IRS revokes a social club's exemption for excess investment income from nonmember sources

Plain-English summary

The IRS revoked a social club's IRC § 501(c)(7) exemption after finding that substantially all of its income came from investments, a nonmember source, well over the 35% of gross receipts that social clubs may receive from outside their membership. Under Public Law 94-568 and Revenue Ruling 66-149, a club that regularly derives a substantial part of its income from nonmember sources such as dividends and interest does not qualify for exemption. The club acknowledged in a letter that it had unintentionally overlooked the income limitation. The IRS concluded the club exceeded the 35% limit on a continuing basis and revoked exemption effective a redacted January 1 date, so the club must file Form 1120 corporate returns going forward. In the released copy the dollar amounts and percentages are redacted and appear as $0 and 0%.

Ruling snapshot

• Question: Does the social club still qualify for exemption under IRC § 501(c)(7) when substantially all its income is investment income?
• Outcome: Revocation.
• Key authorities: IRC §§ 501(a), 501(c)(7), 170, and 7428; Treas. Reg. § 1.501(c)(7)-1; Public Law 94-568 (Senate Report 94-1318); Rev. Rul. 66-149.

Full text (IRS public release)

DEPARTMENT OF THE TREASURY
INTERNAL REVENUE SERVICE
1100 Commerce Street, MC 4920DAL
Dallas, TX 75242

TAX EXEMPT AND
GOVERNMENT ENTITIES
DIVISION
Date: April 24, 2020
Number: 202052021 Taxpayer ID Number:

Release Date: 12/24/2020
Form:
UIL: 501.07-00
For Tax Period(s) Ending:

Person to Contact:
Identification Number:
Telephone Number:

Fax Number:

CERTIFIED MAIL — Return Receipt Requested
LAST DAY FOR FILING A PETITION WITH THE TAX COURT:

Dear

This is a final determination that you do not qualify for exemption from federal income tax under Internal Revenue Code (IRC) Section 501(a) as an organization described in IRC Section 501(c)(7) for the tax period(s) above. Your determination letter dated July 19XX is revoked.

Our adverse determination as to your exempt status 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.

Organizations that are not exempt under IRC 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 IRC Section 7428 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 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

U.S. 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 if you file a petition for declaratory judgment under IRC Section 7428.

You may 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.

Taxpayer Advocate assistance can't be used as substitute for established IRS procedures, formal appeals processes, etc. The Taxpayer Advocate is not able to reverse legal or technically correct tax determination, nor extend the time fixed by law that you have to file a petition in 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 can get any of the forms or publications mentioned in this letter by calling 800-TAX-FORM (800-829-3676) or visiting our website at www.irs.gov/forms-pubs.

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.

Enclosures:
Publication 892

Sincerely,

Maria D. Hooke
Director, EO Examinations

Department of the Treasury Date:
Internal Revenue Service October 8, 2019
IRS Tax Exempt and Government Entities Taxpayer Identification Number: Exempt Organizations Examinations

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

Letter 3618 (Rev. 9-2017)
Catalog Number 34809F

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

Letter 3618 (Rev. 9-2017)
Catalog Number 34809F

Form 886-A Department of the Treasury — Internal Revenue Service Schedule number or exhibit (May 2017) Explanations of Items Name of taxpayer Tax Identification Number (last 4 digits) | Year/Period ended 20XX

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

FACTS:

is recognized as a section IRC 501(c)(7) tax exempt organization. Form 990s for the years ending and show investment income of $0 and $0, respectively. The amounts shown were reported on Form 990s, item 4 and 5a. The investment income accounts for of the organization's gross income in and

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:

Organization provided a letter, received September 23, 20XX, stating the following: "The organization did not meet the income limitations noted because the organization was unaware of the regulation. This was an unintentional oversight.

Government Position:

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).

Catalog Number 20810W Page 1 www.irs.gov Form 886-A (Rev. 5-2017)

Form 886-A Department of the Treasury — Internal Revenue Service Schedule number or exhibit (May 2017) Explanations of Items Name of taxpayer Tax Identification Number (last 4 digits) | Year/Period ended 20XX

Organization received nonmember income in the form of investment income as follows:

-Tax Year Ended , investment income totaled $0, representing
0% of total revenue,

-Tax Year Ended , investment income totaled $0, representing
0% of total revenue,

Conclusion:

Based on our review of all facts and circumstances and the legislative support referenced above, it is the government's position that exempt status should be revoked because it regularly derives a substantial part of its income from nonmember sources such as, for example, dividends and interest on investments which it owns. Accordingly, the organization's exempt status is revoked effective January 1, 20XX.

Form 1120 returns should be filed for the tax periods ending on or after January 1, 20XX.

Catalog Number 20810W Page 2 www.irs.gov Form 886-A (Rev. 5-2017)