IRS revokes social club for excessive investment income

Plain-English summary

A cultural membership organization had been recognized as a tax-exempt social club under § 501(c)(7). During an examination, the IRS found that investment income made up more than a redacted percentage of the club's gross receipts in each of three years. That amount substantially exceeded the 35 percent limit for investment income and other receipts from outside the membership. The organization did not answer an information request or respond to the examination findings. The IRS therefore revoked its exemption effective January 1 of a redacted year and required it to file corporate income tax returns from that point forward.

Ruling snapshot

• Question: Did a social club remain exempt after repeatedly receiving investment income above the permitted nonmember-income limit?
• Outcome: Revocation
• Key authorities: IRC § 501(c)(7); Treas. Reg. § 1.501(c)(7)-1; Rev. Rul. 66-149; Pub. L. 94-568

Full text (IRS public release)

DEPARTMENT OF THE TREASURY
Internal Revenue Service
N 14 W24200 Tower Place, Suite 202
Waukesha, WI 53188

TAX EXEMPT AND
GOVERNMENT ENTITIES
DIVISION

June 11, 2009

Taxpayer Identification Number:

Number: 201448022
Release Date: 11/28/2014 Form:

Tax Year(s) Ended:
Person to Contact/ID Number:

UIL: 501.07-00 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. 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.

Sincerely,

Sunita Lough
Director, EO Examinations

Enclosures:
Publication 892
Publication 3498
Form 6018
Report of Examination
Envelope

Letter 3610 (04-2002)
Catalog Number 34801V

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

Name of Taxpayer Year/Period Ended
December 31, 20XX
December 31, 20XX
December 31, 20XX

Issues:

1. Revocation of an organization granted exemption under IRC Section 501(c)(7).

Facts:

The is a membership organization that conducts various cultural
events for the purposes of promoting the culture and heritage. The
was granted tax-exempt status under IRC Section 501(c)7, in June of 19XX.

The Internal Revenue Service conducted an examination of the

Form 990 for the year ending December 31, 20XX. In examining the Form 990, the IRS
determined that the organization received % of its gross receipts from investments; the
investment income received by the organization was derived from interest and dividends.

Based on the information analyzed by the Internal Revenue Service in examining the Form 990
filed for the year ending December 31, 20XX, an Information Document Request was sent to the
requesting financial information (for the years ending
December 31, 20XX and 20XX) and detailed information of the organization’s activities (For the
years ending December 31, 20XX, 20XX and 20XX). Forms 990 filed for the years ending
December 31, 20XX and 20XX provide that investment income, in each year, totaled more than
%.

A representative of the organization confirmed that the organization had received the Information
Document Request, however the organization has not provided a response to the Information
Document Request (The Information Document Request has gone unanswered for more than 90
days).

Revenue Procedure 1971-17 and Public Law 94-568 provide that Social Clubs, exempt under
IRC Section 501(c)(7), can receive up to 35% of their gross receipts, including investment
income, from sources outside their membership without losing their exempt status.

The investment income received by the for the years ending
December 31, 20XX, 20XX and 20XX, substantially exceeds the amount allowable for Social
Clubs, exempt under IRC Section 501(c)(7).

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

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

Name of Taxpayer Year/Period Ended
December 31, 20XX
December 31, 20XX
December 31, 20XX
Law:

IRC Section 501(c)7 states (in specifying attributes for exemption):

“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.”

Treasury Regulation Section 1.501(c)7-1, further expounds upon Internal Revenue Code
Section 501(c)(7), by indicating that a club engaging in business, is not operated exclusively for
pleasure, recreation, or social purposes. An example given by the regulation to indicate the
presence of a business operation, included the solicitation of public patronage by advertisement.

Revenue Ruling 1966-149, 1966-1, C.B. 146, provides that a Social Club is not exempt from
Federal income tax, under section 501(c)(7) of the Code, where it regularly derives a substantial
part of its income from nonmember sources such as dividends and interest.

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

This Public Law places a 35% limit on the amount of investment income that a Social Club
exempt under IRC Section 501(c)(7) can receive, without jeopardizing its exempt status.

Government’s Position:

Public Law 94-568 places a 35% limit on the amount of investment income that a Social Club
exempt under IRC Section 501(c)(7) can receive, without jeopardizing its exempt status.

The amount of investment income received by in each of the
years ending December 31, 20XX, 20XX and 20XX is more than %; this percentage far
exceeds the amount allowable under IRC Section 501(c)(7).

The was given a chance to review and respond to the findings
regarding their level of investment income; however no response was provided to the Internal
Revenue Service by the

It is thus the Internal Revenue Service’s position, that the does not
meet the requirements for exempt status.

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

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

Name of Taxpayer Year/Period Ended
December 31, 20XX
December 31, 20XX
December 31, 20XX

Taxpayer’s Position:

The has not provided a response.

Conclusion:

All the facts have been considered and it’s been determined that the
has not met the requirements for exempt status under IRC Section 501(c)(7).

The exempt status should therefore be revoked, effective

January 1, 20XX, the date the material change in exempt status was noted.

The effect of this revocation is that the organization is required to file Forms 1120 with the
Internal Revenue Service, for the years ending December 31, 20XX, onward.

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

Page: -3-