IRS revokes a social club's tax exemption for excess non-member and investment income

Plain-English summary

This is a final IRS determination revoking an organization's tax-exempt status as a social club under Section 501(c)(7). Section 501(c)(7) exempts clubs organized for pleasure and recreation that are supported mainly by their members. By law, such a club can take in only a limited share of its money from outside its membership: no more than 35 percent of gross receipts from investment income and non-member sources combined, and within that, no more than 15 percent from the general public's use of club facilities. Here the organization (which served the deaf community with social events and workshops) rented apartment units in its building to the general public, and the IRS audit found its non-member and investment income exceeded both the 15 percent and 35 percent limits over five years (the specific percentages are redacted in the release). The IRS concluded the club no longer qualifies under Section 501(c)(7) and revoked its exemption, meaning it must file corporate income tax returns (Form 1120) going forward. The letter explains the organization's appeal rights, including a declaratory-judgment action under Section 7428.

Ruling snapshot

• Question: Does the organization still qualify as a tax-exempt social club under § 501(c)(7) given its non-member and investment income?
• Outcome: Revocation of exempt status
• Key authorities: IRC § 501(c)(7); Treas. Reg. § 1.501(c)(7); Public Law 94-568; Rev. Rul. 66-149; IRC § 7428

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: August 11, 2020

Taxpayer ID Number:
Number: 202052048

Release Date: 12/24/2020 Form:

For Tax Period(s) Ending:
UIL: 501.07-00

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:

Your non-member income, primarily from renting the apartments, makes up 0% of your gross income for the year under audit. For the last five tax years, your non- member income has comprised between 0 percent and 0 percent of your gross income well in excess of both 15 percent limitation on non-member income and the 35 percent limitation on investment income.

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

1

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.

Sincerely,

[illegible signature]
Sean E. Reilly
Director, EO Examinations

Enclosures:
Publication 892

Department of the Treasury Date:
Internal Revenue Service a 01/23/2020

Tax Exempt and Government Entities Taxpayer ID number:
Form:

Tax periods ended:

Person to contact:
Name:
ID number:
Telephone:

Fax:
Address:

Manager's contact information:
Name:
CERTIFIED MAIL — Return Receipt Requested ID number:

Telephone:
Response due date:

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.

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.

Letter 3618 (Rev. 8-2019)
Catalog Number 34809F

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.

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
Publication 892
Publication 3498

Letter 3618 (Rev. 8-2019)
Catalog Number 34809F

Form 886-A Department of the Treasury — Internal Revenue Service sone number
. |

(May 2017) Explanations of Items

Name of taxpayer Tax Identification Number (last 4 digits) | Year/Period ended

12/31/20XX

ISSUE
Should the continue to qualify as an organization described

in Section 501(c)(7) of the Internal Revenue Code?
FACTS
The is exempt as an organization described in IRC §

501(c)(7) to provide social, recreational and other activities to its members. The organization was created to provide support and involvement for the deaf community in their area.

The organizing holds social gatherings for the neighborhood. This include events such as Thanksgiving fairs, Halloween party, and St. Patrick events. Some events include admission fees and some charge for refreshments. The events may also involve games and prizes. The organization also has workshops for services relating to the deaf community.

The organization has a facility consisting of large open rooms, a kitchen, a basement, and a large meeting room. They hold monthly meetings at the facility and use it for storing various items that the organization uses for its various fundraisers. These items include coolers, paper plates and cups, and other miscellaneous material.

The facility also has units upstairs that are rented out as apartments. The apartments are available for rent to the general public.

The organization reported investment income on its Form 990 EZ return. The investment income reported is non-member rental income derived from renting the apartment units in their facility. The rental income has been reported on Form 990-T, Exempt Organization Business Income Tax Return, for the periods December 31, 20XX — December 31, 20XX, as follows:

Form 990 20XX 20XX 20XX 20XX 20XX

Nonmember Income (gross

rents) $0 $0 $0 $0 $0

Total Revenue $O0| $0 $0 $0 $0

Percentage of non-member

income 0% 0% 0% 0% 0%
LAW

IRC § 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.

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

• i Schedule number
  Form 886-A Department of the Treasury — Internal Revenue Service

. hibit
(May 2017) Explanations of Items sre

Name of taxpayer Tax Identification Number (/ast 4 digits) | Year/Period ended

12/31/20XX

Section 1.501(c)(7) of the 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 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 IRC § 501(c)(7) where it derives a substantial part of its income from non-member sources.

TAXPAYER’S POSITION
Taxpayer's position has not been provided.
VER , ION

Based on the examination, the organization does not qualify for exemption as a social club described in IRC §501(c)(7) and Treas. Reg. §1.501(c)(7) which provides that in general, this exemption extends to social and recreation clubs which are supported solely by membership fees, dues, and assessments.

Rev. Rul. 66-149 support this position stating that a social club is not exempt under Code section 501(c)(7) if it regularly derives a substantial part of its income from nonmember sources, such as investment income.

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

he T _ i Schedule number
Form 886-A Department of the Treasury — Internal Revenue Service

. hibit
(May 2017) Explanations of Items eren

Name of taxpayer Tax Identification Number (last 4 digits) | Year/Period ended

12/31/20XX

The organization’s non-member income, primarily from renting the apartments, makes up 0% of its gross income for the year under audit. For the last five tax years, the non-member income has comprised between 0 percent and 0 percent of its gross income well in excess of both 15 percent limitation on non-member income and the 35 percent limitation on investment income.

Accordingly, it is proposed that the organization’s tax-exempt status be revoked effective January 1, 20XX.

CONCLUSION

The did not qualify for exemption under section 501(c)(7) of the Code during tax period ending December 31, 20XX, as your nonmember income has exceeded the 15 percent nonmember income and 35 percent investment income limitations on a continuing basis. Therefore, it is proposed that your exempt status under § 501(c)(7) of the Code be revoked effective January 1, 20XX.

Should this revocation be upheld, Form 1120 must be filed starting with tax periods ending December 31, 20XX.

If you agree to this conclusion, please sign the attached Forms.

If you disagree please submit a statement of your position.

Catalog Number 20810W Page 3. www. irs.gov Form 886-A (Rev. 5-2017)