ‘bingo game' means any game of bingo - -
(A) ofa type in which usually - -
(i) the wagers are placed,
(ii) | the winners are determined, and
(iii) the distribution of prizes or other property is made, in the presence
of all persons placing wagers in such game, ...."

and then Treasury Regulation Section 1.513-5(d) in 1969 added:

"A bingo game is a game of chance played with cards that are generally printed with five
rows of five squares each. Participants place markers over randomly called numbers on the cards
in an attempt to form a preselected pattern such as a horizontal, vertical, or diagonal line, or all
four corners. The first participant to form the preselected pattern wins the game. As used in this
section, the term bingo game means any game of bingo of the type described above in which
wagers are placed, winners are determined, and prizes or other property is distributed in the
presence of all persons placing wagers in that game. The term bingo game does not refer to any
game of chance (including, but not limited to, keno games, dice games, card games, and lotteries)
other than the type of game described in this paragraph."

Form 886-A(Rev.468) Department of the Treasury - Internal Revenue Service
Page: -7-

Form 886 A Department of the Treasury - Internal Revenue Service Schedule No. or
Unagreed Revocation with Alternative Exhibit 1, Exhibit

Issue 2 Form 1120
Fam0T YearPeriodinded
Name of Taxpayer June 30, 20XX
ORG EIN and June 30,

20XX

GOVERNMENT'S POSITION

Issue 1. ORG has not established that it operates exclusively for exempt purposes listed in
Treas. Reg. § 1.501(c)(7)-1.

An organization described in ILR.C. § 501(c)(7) carries out activities in furtherance of its exempt
purposes only when such activities are carried out exclusively in furtherance of the purposes
listed in Treas. Reg. § 1.501(c)(7)-1. IRC § 501(c)(7) states that these clubs 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. If a club makes its facilities available to the general public to a substantial degree,
and/or a significant amount of the organization's income is received from the general public, the
organization may lose its tax exemption. ORG is involved in the following activities: quarterly
meetings, a crawfish boil, homecoming event, and a formal dinner party/dance where the officers
are elected; and the Festival; room rent for the house, and charitable bingo. The State of State's
laws concerning charitable bingo states that the members of the exempt organizations can
conduct the activity but they cannot participate in the activity. They can participate in the activity
only when the bingo activity is being conducted by another exempt organization. As a result of
our examination of Form 990 for the period ending June 30, 20XX, and June 30, 20XX, we have
determined that the income amounts received from the bingo games are not an exempt activity.

Under The Minnequa University v. Commissioner, where outside income is both substantial and
recurring, the statutory requirements are obviously not met and loss of tax-exempt status must
result. This is consistent with the findings of this examination. Because ORG's non-member
income is substantial in relation to its other income in all years under examination and recurs in
each of the years, ORG must lose its exemption under Section 501(c) (7) of the Internal Revenue

Code.

Issue 2. Whether ORG's gross receipts received from charitable bingo exceeds the % limit for
Internal Revenue Code 501(c) (7)?

Public Law 94-568 specifies that an organization exempt under Section 501(c) (7) may not have
more than % of income from non-member sources. ORG fails the test for the year ending June
30, 20XX where its non-member percentage of total income was %, ORG fails the test for
the year ending June 30, 20XX where its non-member percentage of total income was %.
Because the non-member income for ORG consistently exceeded the % limitation, ORG is no
longer eligible for exemption under IRC Sections 501(a) and 501(c)(7) of the Internal Revenue
Code and said exemption should be revoked.

Form 886-A(Rev.4-68) Department of the Treasury - Internal Revenue Service
Page: -8-

Department of the Treasury - Internal Revenue Service Schedule No. or

Unagreed Revocation with Alternative Exhibit 1, Exhibit
Issue 2 Form 1120
: Form 990-T
Name of Taxpayer Year/Period Ended
ORG EIN June 30, 20XX

and June 30,
LUXX

Form 886A

The following chart shows the amount of bingo income vs. member income for Fiscal Year
Ending June 30, 20XX and June 30, 20XX:

FISCAL YEAR ENDING JUNE 30, 20XX
NON MEMBER - MEMBER ACTIVITIES MEMBER VS NON-
ACTIVITIES MEMBER PERCENTAGES
INCOME ROOM RENT % NON
FESTIVAL MEMBER | MEMBER
INCOME INCOME INCOME

FISCAL YEAR ENDING JUNE 30, 20XX
NON MEMBER MEMBER ACTIVITIES MEMBER VS NON-
ACTIVITIES | MEMBER PERCENTAGES
INCOME ROOM RENT % NON %
FESTIVAL MEMBER | MEMBER
INCOME INCOME INCOME
CONCLUSION

ORG no longer qualifies for exemption under Section 501(c) (7) of the Internal Revenue Code,
as non-member income consistently exceeded the 15 percent limitation of total income, in the
two years under examination. Nonmember income sources consisted of the following activities
with the general public: charitable gaming, sales of ink markers, and sales of food and drinks.
Hence, revocation of ORG's exemption is proposed effective July 1, 20XX.

The first argument proposed by the taxpayer is to be reclassified as a 501(c) (4) exempt
organization. The organization is exempt under a group ruling, , and cannot be reclassified
to 501(c) (4) unless the parent has a 501(c) (4) exemption.

Additionally, the taxpayer does not qualify for exemption under section 501(c) (4) of the Code
because it has been established that the taxpayer is not primarily engaged in social welfare
activities within the meaning of the statute. The activities that have been confirmed are the
quarterly meetings, a crawfish boil, homecoming event, and a formal dinner party/dance where

Form 886-A(Rev.4-68) Department of the Treasury - Internal Revenue Service
Page: -9-

Department of the Treasury - Internal Revenue Service Schedule No. or

Unagreed Revocation with Alternative Exhibit 1, Exhibit
Issue 2 Form 1120

Form 990-T

Name of Taxpayer Year/Period Ended
ORG EIN June 30, 20XX

and June 30,

2OXA

Form 886A

the officers are elected, and the Festival. These activities do not qualify as social welfare
activities.

The second argument proposed by the taxpayer is that the gross receipts should have been
included in the gross receipts of the national fraternity for the calculation of the %/% test. The
IRM 4.75.24(1) states, "A group return is filed by the central organization on behalf its
subordinates who are covered by a group exemption letter. The filing of a group return shall be in
lieu of the filing of separate information returns for each subordinate included in the return." This
would be applicable if the subordinate agreed to be included in the national organization's return,
however, the subordinate chose to file separately, therefore this criteria does not apply.

The third argument proposed by the taxpayer is that the Service considers the facts and
circumstances test per IRM 4.76.16.6.3.1(12). Apply the facts and circumstances test in cases
where outside income exceed the % or % limitations. The factors to be considered in applying
this test include:

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

e The frequency of nonmember use of club facilities.

e The number of years the percentage has been exceeded.

Note: A high percentage of nonmember income in one year should be viewed
more favorably than a pattern of consistently exceeding the limits. For example, a
high percentage of nonmember receipts in 3 consecutive years is more likely to
indicate the existence of a nonexempt purpose than the receipt of a high percentage of
nonmember receipts in 1 year out of 3 years.

The charitable bingo games are open to the public and are not open for use by the members
only. According to Revenue Ruling 69-68, 1969-1 CB 153, (Jan. 01, 1969); the fact that a club
derives a principal part of its revenue from its recreational facilities does not affect its exempt
status, so long as the facilities are used only by the members and their guests. The income
from the charitable bingo games and the number of people that participate in these games has
exceeded the number of members in ORG consistently for two years. The bingo is not a one
time event, and, therefore, the facts and circumstances test cannot be applied in this instance.

The fourth argument proposed by the taxpayer is that bingo should not be considered an
unrelated trade or business according to Internal Revenue Code 513(f). This is true for regular
bingo where wagers are being placed, and bingo cards are being used. Treasury Regulation §
1.513-5(d) defines a bingo game as "a game of chance played with cards that are generally
printed with five rows of five squares each. Participants place markers over randomly called
numbers on the cards in an attempt to form a preselected pattern such as a horizontal, vertical, or
diagonal line, or all four corners. The first participant to form the preselected pattern wins the

Form 886-A(Rev.4-68) Department of the Treasury - Internal Revenue Service
Page: -10-

Form 886A Department of the Treasury - Internal Revenue Service Schedule No. or
Unagreed Revocation with Alternative Exhibit 1, Exhibit
Issue 2 Form 1120

Form 990-T

Name of Taxpayer Year/Period Ended
‘ORG EIN June 30, 20XX

and June 30,

2UXX

game. As used in this section, the term "bingo game" means any game of bingo of the type
described above in which wagers are placed, winners are determined, and prizes or other
property is distributed in the presence of all persons placing wagers in that game. The term
"bingo game" does not refer to any game of chance.

While the electronic video bingo machines are permitted in the state of State, the operation of
the machines differ from the definition. During a tour of the bingo hall, CO-1, the agent noted
that the electronic video bingo machines are in a separate room from the main bingo area. The
room houses approximately 25 — 30 machines. At first glance, the machines resemble slot —
machines or video poker machines (usually found in casinos). Upon further inspection, the
machines contain a bingo card in the top left corner. Numbered bingo balls are selected each
time a patron presses the "Spin Reels" or "Play" button. The number of "bingo balls" changes
with each press of the play button. Meaning that on your first spin 20 bingo balls were selected;
however, on the next spin 15 bingo balls may be selected (not in addition to the first 20 bingo
balls). Additionally, the numbers (i.e. B15 or 075) change on each spin as well as the "dauber"
marks on the card. The machine pays out for each winning pay line on the reels or if a winning
bingo pattern is made.

Based on the above information, revocation is being proposed. If revocation is upheld, effective
July 1, 20XX, ORG will be responsible for filing Forms 1120. (See Exhibit 2 for the direct

income and expenses.)

ALTERNATIVE ISSUE

If it is determined that ORG qualifies for exemption under section 501(c)(7), should the
income from the bingo activities with the general public, sales of ink markers, and food and
drinks to the general public be taxable as unrelated business income under section 511 of
the Code?

FACTS

The ORG of ORG was established as a professional engineering organization in City, State.
The organization is exempt under IRC § 501(c) (7). The organization is currently a social
collegiate organization. The organization was founded at CO-2 in 19XX.

The members of ORG conduct bingo games at the CO-1 in City, State. The CO-1 is an unrelated
for-profit organization. The State of State allows nonprofit organizations to rent a portion of the
facility for conducting charitable bingo. According to the gaming laws for State, exempt
organizations are required to participate in 15 sessions

Form 886-A(Rev.4-68) Department of the Treasury - Internal Revenue Service
Page: -11-

Form 886A Department of the Treasury - Internal Revenue Service Schedule No. or

Unagreed Revocation with Alternative Exhibit 1, Exhibit
. Issue 2 Form 1120

Form 990-T

Name of Taxpayer Year/Period Ended
ORG EIN June 30, 20XX

and June 30,

20XX

per month at a minimum. ORG began participating in the charitable bingo on October 1,
20XX. The bingo hall operates the following games: regular/traditional bingo and electronic
video bingo. Members of ORG conducted the charitable gaming activities with the general
public.

The Office of Charitable Gaming, which governs all charitable gaming activities in State, defines
electronic video bingo as "a machine designed for the specific purpose of playing the game of
bingo that has an electronic random-number generator to select numbers in lieu of the drawing of
numbers from a receptacle and that one or more video images containing numbers or other
designations five or more in one line may be utilized instead of a card" (per OCG's website).
These machines print tickets that are redeemed for cash at the cashier's booth. Chapters 18 and 19
of the State Administrative Code outline the operation and use of electronic video bingo
machines.

While this type of device is permitted in the state of State, the operation of the device differs from
the definition. During a tour of the bingo hall, CO-1, the agent noted that the electronic video
bingo machines are in a separate room from the main bingo area. The room houses approximately
25 — 30 machines. At first glance, the machines resemble slot machines or video poker machines
(usually found in casinos). Upon further inspection, the machines contain a bingo card in the top
left corner. Numbered bingo balls are selected each time a patron presses the "Spin Reels" or
"Play" button. The number of "bingo balls" changes with each press of the play button. Meaning
that on your first spin 20 bingo balls were selected; however, on the next spin 15 bingo balls may
be selected (not in addition to the first 20 bingo balls). Additionally, the numbers (i.e. B15 or 075)
change on each spin as well as the "dauber" marks on the card. The machine pays out for each
winning pay line on the reels or if a winning bingo pattern is made.

ORG received income from both sources during the years under examination. (See Exhibit 2.)

LAW

Internal Revenue Code section 511(a)(1) imposes a tax on unrelated business taxable income on
income received by an organization described in section 501(c), from an unrelated trade or

business activity.

Internal Revenue Code section 512(a)(1) defines unrelated business taxable income as the gross
income from any unrelated trade or business, regularly carried on by an organization, less the
allowable deductions that are directly connected with the carrying on of such trade or business.

Form 886-A(Rev.4-68) Department of the Treasury - Internal Revenue Service
Page: -12-

Form 886 A Department of the Treasury - Internal Revenue Service Schedule No. or

Unagreed Revocation with Alternative Exhibit 1, Exhibit
2 Form 1120

Issue TYeuei
Name of Taxpayer June 30, 20XX
ORG EIN and June 30,
20XX

Internal Revenue Code section 512(a) (3) (A) defines unrelated business taxable income for
social clubs as all gross income that is not exempt function income. Furthermore, it provides that
the unrelated taxable income of an organization described in section 501(c)(7) means the gross
income (excluding any exempt function income), less the deductions allowed by Chapter 1 of the
Code which are directly connected with the production of the gross income (excluding exempt
function income).

Treasury Regulation §1.501(c)(7)-1(b) provides "A club which engages in business, such as
making its social and recreational facilities available to the general public...is not organized and
operated exclusively for pleasure, recreation, and other non-profitable purposes, and is not
exempt under section 501(a)...."

Internal Revenue Code section 513(a) defines an unrelated trade or business as "any trade or
business, the conduct of which is not substantially related to the exercise or performance by such
organization of its charitable, educational, or other purpose" that is the basis for its exemption.

IRC §513(f) defines certain bingo games as not meeting the definition of an unrelated trade or
business. Certain bingo games include any games of bingo, where a wager is placed, and a
winner is determined, and a distribution of a prize is made in the presence of all persons placing
a wager.

Treasury Regulation §1.513-5(d) defines a bingo game as "a game of chance played with cards
that are generally printed with five rows of five squares each. Participants place markers over
randomly called numbers on the cards in an attempt to form a preselected pattern such as a
horizontal, vertical, or diagonal line, or all four corners. The first participant to form the
preselected pattern wins the game. As used in this section, the term "bingo game" means any
game of bingo of the type described above in which wagers are placed, winners are determined,
and prizes or other property is distributed in the presence of all persons placing wagers in that
game. The term "bingo game" does not refer to any game of chance (including, but not limited
to, keno games, dice games, card games, and lotteries) other than the type of game described in

this paragraph."

Treasury Regulation §1.513-1(d) (1) states that income is derived from an unrelated trade or
business "if the conduct of the trade or business which produces the income is not substantially
related to the purposes for which exemption is granted". This requires a relationship between the
business activity and the accomplishment of the organization's exempt purpose.

Treasury Regulation §1.513-1(d)(2) provides that a trade or business is "related" to the
organization's exempt purpose if the conduct of the business activity has a causal relationship to
the achievement of the exempt purpose. When the business activity does not contribute

Form 886-A(Rev.4-68) Department of the Treasury - Internal Revenue Service
Page: -13-

Form 886A Department of the Treasury - Intemal Revenue Service Schedule No. or
Unagreed Revocation with Alternative Exhibit 1, Exhibit
Issue 2 Form 1120

Form 990-T

Year/Period Ended

June 30, 20XX
and June 30,
2OXX

Name of Taxpayer
ORG EIN

importantly to the accomplishment of the organization's exempt purpose, the activity is not
considered a related trade or business.

In Julius M Israel Lodge of B 'Nai B'rith No. 2113 v. Commissioner (98 F.3d 190), the court
held that instant bingo games do not qualify for the "bingo game" exception to the unrelated
business taxable income provision of 26 U.S.C. § 511. The court found that instant bingo games
do not meet the preliminary requirement in IRC §513(f), but that instant bingo is, "for all
practical purposes, a lottery." The court established that "winners in the Instant Bingo games are
determined at the time the deck of cards is manufactured, and thus the winners are already
predetermined outside the presence of any persons placing wagers in such game."

GOVERNMENT'S POSITION

ORG is licensed with the State of State to conduct charitable bingo activities. Members of ORG
conducted the charitable gaming activities with the general public. When ORG conducted the
charitable gaming activities with the general public, ORG violated Section 1.501(c) (7)-1(b) of

the Regulations.

The income of $ for the fiscal year ending June 30, 20XX; and the income of $ for the fiscal year
ending June 30, 20XX for charitable bingo is not exempt function income. Video bingo does not
meet the definition of traditional bingo as defined in Treasury Regulation §1.513- 5(d), and is
therefore unrelated business income and taxable under IRC Section 511 of the Internal Revenue
Code. While traditional bingo does meet the definition, because all of the bingo is open to the
public and is considered non-member income that makes the income subject to unrelated
business income and taxable under IRC Section 511 of the Internal Revenue Code.

ORG sold drinks, food, and ink markers to the general public during charitable gaming
activities. Since the State of State doesn't allow the members to participate in the bingo games
on the nights that their particular organization is running the session, all of the sales are
deemed to be from non-members and are by definition unrelated business income.

TAXPAYER'S POSITION

Taxpayer's position is unknown at this time. However, the results of the examination have been
discussed with the organization's representative.

CONCLUSION

ORG is liable for unrelated business income on the charitable bingo activities conducted with
the general public.

Form 886-A(Rev.4-68) Department of the Treasury - Internal Revenue Service
Page: -14-

F 886A Department of the Treasury - Internal Revenue Service . Schedule No. or
om Unagreed Revocation with Altemative Exhibit 1, Exhibit 2
Issue Form 1120

Form 990-T

Name of Taxpayer Year/Period Ended
ORG EIN June 30, 20XX and
June 30, 20XX

ORG is liable for filing Form 990-T for fiscal years ending June 30, 20XX, and June 30, 20XX.

After calculating the amount of tax that would be due for the video bingo income, the
results are represented on Form 4549 attached.

Form 886-A(Rev.4-68) Department of the Treasury - Intemal Revenue Service
Page: -15-

ORG OF ORG
Exhibit 1, page 1

INCOME

Income | Video Income | Income for Supplies | Cost of Prizes | Adjusted Gross Proceeds

July 1, 20XX to September 30, 20XX - No income.
Oct 20XX to Dec 20XX
Jan 20XX to Mar 20XX
April 20XX to June 20XX
TOTALS FOR FYE 6/30/20XX

July 20XX to Sept 20XX
Oct 20XX to Dec 20XX
Jan 20XX to March 20XX
April 20XX to June 20XX
TOTALS FOR FYE 6/30/20XX

ORG OF ORG
Exhibit 1, page 1

INCOME

Income | Video Income | Income for Supplies | Cost of Prizes | Adjusted Gross Proceeds

July 1, 20XX to September 30, 20XX - No income.
Oct 20XX to Dec 20XX
Jan 20XX to Mar 20XX
April 20XX to June 20XX
TOTALS FOR FYE 6/30/20XX

July 20XX to Sept 20XX
Oct 20XX to Dec 20XX
Jan 20XX to March 20XX
April 20XX to June 20XX
TOTALS FOR FYE 6/30/20XX

ORG OF ORG
Exhibit 1, page 1

INCOME

Income | Video Income | Income for Supplies | Cost of Prizes | Adjusted Gross Proceeds

July 1, 20XX to September 30, 20XX - No income.
Oct 20XX to Dec 20XX
Jan 20XX to Mar 20XX
April 20XX to June 20XX
TOTALS FOR FYE 6/30/20XX

July 20XX to Sept 20XX
Oct 20XX to Dec 20XX
Jan 20XX to March 20XX
April 20XX to June 20XX
TOTALS FOR FYE 6/30/20XX

Exhibit 2

Member/Non Member Income and Expenses

FISCAL YEAR ENDING JUNE 30, 20XX
INCOME
Traditional
Video
Income for Supplies
TOTAL INCOME

EXPENSES
EXPENSES | MEMBER RELATED EXPENSES
Gaming Supplies
Accounting Fees
Payroll for:
Bank Charges
Hat Rental
Refreshments
Licenses
Total Related Expenses
Room Rent
Depreciation
Supplies
Member Recruitment
Chapter Expenses/Insurance/Activity Related
Interest Expense
Conferences, conventions, & meetings
Postage & Shipping
Printing & publications
Festival
ORG Foundation
Charitable Contributions
Total Member Related Costs

Member Income for Room Rent
Festival Income

FISCAL YEAR ENDING JUNE 30, 20XX
INCOME
Member Income for Room Rent
Festival Income
EXPENSES
EXPENSES | MEMBER RELATED EXPENSES