Social club loses exemption over public event business

Plain-English summary

A social club regularly rented event rooms to nonmembers, promoted itself as a public event venue, and relied on outside functions to support its restaurant and clubhouse. The IRS calculated nonmember income at 45 percent, 30 percent, and 27 percent of gross receipts for three examined years, before counting several additional categories of nonmember revenue. Those amounts exceeded the 15 percent limit for public use of club facilities, and the club also failed the recordkeeping requirements for the applicable gross-receipts guidance. The IRS found that the repeated nonmember activity was a business rather than incidental use in furtherance of the club's exempt purpose. After the club consented to the proposed action, the IRS revoked its IRC § 501(c)(7) exemption effective on the stated date.

Ruling snapshot

• Question: Did the club remain exempt when it regularly marketed facilities to nonmembers and exceeded the public-use receipts limit?
• Outcome: Revocation
• Key authorities: IRC §§ 501(c)(7) and 512(a)(3); Treas. Reg. § 1.501(c)(7)-1; Rev. Proc. 71-17; Rev. Rul. 58-589; Rev. Rul. 60-324

Full text (IRS public release)

UIL 501.07-00

DEPARTMENT OF THE TREASURY
INTERNAL REVENUE SERVICE

TAX EXEMPT AND
GOVERNMENT ENTITIES
DIVISION
Release Number: 201501015
Release Date: 1/2/2015 Taxpayer Identification Number:
Date: September 15, 2014

Form:

Tax Year(s) Ended:
August 31, 20XX, 20XX, 20XX
Person to Contact/ ID Number

Contact Numbers:
Phone:
Fax:

CERTIFIED MAIL — RETURN RECEIPT REQUESTED

Dear

In a determination letter dated December, 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 September 1, 20XX. This is a final letter with regard to your exempt

status.

We previously provided you a report of examination explaining why we believe revocation of your
exempt status was necessary. On June 13, 20XX you signed Form 6018-A, Consent to Proposed
Action, agreeing to the revocation of your exempt status under section 501(c)(7) of the Code.

You are required to file Federal income tax returns for the tax period(s) shown above. If you have
not yet filed these returns, please file them with the Ogden Service Center within 60 days from the
date of this letter, unless a request for an extension of time is granted. 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

UIL 501.07-00
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:

Internal Revenue Service
Office of the Taxpayer Advocate

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

Thank you for your cooperation.

Sincerely,

Barbara L. Harris
Acting Director, EO Examinations

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

Name of Taxpayer Year/Period Ended

August 31, 20XX,
20XX and 20XX

ISSUE:

Whether failed the gross receipts test and whether they will continue to qualify as
an exempt social club under section 501(c)(7) of the Internal Revenue Code (Code).

FACTS:

(Club) is exempt from federal income tax under section 501(a) of the Code, as
an organization described under section 501(c)(7) of the Code which was effective in December
of 19XX.

The activities as they are stated in the Articles of Incorporation were difficult to read and were,
overall, illegible. However, there was language that the Club will foster social activities among
the members.

Historically the Club has mirrored the activities of east coast and west coast “gentlemen’s clubs”
in that they offered, in part, a place to gather and smoke cigars. It has since evolved to where it
is now open to women as well. The membership is limited to individuals who hold a bachelor's
degree from a four-year college or university. Generally the Club offers several event-type
rooms that are made available for rent; in addition the facility offers dining facilities for members
that are used for the day-to-day activities. There are two squash courts that are provided for
use as well.

Nonmember Use:

Throughout the minutes there is a recurring theme of the financial challenges the Club has
been encountering for the past several years. There are recorded in the minutes, issues
regarding the marketing efforts by the Event Coordinator to increase outside, nonmember
participation such as partnering with - talking to the Convention Center; maintaining a
good profile on website; visiting shows, etc. Also recorded in the minutes is
the Club's reliance on the function business or outside business to support a substantial portion
of the general operating costs of the restaurant and clubhouse.

The Club’s website contains solicitation of public patronage such as the following example:

The Club is known to the general public as an option to host a private event. has
featured the Club on its publication. In addition the Club has been
featured in the as one of top 0.

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

Page: -1-

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

Name of Taxpayer Year/Period Ended

August 31, 20XX,
20XX and 20XX

As it was stated by the Event Coordinator, nonmembers are welcome to reserve event rooms.
Nonmember events are provided a member-sponsor when needed but typically the nonmember
knows a member who will be willing to sponsor the event. All nonmembers are issued an
account number for their particular event.

Overall the Club did not comply with the record keeping requirements as they are outlined in
Revenue Procedure 71-17. In computing the gross income tests it was determined that the
Club had nonmember income for the years ending August 31, 20XX, 20XX and 20XX with
percentages of 45%, 30% and 27% respectively. It should be emphasized that the nonmember
income percentages are without consideration of a complete analysis of the day-to-day sales
which does in fact contain non-member income. In addition, for the 20XX and 20XX years,
these percentages do not consider the nonmember events sponsored by members that include
weddings and numerous other nonmember events; nor does it include the cash sales. These
revenue items were not pursued at this time due to time constraints and the fact that the Club
had exceeded the 15% limitation without their consideration.

LAW:

Organizations exempt from federal taxes as described in section 501(c)(7) of the Code include
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.

Section 1.501(c)(7)-1 of the Income Tax Regulations, relating to the requirements of exemption
of such clubs under section 501(a), reads in part as follows:

(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
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.

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

Page: -2-

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

Name of Taxpayer Year/Period Ended

August 31, 20XX,
20XX and 20XX

Section 512(a)(3)(A) of the Code states that in the case of an organization described in
paragraph (7), the term “unrelated business taxable income” means the gross income
(excluding any exempt function income), less the deductions allowed by this chapter which are
directly connected with the production of the gross income (excluding exempt function income),
both computed with the modifications provided in paragraphs (6), (10), (11), and (12) of
subsection (b). For purposes of the preceding sentence, the deductions provided by sections
243, 244, and 245 (relating to dividends received by corporations) shall be treated as not
directly connected with the production of gross income.

Section 512(a)(3)(B) of the Code states that for purposes of subparagraph (A), the term
“exempt function income” means the gross income from dues, fees, charges, or similar
amounts paid by members of the organization as consideration for providing such members or
their dependents or guests goods, facilities, or services in furtherance of the purposes
constituting the basis for the exemption of the organization to which such income is paid. Such
term also means all income (other than an amount equal to the gross income derived from any
unrelated trade or business regularly carried on by such organization computed as if the
organization were subject to paragraph (1)), which is set aside.

Revenue Ruling 74-489 states that a country club that issues corporate membership is dealing
with the general public in the form of the corporations’ employees. Gross receipts from such
members will be a factor in determining whether the club qualifies as a social club under section
501(c)(7) of the Code.

Revenue Ruling 58-589 sets forth the criteria for exemption under section 501(c)(7) of the
Code, and provides that a club must have an established membership of individuals, personal
contacts, and fellowship. It also provides that, while the regulations indicate that a club may
lose its exemption if it makes its facilities available to the general public, this does not mean that
any dealings with nonmembers will automatically cause a club to lose its exemption. A club
may receive some income from the general public, that is, persons other than members and
their bona fide guests, or permit the general public to participate in its affairs, provided that such
participation is incidental to and in furtherance of the club's exempt purposes, such dealings
with the general public and the receipt of income therefrom does not indicate the existence of a
club purpose to make a profit, and the income does not inure to club members.

Revenue Ruling 60-324 provides that a social club that made its social facilities available to the
general public through its member-sponsorship arrangement can not be treated as being
operated exclusively for pleasure, recreation, or other nonprofitable purposes and the club no
longer qualified for exemption under 501(c)(7) of the Code.

Revenue Procedure 71-17 sets forth guidelines for determining the effect of gross receipts
derived from nonmember use of a social club’s facilities on exemption under Internal Revenue
Code Section 501(c)(7) and recordkeeping requirements. Failure to maintain such records or
make them available to the Service for examination will preclude use of the minimum gross
receipts standard and audit assumptions set forth in this Revenue Procedure.

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

Page: -3-

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

Name of Taxpayer Year/Period Ended

August 31, 20XX,
20XX and 20XX

If a club exceeds the 15/35% test, then it will maintain its exempt status only if it can show
through facts and circumstances that “substantially all” of its activities are for “pleasure,
recreation and other nonprofitable purposes.”

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):

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

• 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.

• 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).

• Purposes for which the club's facilities were made available to nonmembers.

• Whether the nonmember income generates net profits for the organization. Profits
derived from nonmembers, unless set aside, subsidize the club’s activities for
members and result in inurement within the meaning of IRC 501(c)(7).

Prior to its amendment in 1976, IRC Section 501(c)(7) required that social clubs be operated
exclusively for pleasure, recreation, and other non-profitable purposes. Public Law 94-568
amended the “exclusive” provision to read “substantially” in order to allow a section 501(c)(7)
organization to receive up to 35 percent of its gross receipts, including investment income, from
sources outside its membership without losing its tax exempt status. The Committee Reports
for Public Law 94-568 further state:

(a) 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. This
means that an exempt social club may receive up to 35 percent of its gross receipts
from a combination of investment income and receipts from non-members, so long as
the latter does not represent more than 15 percent of total receipts. These percentages
supersede those provided in Revenue Ruling 71-17, 1971-1 C.B. 683.

(b) Thus, a social club may receive investment income up to the full 35 percent of its gross
receipts if no income is received from non-members’ use of club facilities.

(c) In addition, the Committee Reports state that where a club receives unusual amounts of
income, such as from the sale of its clubhouse or similar facilities, that income is not to
be included in the 35 percent formula.

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

Form 886-A Department of the Treasury - Internal Revenue Service Schedule No. or
Explanation of Items Exhibit
Name of Taxpayer Year/Period Ended
August 31, 20XX,
20XX and 20XX

(d) The Senate report also indicates that even though gross receipts from the general
public exceed this standard, it does not necessarily establish that there is a nonexempt
purpose. A conclusion that there is a nonexempt purpose will be based on all the facts
and circumstances including, but not limited to, the gross receipts factor.

TAXPAYER'S POSITION:

The Club has not provided its position at this time.

GOVERNMENT'S POSITION:

An organization exempt from federal income taxes as described in section 501(c)(7) of the
Code must meet the gross receipts test in order to maintain its exemption. In order to meet the
gross receipts test, an organization can receive up to thirty-five percent (35%) of its gross
receipts, including investment income, from sources outside its membership without losing its
tax exempt status. Within this 35% amount, not more than fifteen percent (15%) of the gross
receipts should be derived from the use of a social club’s facilities or services by non-members.

has exceeded the 15% gross receipts standard for non-member income on a
continuous basis for at least three years. The non-member receipts are earned throughout
the year. There was no one single or unusual event that caused the club to exceed the 15%
threshold.

Based on the percentages of gross non-member income to total gross receipts of the Club
(e.g. 45%, 30% and 27% as noted in the above table) which exceeds the limitation of 15%
as set forth by section 501(c)(7) of the Code for each of these years, it is the Government's
position that the Club is no longer operated exclusively for the pleasure and recreation of its
members and is not exempt under section 501(c)(7) of the Code.

The Club did not satisfy the Facts and Circumstances test in that the Club allowed for
consistent and regular nonmember use of the Club's facilities through numerous outside,
nonmember events.

From reviewing the Club’s website it is apparent that there is a significant amount of marketing
devoted to attracting non-member business use particularly . Also in a “
” search there were various — vendors who mention the Club as an ideal venue.

Overall the minutes speak of the decline in membership and that more are needed in addition to
the day-to-day member usage to sustain the Club. There is also the overarching discussion of
the Function activity as being one the primary revenue makers. As such the Event Coordinator
actively seeks outside events such as to be held at the Club.

has posted photos taken at the Club to advertise that the Club is available for

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

Page: -5-

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

Name of Taxpayer Year/Period Ended

August 31, 20XX,
20XX and 20XX

. The Event Coordinator also purchased software to increase sales. It is evident
that the Event Coordinator, as directed by the Club, actively markets for public patronage.

Section 1.501(c)(7)-1(b) of the Income Tax Regulations states in relevant part that 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) of the Code. 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.

Based on the marketing activities of the Club it is clearly prima facie evidence of the Club’s
intent to open its facilities to the general public which is inconsistent with an organization
described in section 501(c)(7) of the Code. For this reason it is the Government's position that
the Club is no longer operated exclusively for the pleasure and recreation of its members and is
not exempt under section 501(c)(7) of the Code.

CONCLUSION:

The tax exemption of under section 501(c)(7) of the Code should be revoked since the
non-member income received by the Club exceeded 15% of the Club’s total gross receipts for
the years under examination. Further, it advertises the use of its facilities to the general public
reflecting evidence that the Club is engaged in a business and is not being operated exclusively
for pleasure, recreation, or social purposes.

no longer meets the requirements to qualify as exempt from federal income tax
under section 501(a) as described in section 501(c)(7) of the Code. Therefore, the exempt
status under 501(c)(7) of the Code will be revoked effective September 1, 20XX.
As a taxable entity, the organization would be required to file Form 1120, U.S. Corporation
Income Tax Return for the periods open under statute. Under 6501(g) of the Code these
periods include the years ending August 31, 20XX; 20XX and 20XX.

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

TAXPAYER’S OPTIONS:

1. If you AGREE please provide the following documents:

➢ Original signed copy of the enclosed Form 6018-A

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

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

Explanation of Items Exhibit

Name of Taxpayer Year/Period Ended

August 31, 20XX,
20XX and 20XX

➢ Original signed copies of the Forms 1120 for the tax years ending August 31, 20XX,
20XX and 20XX.

2. If you DO NOT AGREE please provide the following documents:

➢ A detailed explanation of your current position. Provide documents and legal authority
that will support your position.

➢ As an alternative, you have the option of presenting your case to an appeals officer in a
Fast Track Settlement setting.

TE/GE Fast Track Settlement (FTS) offers taxpayers an alternative to resolving
unagreed issues during the examination process. Working with the Tax
Exempt/Government Entities Division (TE/GE) and Appeals, taxpayers can use the
settlement authority and mediation skills of Appeals while shortening their overall
experience with the Internal Revenue Service. FTS can reduce a taxpayer’s combined
TE/GE and Appeals audit process time by as much as one year.

If any issues remain unresolved at the conclusion of the FTS process, taxpayers retain
their traditional appeal rights as explained in Publication 5, Your Appeal Rights and How
To Prepare a Protest If You Don't Agree.

Enclosed is Publication 5092, Fast Track Settlement, that briefly explains the process.
Also enclosed is a partially completed application (Form 14017) should you decide to
consider this offer.

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

Page: -7-