Investment-funded social club lost exemption

Plain-English summary

A fraternity-related organization held investments and used the income to provide housing for chapter members. Investment income had been its sole reported income for years, and it did not provide evidence of any other activities. The IRS found that outside income exceeded the 35 percent limit generally allowed to section 501(c)(7) social clubs. It also concluded that the organization was not operated substantially for member pleasure, recreation, or other qualifying nonprofit purposes. The IRS revoked exemption effective January 1 of a redacted year.

Ruling snapshot

• Question: Could a social club retain section 501(c)(7) exemption when investment income was its sole income and exceeded the outside-income limit?
• Outcome: Exemption revoked.
• Key authorities: IRC §§ 501(c)(7) and 512(a)(3)(B); Treas. Reg. § 1.501(c)(7)-1; Rev. Rul. 66-149; Pub. L. 94-568.

Full text (IRS public release)

Transcriber's note: this seven-page scan contains a final revocation letter, the proposed revocation letter, and a three-page examination report. All page images were checked. Obvious OCR errors were corrected, repeated page numbers and form headers and footers were omitted, and blank identifying fields remain blank. Original wording is preserved.

DEPARTMENT OF THE TREASURY
Internal Revenue Service
TE/GE EO Examinations
1100 Commerce Street MC 4920 DAL
Dallas, TX 75242

TAX EXEMPT AND
GOVERNMENT ENTITIES
DIVISION

Date: OCT 16 2018
Release Number: 201906009
Release Date: 2/8/2019
UIL: 501-03-00
Person to Contact:
Identification Number:
Contact Telephone Number:
In Reply Refer to: TE/GE Review Staff
EIN:
LAST DATE FOR FILING A PETITION
WITH THE TAX COURT:
JAN 14 2019

CERTIFIED MAIL - Return Receipt Requested

Dear

This is a Final Adverse Determination Letter as to your exempt status under section 501(c)(7) of
the Internal Revenue Code (IRC). Your exemption from Federal income tax under IRC section
501(c)(7) is hereby revoked effective January 1, 20XX.

Our adverse determination was made for the following reasons:

You have not established that you are operated substantially for pleasure
and recreation of its members or other non-profitable purposes and no part
of the earnings inures to the benefit of private shareholder within the
meaning of IRC section 501(c)(7).

You have exceeded the non-member income test for tax year ending
December 31, 20XX.

You are required to file Federal income tax returns on Form 1120. These returns should be
filed with the appropriate Service Center for the year ending December 31, 20XX and for all
years thereafter.

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

If you decide to contest this determination in court, you must initiate a suit for declaratory
judgment in the United States Tax Court, the United States Claim Court or the District Court
of the United States for the District of Columbia before the 91st day after the date this
determination was mailed to you. Contact the clerk of the appropriate court for the rules for
initiating suits for declaratory judgment.

The Taxpayer Advocate Service (TAS) is an independent organization within the IRS that
can help protect your taxpayer rights. We can offer you help if your tax problem is causing a

hardship, or you've tried but haven't been able to resolve your problem with the IRS. If you qualify for
our assistance, which is always free, we will do everything possible to help you. Visit
taxpayeradvocate.irs.gov or call 1-877-777-4778.

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

Sincerely yours,

Maria Hooke
Director, Exempt Organizations Examinations

Enclosures:
Publication 892

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

Date: July 26, 2018
Taxpayer Identification Number:
Form: 990-EZ Return
Tax Year(s) Ended: 12/31/20XX
Person to Contact:
Employee ID:
Telephone:
Fax:
Manager’s Contact Information:
Employee ID:
Telephone:
Response Due Date: August 27, 2018

CERTIFIED MAIL — Return Receipt Requested

Dear

Why you're receiving this letter

We enclosed a copy of our audit report, Form 886-A, Explanation of Items, explaining that we
propose to revoke your tax-exempt status as an organization described in Internal Revenue
Code (IRC) Section 501(c)(7).

If you agree

If you haven't already, please sign the enclosed Form 6018, Consent to Proposed Action, and
return it to the contact person shown at the top of this letter. We'll issue a final adverse letter

determining that you aren't an organization described in IRC Section 501(c)(7) for the periods
above.

After we issue the final adverse determination letter, we'll announce that your organization is no
longer eligible to receive tax deductible contributions under IRC Section 170.

If you disagree

1. Request a meeting or telephone conference with the manager shown at the top of this

letter.

2. Send any information you want us to consider.

3. File a protest with the IRS Appeals Office. If you request a meeting with the manager or
   send additional information as stated in 1 and 2, above, you'll still be able to file a protest
   with IRS Appeals Office after the meeting or after we consider the information.

The IRS Appeals Office is independent of the Exempt Organizations division and
resolves most disputes informally. If you file a protest, the auditing agent may ask you to
sign a consent to extend the period of limitations for assessing tax. This is to allow the

IRS Appeals Office enough time to consider your case. For your protest to be valid, it
must contain certain specific information, including a statement of the facts, applicable
law, and arguments in support of your position. For specific information needed for a
valid protest, refer to Publication 892, How to Appeal an IRS Determination on Tax-

Exempt Status.

Fast Track Mediation (FTM) referred to in Publication 3498, The Examination Process,
generally doesn’t apply now that we've issued this letter.

4. Request technical advice from the Office of Associate Chief Counsel (Tax Exempt
   Government Entities) if you feel the issue hasn't been addressed in published precedent
   or has been treated inconsistently by the IRS.

If you’re considering requesting technical advice, contact the person shown at the top of
this letter. If you disagree with the technical advice decision, you will be able to appeal
to the IRS Appeals Office, as explained above. A decision made in a technical advice
memorandum, however, generally is final and binding on Appeals.

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 adverse determination letter.

Contacting the Taxpayer Advocate Office is a taxpayer right

The Taxpayer Advocate Service (TAS) is an independent organization within the IRS that can
help protect your taxpayer rights. TAS can offer you help if your tax problem is causing a
hardship, or you've tried but haven't been able to resolve your problem with the IRS. If you
qualify for TAS assistance, which is always free, TAS will do everything possible to help you.
Visit www.taxpayeradvocate.irs.gov or call 877-777-4778.

For additional information
You can get any of the forms and publications mentioned in this letter by visiting our website at

www.irs.gov/forms-pubs or by calling 800-TAX-FORM (800-829-3676).
If you have questions, you can contact the person shown at the top of this letter.

Sincerely,

[illegible signature]

Maria Hooke
Director, Exempt Organizations
Examinations

Enclosures:
Form 6018
Form 4621-A
Form 886-A
Publication 892
Publication 3498

Form 886-A
Explanation of Items
Proposal for Tax
Year/Period Ended: 12/31/20XX

ISSUE

1. Does , hereafter referred to as , qualify for

exempt status under section 501(c)(7) of the Internal Revenue Code when it has
investment income in excess of % and none of that income for is set aside for —

charitable purposes?

2. Do the activities for meet the qualifications for

exemption under Section 501(c)(7)?

FACTS

, hereafter referred to as , was granted exemption in
19XX as a 501(c)(7) organization. According to the Articles of Incorporation, . purpose is to
oversee and/or conduct educational and financial matters of the Chapter of
fraternity.

Their sole source of income is investment income. The organization then uses this money to
provide housing for chapter members. The organization didn’t provide any information about any
other activities as requested on June 4, 20XX. Contacted on June 19, 20XX, and he
confirmed that this is their only activity. The investment income has been the only income
reported since 20XX.

LAW

Section 501(c)(7) Law

Section 501(a) of the Internal Revenue Code exempts from taxation organizations described at
subsection 501(c)(7) as clubs organized for pleasure, recreation, and other non-profitable
purposes, substantially all of the activities of which are for such pleasure, recreation, and other
non-profitable 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 states in pertinent part, that:

(a) The exemption provided by § 501(c)(7) of the code applies only to clubs which are
organized and operated exclusively for pleasure, recreation, and other non-profitable
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 that 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 their products, is not
organized and operated exclusively for pleasure, recreation, or social purposes.

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, including investment income, without losing
their exempt status. Prior passage of this law in 1976, section 501(c)(7) of the Code provided
exemption for social clubs organized exclusively for pleasure, recreation, and other non-
profitable purposes. P.L. 94-568 substitutes the word “substantially” for “exclusively”.

Both Senate and House Committee Reports show that this wording change was intended to make
it clear that social clubs may receive outside income, without losing their exempt status.
However, the committee reports also specified clearly defined limits on this outside income,
which if exceeded then invoke the application of a facts and circumstances test. The law allows
social clubs to receive up to 35% of their gross receipts, including investment income, from
sources outside their membership without losing their exempt status. Within this 35%, no more
than 15% of gross receipts may be derived from non-member use of club facilities and/or
services. (S. Report No. 94-1318 (1976), 2d Sess.,1976-1 C.B. 597; H. Report No. 94-1353, to
accompany H. Report 1144 (Public law 94-568, 3-4, 8 (1976)).

Revenue Ruling 66-149; 1966-1 C.B.; A social club is not exempt from Federal income tax as an
organization described in section 501 (c) (7) of the Internal Revenue Code of 1954 where it
regularly derives a substantial part of its income from nonmember sources such as, for example,
dividends and interest on investments which it owns.

Internal Revenue Code Section 512(a)(3)(B) 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 for a purpose specified in section 170(c)(4).

GOVERNMENT’S POSITION

According to the law, the investment income exceeds 35% limitations according to IRC
§513(f)(2)(C). The organization does not conduct any activities that meet 501(c)(7) requirements.

TAXPAYER’S POSITION
The taxpayer’s position is unknown at this time.
CONCLUSION

Accordingly, based on the facts and circumstances described, it is concluded that does not
meet the exemption requirements for 501(c)(7). has failed to meet the 35% threshold for
gross receipts from sources outside their membership with no more than % being derived from
non-member use. also failed to demonstrate that their activities meet the definition of an
organization described in Section 501(c)(7). Therefore, revocation of exemption is recommended
effective January 1, 20XX.