Social club exemption revoked for excessive nonmember investment income

Plain-English summary

A social club recognized under section 501(c)(7) reported that substantially all of its income for two examined years came from investments. Social clubs may generally receive no more than 35 percent of gross receipts, including investment income, from outside their membership without losing exemption. The IRS found that the organization exceeded that limit on a continuing basis. It therefore revoked the club's exemption for the listed tax periods. The determination did not address other periods.

Ruling snapshot

• Question: Does the social club remain exempt when substantially all of its income comes from investments?
• Outcome: revocation, because nonmember receipts exceeded the 35 percent limit
• Key authorities: IRC § 501(c)(7); Treas. Reg. § 1.501(c)(7)-1; Rev. Rul. 66-149; S. Rep. No. 94-1318

Full text (IRS public release)

DEPARTMENT OF THE TREASURY
INTERNAL REVENUE SERVICE
TEGE EO Examinations Mail Stop 4920 DAL
1100 Commerce St.
Dallas, Texas 75242

TAX EXEMPT AND
GOVERNMENT ENTITIES
DIVISION

Date: April 8, 2019
Number: 201933017
Release Date: 8/16/2019

Tax Year(s) Ending:

Taxpayer Identification Number:
Person to Contact:

Employee Identification Number:

Employee Telephone Number:

UIL: 501.03-00

CERTIFIED MAIL – RETURN RECEIPT

Dear                  :

This is a final 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) for the tax period(s) above. Your determination letter dated 11/28/19XX is revoked.

Our adverse determination as to your exempt status was made for the following reason(s):

You have exceeded the 35% gross receipts limitation on income from non-member sources.

This letter isn’t a determination of your exempt status under section 501 for any periods other
than the tax period(s) listed above.

Organizations that are not exempt under section 501 generally are required to file federal income
tax returns and pay tax, where applicable. For further instructions, forms, and information please
visit www.irs.gov.

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, N.W.
Washington, D.C. 20217

U.S. Court of Federal Claims
717 Madison Place, N.W.
Washington, D.C. 20439

U.S. District Court for the District of Columbia
333 Constitution Ave., N.W.
Washington, D.C. 20001

Processing of income tax returns and assessments of any taxes due will not be delayed if you file
a petition for declaratory judgment under section 7428 of the Internal Revenue Code.

You may also be eligible for help from the Taxpayer Advocate Service (TAS). 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 1-877-777-4778.

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

Sincerely,

Maria Hooke
Director, EO Examinations

Enclosures:
Publication 892

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

Date: August 7, 2018

Taxpayer Identification Number:

Form:

Tax Year(s) Ended:

Person to Contact:

Employee ID:
Telephone:
Fax:
Manager’s Contact Information:

Employee ID:
Telephone:
Response Due Date:

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,

Maria Hooke
Director, Exempt Organizations
Examinations

Enclosures:
Form 886-A
Form 6018

Form 886-A
Department of the Treasury Internal Revenue Service
Explanations of Items
Schedule number or exhibit
A
Name of taxpayer
Tax Identification Number (last 4 digits)
Year/Period ended
20XX

PRIMARY ISSUE:

Whether [redacted], an organization exempt under
IRC 501(c)(7) continues to qualify for exemption given the fact that substantially all of its income is from
investment income?

FACTS:

[redacted] is recognized as a section IRC 501(c)(7) tax exempt organization. Form 990s for the
years ending 20XX and 20XX show investment income of $0 and $0, respectively. The amounts shown
were reported on Form 990s, item 4 and 5a, per officer’s statement made via telephone March 27, 20XX.
The investment income accounts for 0% of the organization’s income in 20XX and 20XX.

LAW:

Internal Revenue Code Section 501(c)(7) provides exemption to 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.”

Income Tax Regulation 1.501(c)(7)-1(a) states, in part, exemption is provided only to “clubs which are
organized and operated exclusively for pleasure, recreation, and other nonprofitable purposes...” and “...
exemption extends to social clubs and recreation clubs which are supported solely by membership fees,
dues, and assessments.”

The Committee Reports for Public Law 94-568 (Senate Report No. 94-1318 2d Session, 1976-2 C.B. 597)
states that it is intended that social clubs be permitted to receive up to 35% of their gross receipts, including
investment income, from sources outside of their membership without losing their tax exempt status.

Revenue Ruling 66-149 states, in part, a social club is not exempt from Federal income tax as an
organization described in section 501(c)(7) of the Code 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.

Taxpayer’s Position:
Unknown.

Government Position:

It appears that the organization has exceeded the 35% gross receipts limitation on a continuous basis and
therefore, does not qualify for exempt status under section 501(c)(7).