Marina social club lost exemption over leasing and nonmember income

Plain-English summary

A marina organization had been recognized as a Section 501(c)(7) boating social club. Members owned boat slips, and the organization actively arranged rentals of unused slips and storage space to nonmembers, including invoicing renters, approving contracts, advertising, and finding renters. Some members owned additional slips for rental income, so the IRS found private benefit and inurement rather than operation exclusively for recreation and other nonprofitable purposes. The organization called renters “transient members,” but they paid no annual dues, had no voting rights, and were charged different rates. The examination also found significant nonmember rental, storage, fee, and fishing-tournament income exceeding the 15 percent public-use guideline. The IRS revoked exemption effective from the redacted date and required Form 1120 filings, with member and nonmember activity separated under Section 277.

Ruling snapshot

• Question: Did the marina continue to qualify as an exempt social club under Section 501(c)(7)?
• Outcome: Revocation.
• Key authorities: IRC §§ 277 and 501(c)(7); Treas. Reg. § 1.501(c)(7)-1; Rev. Proc. 71-17

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Appeals Office

Employer Identification Number:
Release Number: 201824013
Release Date: 6/15/2018

Date: March 22, 2018

Person to Contact:

Employee ID Number:

Tel:
Fax:
UIL: 501.07-00
Certified Mail
Dear [redacted]:

This is a final adverse 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 favorable determination letter issued to you in September XXXxX is hereby revoked and you are no
longer exempt under section 501(a) of the Code effective January 1, XXXX.

The adverse determination was made for the following reason(s):
You are not operated exclusively for pleasure, recreation, and other nonprofitable purposes.

You are required to file Federal income tax returns on Forms 1120. 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.

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, in a
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.

If you decide to contest this determination, you may file an action for declaratory judgment under the
provisions of section 7428 of the Code in one of the following three venues: 1) United States Tax Court,
2) the United States Court of Federal Claims, or 3) the United States District Court for the District of
Columbia. A petition or complaint in one of these three courts must be filed within 90 days from the date
this determination letter was mailed to you. Please contact the clerk of the appropriate court for rules and
the appropriate forms for filing petitions for declaratory judgment by referring to the enclosed Publication

892. You may write to the courts at the following addresses:

United States Tax Court
400 Second Street, NW
Washington, DC 20217

US Court of Federal Claims
717 Madison Place, NW
Washington, DC 20005

U. S. District Court for the District of Columbia

333 Constitution Ave., N.W.
Washington, DC 20001

Processing of income tax returns and assessments of any taxes due will not be delayed should a petition
for declaratory judgment be filed under section 7428 of the Code.

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 matter
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, please contact the person whose name and telephone number are shown in
the heading of this letter.

Sincerely Yours,

Appeals Team Manager

Enclosure: Publication 892

Department of the Treasury

Internal Revenue Service

Tax Exempt and Government Entities Division
Exempt Organizations: Examinations

Date:
April 29, 2016
Taxpayer Identification Number:

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

Contact Numbers:
Telephone:
Fax:

Manager’s name:

Manager’s contact number:

Response due date:

Certified Mail — Return Receipt Requested
Dear [redacted]:

Why you are receiving this letter

We propose to revoke your status as an organization described in section 501(c)(7) of the
Internal Revenue Code (Code). Enclosed is our report of examination explaining the proposed
action.

What you need to do if you agree

If you agree with our proposal, please sign the enclosed Form 6018, Consent to Proposed
Action — Section 7428, and return it to the contact person at the address listed above (unless
you have already provided us a signed Form 6018). We'll issue a final revocation letter
determining that you aren’t an organization described in section 501(c)(7).

If we don't hear from you

If you don’t respond to this proposal within 30 calendar days from the date of this letter, we'll
issue a final revocation letter. Failing to respond to this proposal will adversely impact your legal
standing to seek a declaratory judgment because you failed to exhaust your administrative
remedies.

Effect of revocation status
If you receive a final revocation letter, you'll be required to file federal income tax returns for the
tax year(s) shown above as well as for subsequent tax years.

Letter 3618 (Rev. 6-2012)
Catalog Number 34809F

What you need to do if you disagree with the proposed revocation

If you disagree with our proposed revocation, you may request a meeting or telephone
conference with the supervisor of the IRS contact identified in the heading of this letter. You also
may file a protest with the IRS Appeals office by submitting a written request to the contact
person at the address listed above within 30 calendar days from the date of this letter.

The Appeals office is independent of the Exempt Organizations division and resolves most
disputes informally.

For your protest to be valid, it must contain certain specific information including a statement of
the facts, the applicable law, and arguments in support of your position. For specific information
needed for a valid protest, please refer to page one of the enclosed Publication 892, How to
Appeal an IRS Decision on Tax-Exempt Status, and page six of the enclosed Publication 3498,
The Examination Process. Publication 3498 also includes information on your rights as a
taxpayer and the IRS collection process. Please note that Fast Track Mediation referred to in
Publication 3498 generally doesn’t apply after we issue this letter.

You also may request that we refer this matter for technical advice as explained in Publication

892. Please contact the individual identified on the first page of this letter if you are considering
     requesting technical advice. If we issue a determination letter to you based on a technical
     advice memorandum issued by the Exempt Organizations Rulings and Agreements office, no
     further IRS administrative appeal will be available to you.

Contacting the Taxpayer Advocate Office is a taxpayer right

You have the right to contact the office of the Taxpayer Advocate. Their assistance isn’t a
substitute for established IRS procedures, such as the formal appeals process. The Taxpayer
Advocate can't reverse a legally correct tax determination or extend the time you have (fixed by
law) to file a petition in a United States court. They can, however, see that a tax matter that
hasn't 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

For additional information

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,

Margaret Von Lienen
Director, EO Examinations

Enclosures:
Report of Examination -RAR 886-A

Letter 3618 (Rev. 6-2012)
Catalog Number 34809F

Form 4621-A
Form 6018
Publication 892
Publication 3498

Letter 3618 (Rev. 6-2012)
Catalog Number 34809F

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

Name of Taxpayer Year/Period Ended

December 31, 20XX

EIN:

Issue:
Whether or not the , qualifies for exemption under Section 501(c) (7) of the

Internal Revenue Code?

Facts:
The received tax exempt status as an organization described in Internal Revenue

Code section, 501(c)(7) on October 1, 20XX.

The provided a copy of its Form 1024 Application for Recognition of Exemption
dated March 29, 20XX. Part II of Form 1024 ‘Activities and Operational Information’, states
that the purpose of the organization is to purchase and operate a marina in ,

as a non-profit boating social club exempt under IRC section 501(c)(7). Anyone can become a
member of the organization. The only requirements are to purchase a boat slip from a for
profit business, that goes by the name ‘ , d/b/a ’ and pay the annual dues
to the . In the year under examination the dues are roughly zero ($0). The
organization also puts together a fishing tournament every year. A majority of the individuals
who paid to be part of this tournament in 20XX were non-members.

According to Article 1, Section 2 of the bylaws, the purposes of the Club are set
forth in the Club’s Articles of Organization. Specifically, the purposes of the Club are; (1) to
support recreational boating activities among its members;(2) to encourage and facilitate the
interaction of its members through social events, educational programs, publications and
activities related to boating and; (3) to provide programs in furtherance of the foregoing
purposes as may be carried out and conducted by a Club organized under Chapter 180 of the

General Laws. The Club is organized as a nonprofit Club, and its activities shall be
conducted for the aforesaid purposes in such a manner that no part of its net earnings shall
inure to the benefit of any Director or officer thereof or any other individual.

The organization was formed by purchasing marina assets from an organization known as

. The Installment Sale Agreement dated July 1, 20XX, sets the price of the Assets at
($0). However, no evidence of the actual value of these assets is present in this agreement.
The Installment Sale Agreement also goes on to state that the purchase price is subject to
changes in accordance with paragraph (5), which states that the sale price is subject to market
adjustment by Seller from time to time. The Agent requested more information about the
purchase of assets and was informed no private valuation of the assets was conducted. The
Agent was also told it was an arms-length transaction and therefore private valuation was not
completed. The Installment Sale Agreement is consistently written like a ‘long-term sale
agreement’ rather than a ‘installment sale agreement’, as paragraph {5} of the Installment Sale
Agreement allows the sale price to change. This is not typical in a sale agreement.

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 Exhibit
Explanation of Items

Name of Taxpayer Year/Period Ended

December 31, 20XX

EIN:

As part of the examination, the Agent requested a copy of the signed Installment Sale
Agreement between the parties. A review of the ‘Installment Sale Agreement’ determined that

the directors of ; who signed the Installment Sale Agreement, were and
. A review of the directors at the time that this sale was negotiated
showed that was the organization’s sole director. The Agent does not agree that

this Installment Sale Agreement was at an arm-length transaction (see response to IRS
request #3, Explanation of #1).

Issue 1: Operations inure to the benefit of its members and its related party
The organization is supposed to be operated as a social club under IRC Section 501(c)(7).
Section 1.501(c)(7) of the Regulations provides that this exemption extends to social and
recreation clubs which are supported solely by membership fees, dues, and assessments.
Members are entitled to (1) access to the club house; (2) a place to dock their boat; and (3)
storage for their boat. According to the organization website and other publications produced
by the , members are encouraged to lease out their slip or storage space if they
do not plan to use them. Several members allow their slip space or storage space to be leased
out. In fact, some members own more than one slip for the sole purpose of leasing out the
additional space to non-members for financial benefit.

The Agent received a blank ‘Lease Agreement Contract’ that the issues to non-
members who wish to lease a slip or storage space for personal use. Below is the heading of
this agreement.

‘Acting as an agent on behalf of a member(“Lessor”) or of :
(“Lessor”), the herby agrees to facilitate a leasing agreement between the Lessor
and the individual named herein (“Lessee”), who is not a member, for space sufficient to
accommoaate the yacht listed herein for the purpose, period, and price specified.’ (See
Lease Agreement Contract)

It is clear that the is not operating solely for an exempt purpose. Instead it is
merely a leasing agent for its members and . Since the members own their own slips
and owns several slips, it is clear that the is organized and operated

in a manner which permits and encourages benefits to private individuals and companies and is
not an organization exempt under 501(c)(7) of the Internal Revenue Code. 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). 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.

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 Exhibit
Explanation of Items

Name of Taxpayer Year/Period Ended

December 31, 20XX

EIN:

Issue 2: Non-Member Income

As part of the examination, the Agent was able to determine that the failed to
report a significant amount of non-member slip rental income and several other fees collected
from non-members on their filed Form 990 and Form 990-T for the period ending December
31, 20XX. In the organization’s response to Information Document Request #3 (IDR-#3), the
organization revealed $O in non-member income. In tax year 20XX, the organization charged
Slip Rental Fees for the rental of members’ slips, which totaled $0. The organization reported
$0 in non-member fees on the Form 990. This represented zero percent (0%) of the total non-
member income the organization attempted to receive. The organization also states in its
response, that of the $0 of invoiced slip rentals, $O was paid out to members, $O was
uncollected and the remainder $0 was kept by to pay other member fees and/or
note balances (see _ response to IRS request #3, Explanation of #2).

In addition to the organization’s response to IDR #3, the organization stated that it received
‘Winter Storage Fee’ and ‘Summer Storage Fee’ from its members, in the amounts of $O and
$0, respectively (see response to IRS request #3, Explanation of #2). It was later determined
that most of this income was non-member income as well. The Agent was able to determine
this by comparing the last name invoiced to the organization membership fees list and
determined many of the individuals were not members of the organization (See Non-Member
Income work sheet). Following the same procedures the Agent also found that approximately
$0 in other non-member income was reported on the Form 990 under Section VIII, Line 2a:
Members’ Dues & Activities. It was determined that the income reported was in fact non-
member income by comparing the organization’s membership list, to the names invoiced on
the detailed account transaction (See Non-Member Income work sheet).

After review of the organization’s books and records, as well as the organization’s response to
the Agent’s IDRs, it was determined that the non-member income was significant and was
determined to be as high as zero (0%) (Refer to Member vs. Non-Member income worksheets).
According to Revenue Procedure 71-17, non-member income should not exceed fifteen
percent (15%) of the total income received by an organization exempt under 501(c)(7) of the
Internal Revenue Code. The had zero percent (0%) non-member income for tax
year 20XX, equating to zero times the allowable amount of non-member income. Based on the
facts of the examination, and the above mentioned Revenue Procedure 71-17, the organization
does not qualify for exemption, since the income was more than insubstantially from non-
members.

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

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

Name of Taxpayer Year/Period Ended

December 31, 20XX

EIN:

Law:

Internal Revenue Code section 501(a) provides for exemption from taxation for certain
organizations described in subsection (c).

Internal Revenue Code section 501(c)(7) describes social clubs as clubs organized for pleasure,
recreation, and other 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.

Regulation 1.501(c)(7)-1(a) states in part that in general, the exemption extends to social and
recreation clubs which are supported solely by membership fees, dues, and assessments.

Regulation 1.501(c)(7)-1(b) states 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 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

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 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.

Taxpayers Position:

The does not agree with the Agent’s position. The organization attests that the
non-member income identified by the Agent is actual income from ‘transient members’. The
organization goes on to state members rent out their slips to transient members and the

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

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

Name of Taxpayer Year/Period Ended

December 31, 20XX

EIN:

organization keeps a small fee and turns over the remainder of the money to the member. It
was also made clear that the transient members do not have voting rights but have full access
to the club as a traditional member. The organization also claims that it does not get involved
in the rental of slips and that slips rented out by members to transient members does not
constitute private benefit.

Response to Taxpayers Position:

The organization states that it allows members to rent out their slip and membership to
‘transient members’ and that these transactions are between the member and the transient
member. These transient members have the right to use the club but do not have voting rights
and cannot attend member meetings. It goes on to state that the ( ) only
participates only in facilitating the transaction for the member.

A review of the current Rules-and-Regulations dated August 20XX and posted on the
organization current website as of June 23, 20XX brings doubt to the claim, that the
organization is only facilitating the transaction. Rules and regulations section 24.1 Member
Leasing Rights & Restrictions paragraph three states “will make every reasonable effort to
rent the slip, subject to market demand and other variables (see Rules & Regulations Section
24.1 page 21-22). The Club, however, makes no representations or assurances as to its ability
to do so.” Paragraph four goes on to state the Board has the right to approve the
transaction and individuals must execute a ‘leasing contract’ with the Club, which remains
solely responsible for all leasing arrangements in its capacity as agent acting on behalf of the
member. It is clear that the organization is not just facilitating a transaction, but the
organization is clearly an active participant in the leasing of slips.

The organization invoices non-members or transient members as the organization refers to
them in the response to the thirty day letter, but according to response to IRS request #3,
Explanation of #2 the organization refers to them as non-members and goes on to state that
fees are only paid out to members when the fee is collected from the non-member. These
payouts are zero percent (0%) of the fee collected.

A further review of the organization’s meeting minutes mention of transient slip rental, which
describes the organization’s legal obligation to make vacant slips available to transients (

Board of Directors Minutes 02/27/20XX). There are no references to ‘transient members’ in the
organization’s meeting minutes. The organization does however make several references to
members and renters in the board of director’s minutes. In several instances the minutes
describe the organization’s general manager finding renters for the available

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 Exhibit
r .
Explanation of Items

Name of Taxpayer Year/Period Ended

December 31, 20XX

EIN:

slips, and future efforts to find renters at boat shows, open houses, ads on Craigslist, etc.
(Minutes)..

The organization letter also states that there is little difference between members and
transient members. However the organization has a complete ‘rate schedule’ posted on their
website for current year 20XX, which shows various rates for members and renters. These
rates are higher for renters and in some cases the organization will charge non-members a fee
for the same service that members receive for no cost. The organization mentions that
transient members are another class of members in the organization, but transient members
do not pay annual dues, have no voting rights, and do not have an advocate on the Board of
Directors.

During the year under examination the organization held a fishing tournament and the
majority of individuals attending this tournament were non-members. This was easy to
determine by comparing the membership annual membership fee paid, with the individuals
who paid to attend the fishing tournament (see membership annual fee and fishing
tournament fee collection).

The organization claims there is no private benefit from the rental of member slips to transient
members. The organization allows its members slips to be rented out and zero percent of the
proceeds are then turned over to the member. The use of club assets to produce financial gain
for individual members is private benefit.

Government’s Position:

Issue 1:

The government believes that revocation of the organization’s exempt status should be sought.
The organization does not qualify for exemption in part due to the organization’s operations
and the above stated law. It is clear that the is not operating for an exempt
purpose; instead it is merely a leasing agent for its members and . Since the
members own their own slips and owns several of the slips, it is clear that the

is organized and operated in a manner such that its net earnings benefits private shareholders.
It is not an organization exempt under IRC section 501(c)(7) of the Internal Revenue Code.

Issue 2:
The government believes that revocation of the organization’s exempt status should be sought.
Based on the facts of the examination, the organization does not qualify for exemption. This

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

Page: -6-

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

Name of Taxpayer Year/Period Ended

December 31, 20XX

EIN:

organization substantially exceeded the 15% limitation for non-member income for the year
ending December 31, 20XX.

Conclusion:

Based on the foregoing reasons, the organization does not qualify for exemption under section
501(c)(7) and its tax exempt status should be revoked. Accordingly, the organization's exempt
status is revoked effective January 1, 20XX.

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 returns should be filed for the tax periods ending on or after December 31, 20XX.

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

Page: -7-