Social club loses exemption after recurring public-use income exceeds 15 percent

Plain-English summary

A social and recreational club regularly opened its dance and bowling activities to nonmembers, who could enter through an unlocked gate and pay a nonmember fee at the counter. Its nonmember receipts were 20.1 percent and 40.7 percent in two successive tax years. The examination report explained that a section 501(c)(7) club may generally receive no more than 15 percent of gross receipts from public use of its facilities, within a broader 35 percent allowance for nonmember and investment income. Because the club repeatedly exceeded the public-use threshold, the IRS concluded that it no longer operated primarily for members’ pleasure and recreation. The club said it needed nonmember participation to continue operating and agreed that its exemption should be revoked.

Ruling snapshot

• Question: Did the club continue to qualify under IRC § 501(c)(7) when recurring public-use receipts exceeded 15 percent of gross receipts?
• Outcome: Revocation
• Key authorities: IRC § 501(c)(7); Treas. Reg. § 1.501(c)(7)-1; Pub. L. No. 94-568; Rev. Rul. 66-149; Rev. Proc. 71-17

Full text (IRS public release)

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

Exempt Organizations: Examinations

801 Tom Martin Drive

Room 263

Birmingham, AL 35211

Number: 201544026
Release Date: 10/30/2015 Taxpayer Identification Number:

Form:

Tax Year(s) Ended:
Date: December 10, 2012 Person to Contact ID Number:
Contact Numbers:

Telephone:
Fax:

UIL Code: 501.07-00

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) shown

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

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:

Internal Revenue Service
Office of the Taxpayer Advocate

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

Form 886 A Department of the Treasury - Internal Revenue Service
Explanation of Items

Name of Taxpayer Year/Period Ended
20XX/
20XX/20XX
ISSUE
Does continue to qualify for exemption under Internal Revenue Code §

501(c)(7) given that it receives more than 15% of its income from the general public on
a recurring basis?

FACTS
is open to the public the following days:
Friday Dance 6pm — 10pm Year Round
Half & Half 6pm — 10pm Year Round
Bowling Year Round

During these times, nonmembers may participate in several of the Club’s activities including,
but not limited to, the Friday Night Dance, the Half & Half and the Bowling events.

Nonmembers may enter the grounds of the through an entry gate that is unlocked
during these hours. In order to participate in these activities, they have only to identify
themselves to the employee working the counter in the facility. The counter person then charges
them the nonmember fee for participating in these activities.

The is organized and operating as an organization described in
Internal Revenue Code § 501(c)(7) to provide social, recreational and other activities to its
members. The benefits provided to the members include, but are not limited to, the following
activities: the Friday Night Dance, the Half & Half, and bowling events.

The specific and primary purpose of the per its’ Articles of Incorporation, is
to improve the social climate for its members through recreational, cultural, and charitable
activities. The members of this Corporation shall be reputable single persons, including divorced
or widowed, of good moral character.

Your organization reported the following sources and amounts of revenue on Forms 990 for
periods ending December 31, 20XX, December 31, 20XX and December 31, 20XX

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

Page: -1-

Form 886A Department of the Treasury - Internal Revenue Service
Explanation of Items

Name of Taxpayer Year/Period Ended
20XX/
20XX/20XX
Club Activities-Nonmember $ $ $ $
Membership Dues and Assessments $ $ $ $ -
Interest on savings and temporary cash investments $ $ $ $ -
Total Nonmember Income $ $ $ $
Total Nonmember & Investment Income $ $ $ $
Total Income $ $ $ $ -
Nonmember % - A/C $ $ $ $
Total Nonmember & Investment % - B/C $ $ $ $

While reviewing the Income/Expense Statement, Minutes of meetings, your website, as well as
other internal documents provided by your organization, such as cash register receipts and
Income/Expense Report, it has been noted that your organization is open to the general public
on a regular basis, as stated previously. The nonmember income has been recorded in the
following accounts within your Income/Expense Report:

Account Friday Dance Guest
Account Half & Half

Account Money Market
Account Bowling

Based on conducting a two year analysis of gross receipts, it has been noted that the
organization received 20.1% and 40.7%, respectively, during tax years ending December 31,
20XX and December 31, 20XX. The gross receipts received by your organization are well over
the 15% threshold permitted in Public Law 94-568.

LAW

Internal Revenue Code § 501(c)(7) exempts from Federal income tax: “Clubs organized for
pleasure, recreation, and other non-profitable purposes, substantially all of the activities of which
are for such purposes and not part of the net earnings of which inures to the benefit of any
private shareholder.”

Section 1.501(c)(7) of the Income Tax Regulations provides that, in general, the exemption
extends to social and recreation clubs supported solely by membership fees, dues and
assessments. However, a club that engages in a business, such as making its social and
recreational facilities open 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).

Prior to its amendment in 1976, IRC § 501(c)(7) required that social clubs be operated
exclusively for pleasure, recreation and other nonprofitable purposes. Public Law 94-568

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

Form 886A Department of the Treasury - Internal Revenue Service
Explanation of Items

Name of Taxpayer Year/Period Ended
20XX/

20XX/20XX

amended the “exclusive” provision to read “substantially’ in order to allow an IRC § 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 (Senate Report No. 94-1318 2d Session, 1976-2 C.B. 597) further states;

(a) Within the 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 do not represent
more than 15 percent of total receipts.

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

(c) In addition, the Committee Report states 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.

Revenue Ruling 66-149 holds a social club as not exempt as an organization described in
Internal Revenue Code § 501(c)(7) where it derives a substantial part of its income from
non-member sources.

Revenue Procedure 71-17 sets forth the guidelines for determining the effect of gross receipts
derived from the general public’s use of a social club’s facilities on exemption under Internal
Revenue Code § 501(c)(7). Where nonmember income from the usage exceeds the standard
as outlined in this Revenue procedure, the conclusion reached is that there is a non-exempt
purpose and operating in this manner jeopardizes the organization’s exempt status.

TAXPAYER’S POSITION

The taxpayer's position is that the only way they are going to be able to operate is to allow
nonmembers to participate in member events. The organization has agreed that their exempt
status should be revoked.

GOVERNMENT’S POSITION

Your organization has exceeded the 15% non-member threshold on a recurring basis during
tax years ending December 31, 20XX and December 31, 20XX and therefore revocation of
your organization’s exempt status is warranted.

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

Form 886A Department of the Treasury - Internal Revenue Service
Explanation of Items
Name of Taxpayer Year/Period Ended
20XX/
20XX/20XX
CONCLUSION

no longer qualifies for exemption under § 501(c)(7) of the Internal Revenue

Code as your nonmember income has exceeded the 15% nonmember threshold as outlined in
Public Law 94-568. Therefore, your exempt status under § 501(c)(7) of the Internal Revenue
Code should be revoked effective January 1, 20XX. Should this revocation be upheld, Form
1120 must be filed starting with tax periods ending December 31, 20XX and December 31,

20XX.

Note: If you are planning to appeal the proposed revocation, please refer to Publication 892
which is enclosed. Appeal should contain statement of facts declared true under penalties of
perjury. Please refer to Publication 892, page 3 for example of statement signed under penalties

of perjury.

Form 886-A (Rev. 4-68)

Department of the Treasury - Internal Revenue Service

Page: -4-