IRS revokes a social club's exemption for excessive nonmember income

Plain-English summary

The IRS revoked a social club's federal tax exemption under IRC § 501(c)(7), effective January 1 of the stated year. The examination found that the club's nonmember income exceeded the applicable gross-receipts limits for three consecutive years. The IRS also explained that, after revocation, the organization must file Form 1120 and that IRC § 277 may limit deductions for member activities. The letter states that the organization agreed with the proposed adverse action by signing Form 6018.

Ruling snapshot

• Question: Did the social club continue to qualify for exemption under IRC § 501(c)(7)?
• Outcome: Revocation.
• Key authorities: IRC §§ 277 and 501(c)(7); Treas. Reg. § 1.501(c)(7)-1; Rev. Proc. 71-17; Public Law 94-568 and Senate Report No. 94-1318

Full text (IRS public release)

Department of the Treasury
Internal Revenue Service
1100 Commerce Street
Dallas, TX 75242

Form:
Number: 201406016
Release Date: 2/7/2014 Tax Year(s) Ended:

December 31
Person to Contact:

December 8, 2010
Contact Telephone Number:

CERTIFIED MAIL UIL: 501.07-00

Dear

We have completed our examination of your Form 990 for the periods ended
December 31, It has been determined that your exempt status should be revoked.

The previous report of examination issued on June 18, states the basis for the revocation.
You have concurred with our determination by signing Form 6018, Consent to Proposed
Adverse Action, on July 14, A copy of which is enclosed. Accordingly, your exemption
from Federal income tax under section 501(c)(7) of the Internal Revenue Code has been
revoked effective January 1,

You are required to file Federal income tax return, Form 1120, with the Internal Revenue
Service Center. We have secured the delinquent Forms 1120 for the periods ended
December 31, December 31, and December 31, When filing future returns,
remember the Internal Revenue Code section 277 may limit your deductions.

You also have the right to contact the Office of the Taxpayer Advocate. However, you should
first contact the person whose name and telephone number are shown above since this person
can access your tax information and can help you get answers. You can call 1-877-777-4778,
and ask for the Taxpayer Advocate assistance or you can contact the Advocate from the site
where this issue was determined by writing to:

Taxpayer Advocate assistance cannot be used as substitute for established IRS procedures,
formal appeals processes, etc. The Taxpayer Advocate is not able to reverse legal or technically
correct tax determination, nor extend the time fixed by law that you have to file a petition in
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. If we do not hear from
you within 30 days of the date of this letter, this determination will be considered final and no
further action will be required.

Please keep a copy of this report with your permanent records.

If you have any questions regarding this matter, please contact the person whose name and
telephone number are shown above.

Sincerely yours,

Nanette M. Downing
Enclosure(s): Director, EO Examination
Publication 892

DEPARTMENT OF THE TREASURY
Internal Revenue Service
1616 Capitol St Ste 450 Stop 47100MA
Omaha, NE 68102-4923

TAX EXEMPT AND
GOVERNMENT ENTITIES
DIVISION

June 14, 2009

Taxpayer Identification Number:
Form:

Tax Year(s) Ended:
December 31.
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 4801

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 modifying or revoking
exempt status. If we do not hear from you within 30 days from the date of this letter, we
will process your case on the basis of the recommendations shown in the report of
examination and this letter will become final. In that event, you will be required to file
Federal income tax returns for the tax period(s) shown above. File these returns with the
Ogden Service Center within 60 days from the date of this letter, unless a request for an
extension of time is granted. File returns for later tax years with the appropriate service
center indicated in the instructions for those returns.

You have the right to contact the office of the Taxpayer Advocate. Taxpayer Advocate
assistance is not a substitute for established IRS procedures, such as the formal
appeals process. The Taxpayer Advocate cannot reverse a legally correct tax
determination, or extend the time fixed by law that you have to file a petition in a United
States court. The Taxpayer Advocate can, however, see that a tax matter that may not have
been resolved through normal channels gets prompt and proper handling. You
may call toll-free 1-877-777-4778 and ask for Taxpayer Advocate Assistance. If you
prefer, you may contact your local Taxpayer Advocate at:

If you have any questions, please call the contact person at the telephone number
shown in the heading of this letter. If you write, please provide a telephone number
and the most convenient time to call if we need to contact you.

Letter 3610 (04-2002)

Catalog Number 34801V

Thank you for your cooperation.

Enclosures:
Publication 892
Publication 3498
Form 6018

Report of Examination
Envelope

Sincerely.

Nanette M. Downing
Director, EO Examinations

Letter 3610 (04-2002)

Catalog Number 34801 V

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

Name of Taxpayer

EIN:
: : Whether qualifies for exemption under Section
501(c)(7) of the Internal Revenue Code?
|
FACTS: The _ (the * ") was created with Articles of Incorporation |
(the “Articles”) on August 17, _ . The Articles provide that the was created for the

common purpose for pleasure and recreation to operate a golf course establishing an
organization which is described in IRC § 501(c)(7). The obtained their exempt status in
November of . The membership is any person of legal age that resides in the rural area
and incorporated communities with a population of 2,500 or less. Each member will
purchase a stock certificate for $ . The has five classes of membership as shown

below:

Family membership- Membership is available to parents and all unmarried children and
students. The membership entitles all such members to participate in all associated
activities.

Single- Membership is available to unmarried and non-students. The benefits are the same
as the Family membership.

Social- Membership is available to one or more non-golfing family members. The
membership entitles such member and family to participate in all association activities
except golf and golf cart stall rental.

College student- Membership is available to bona fide college students who do not qualify
under a family membership. The membership entitles such member to the same benefits as
a Single membership.

High School- Membership is available to bona fide high school students (not past
graduation) who do not qualify under a Family membership. The membership entitles such
member to unlimited golf participation only.

rules and fees:
Residents within the original boundaries must become
stockholders in order to participate in association activities. Anyone living outside of this
area may become stockholders by purchasing a fully paid stock certificate, or may
participate in association activities by paying appropriate membership fee or green fee. Non
stockholders living inside the area may play only twice in each calendar year by
paying green fees.

The minutes have discussed the has been struggling to keep the cash flow above their
expenses. They have increased their dues in the past years. Since surrounding areas have
golf courses, they are in competition for the rural members in the area.

The chart below shows the total income reported on the Forms 990 and the amount of non-
member income received for years ending December 31, and The non-
member income is on the right side under UBI Income.

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

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

Name of Taxpayer

EIN:

GROSS RECEIPTS | % NON-MEMBER INCOME TEST

TXPD 12/34 ‘PERCENTAGE re %
FORM 930 _ ee TEST
GROSS RECEIPTS _ UBI INCOME $§ oe
LINE # 1d GROSS RECEIPTS %
2 Green Fees
3 Tournament
4 interest
6a ‘Cart Rentals
10a Bar Sales & Rentals
TXPD 42/3 PERCENTAGE
FORM990. ee — TEST
GROSS RECEIPTS __ UBIINCOME. SL
LINE#te SB GROSS RECEIPTS _ ee
30 — a ‘Tournament 7 -
6a
os _ __ Sales & Rentals _
a.
TXPD 42/31,
FORM 990 FEST |
GROSS RECEIPTS oe PERCENTAGE
LINE #1d $ — UBLINCOME &
2 _. GROSS RECEIPTS 7
3 Green Fees
6a | a Tournament
10a oe [Cart Rentals
1 _ Bar Sales & Rentals
TOTAL —f

The gross receipts were taken from all the 990 Forms from. to
Removed the refunds for ofs off and of$ = Not Income
Took the unrelated business income (UBI) from the POA's work papers.
Form 886-A (rev. 4-68) Department of the Treasury - Internal Revenue Service

Page: -2-

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

Name of Taxpayer

EIN:

The Forms 990 from to were used to compute the 12/31, and the

12/31) unrelated business income (UBI) gross receipts test. The POA's work papers

were used to compute the UBI. The percentages for the UBI gross receipts test for to
are as follows: |%, %and| % as shown above.

*

IRC § 501(c)(7) 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.

REGS, §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 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 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 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.
(Reg. §1.501(c)(7)-1.)

IRC § 277. DEDUCTIONS INCURRED BY CERTAIN MEMBERSHIP ORGANIZATIONS
IN TRANSACTIONS WITH MEMBERS.

IRC § 277(a) GENERAL RULE. In the case of a social club or other membership organization
which is operated primarily to furnish services or goods to members and which is not
exempt from taxation, deductions for the taxable year attributable to furnishing services,
insurance, goods, or other items of value to members shall be allowed only to the extent of
income derived during such year from members or transactions with members (including
income derived during such year from institutes and trade shows which are primarily for the
education of members). If for any taxable year such deductions exceed such income, the
excess shall be treated as a deduction attributable to furnishing services, insurance, goods, or
other items of value to members paid or incurred in the succeeding taxable year. The
deductions provided by sections 243, 244, and 245 (relating to dividends received by
corporations) shall not be allowed to any organization to which this section applies for the
taxable year.

Revenue Procedure 71-17, 1971-1 C.B. 683, describes the record-keeping requirements
for social clubs exempt under IRC 501(c)(7) with respect to nonmember use of their
facilities; it sets forth guidelines for determining the effect of gross receipts derived from

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

Page: -3-

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

Name of Taxpayer

EIN:

public use of the club's facilities on exemption and liability for unrelated business income
tax.

Gross Receipts Test / Public Law 94-568

Section 501(c)(7) was amended in 1976 by Public Law 94-568 to provide that section
501(c)(7) organizations could receive some outside income without losing their exempt
status. Senate Report No. 94-1318 (1976), 2d Session, 1976-2 C.B. 597, explains that a
social club is permitted to receive up to 35 percent of its gross receipts, including
investment income, from sources outside of its membership without losing its tax-exempt
status. It is also intended that 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 (nonmembers). In effect, the latter modification increases from 5 percent
(Rev. Proc. 71-17, 1971-1 C.B. 683) to 15 percent the proportion of gross receipts a club
may receive from making its club facilities available to the general public without losing its
tax exempt status.

The Senate Report also states that it is not intended that these organizations should be
permitted to receive, within the 15 percent or 35 percent allowances, income from the
active conduct of businesses not traditionally carried on by these organizations. In cases
where an organization's nontraditional income would cause the organization to exceed the
15 or 35 percent allowances, consideration should be given as to whether the organization
continues to be substantially operated for IRC § 501(c)(7) purposes.

According to the Committee Reports, where a club receives income from other sources (non-
traditional or unusual), including income from the sale of its clubhouse or similar facility,
that income is not to be included in the formula; that is, such income is not to be included
in either the numerator or the denominator for purposes of computing the 35 or 15 percent
allowances.

The Committee Reports provide that gross receipts include, charges, admissions,
membership fees, dues, assessments, investment income (such as dividends, rents, and
similar receipts), and normal recurring capital gains on investments, but excluding
initiation fees and capital contributions.

Where college fraternities or sororities charge membership initiation fees but not normal
dues, such fees will be included in their gross receipts, notwithstanding that initiation fees
are ordinarily excluded (Senate Report 94-1318, 2d Session, 1976-2 C.B. 599.).

GOVERNMENT'S POSITION:

Based on the facts of the examination, the organization does not qualify for exemption since
the operations were more than substantial for non-members. The has operated from 1-
1- to 12-31- above the provisions for non-member income described in IRC §
501(c)(7). Because the UBI gross receipts are over the 7% for non-member income for
three years, revocation was recommended effective January 1,

The Public Law 94-568 and Senate Report No. 1318 amended IRC 501(c)(7) as of
October 20, provide that to be exempt under Section 501(c)(7) a club is limited to
receiving % of its income for use of club facilities from non-members. This organization

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

Page: -4-

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

Name of Taxpayer

EIN:

substantially exceeded the limitation from non-member income for three
consecutive years.

TAXPAYER'S POSITION:

Discussed the issue with the POA and the Taxpayer and they agreed the non-member
income exceeded the gross receipts limitations. POA has been compliant and sent in
converted Forms 1120 for the December 31, and tax periods.
CONCLUSION:

The status of (the " ") as an organization described under section
501(c)(7) should be revoked, effective January 1, because it did not operate within the
provisions for exempt purposes. The exceeded the amount of allowable non-
member income for three consecutive years therefore, no longer qualifies to be exempt.

Per Section 277 of the Internal Revenue Code (Code), a non-exempt organization that is a
membership organization is allowed a deduction for expenses that relate to the operation of
the organization for its members. Section 277(a) states that "In the case of a social club or
other membership organization which is operated primarily to furnish services or goods to
members, and which is not exempt from taxation, deductions for the taxable year
attributable to furnishing services, insurance, goods, or other items of value to members
shall be allowed only to the extent of income derived during such year from members or
transactions with members (including income derived during such year from institutes and
trade shows which are primarily for the education of members)".

When completing the Form 1120, the organization must divide the income and expenses
between the member and non-member activities. If there is a loss from the membership
activity it cannot be used to offset the income from the non-member activities. A loss on the
member activity can be carried forward to a later year to be taken against member income.

Form 1120, U.S. Corporation Income Tax returns for years ending December 31, and
later is due no later than the 15th day of the 3rd month following the close of the
Organization's tax year.

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

Page: -5-