Catering income revokes business club exemption

Plain-English summary

A private business club contracted with an outside catering corporation and received monthly payments that made up most of the club’s gross revenue. The club correctly reported the payments as nonmember income and paid unrelated business income tax, but the income from nonmember facility use far exceeded 15 percent of gross receipts. The same recurring pattern appeared in the prior and subsequent years, rather than arising from a single unusual event. The IRS revoked the club’s Section 501(c)(7) exemption, and the club agreed with that result.

Ruling snapshot

• Question: Did the club remain eligible under Section 501(c)(7) when recurring catering income from nonmembers exceeded the 15 percent facility-use limit?
• Outcome: Revocation effective January 1 of the redacted year.
• Key authorities: IRC §§ 501(c)(7), 6501(g), and 7428; Treas. Reg. § 1.501(c)(7)-1; Rev. Proc. 71-17; Rev. Ruls. 58-589, 60-324, 66-149, and 68-119; Public Law 94-568

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

Number: 202110032
Release Date: 3/12/2021
UIL: 501.07-00
Date: September 23, 2020
Taxpayer ID Number: [redacted]
Form: [redacted]
For Tax Period(s) Ending: [redacted]
Person to Contact: [redacted]
Identification Number: [redacted]
Telephone Number: [redacted]

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

Dear [redacted]:

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.

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 made your recreational and social facilities available to the
general public. 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.

Sincerely,

Sean E. O'Reilly
Director, Exempt Organizations Examinations

Enclosures:
Publication 892

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

Date: 6/03/2020
Taxpayer ID number: [redacted]
Forms: [redacted]
Tax periods ended: [redacted]

Person to contact:
Name: [redacted]
ID number: [redacted]
Telephone: [redacted]
Fax: [redacted]
Address: [redacted]

Manager’s contact information:
Name: [redacted]
ID number: [redacted]
Telephone: [redacted]
Response due date: [redacted]

CERTIFIED MAIL — Return Receipt Requested
Dear [redacted]:

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.

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

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).

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

If you have questions, you can contact the person shown at the top of this letter.

Sincerely,

Sean E. O’Reilly
Director, Exempt Organizations
Examinations

Enclosures:
Form 886-A
Form 6018

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

Form 886-A
Department of the Treasury - Internal Revenue Service
Explanation of Items
Schedule No. or Exhibit: [redacted]
Name of Taxpayer: [redacted]
Year/Period Ended
20XX

ISSUE:
Whether the [redacted] will continue to qualify as an exempt social club under section
501(c)(7) of the Code?
FACTS:
The [redacted] (the “Club”) was granted exemption as a social club exempt from Federal

income tax under Internal Revenue Code section 501(c)(7) pursuant to a ruling issued in July,
19XX. The Club was established as a private business club in 19XX as a premier gathering
place for business executives. The organization’s mission is “to provide social, intellectual, and
recreational activity for the benefit of its members”.

The Club’s principal activity is providing facilities and services for the pleasure and recreation of
its members and their guests. The Club contracts with an outside food vendor which provides
food service for the Club. The Club received income as a result of a [redacted]
between the Club and the outside catering corporation. The Club received gross revenue of $0
per month totaling $0 for the year ended December 31, 20XX as a result of the income received
from the outside catering corporation. The income received from the outside catering
corporation was correctly classified as nonmember income and Unrelated business revenue on
Form 990, however this gross revenue was a majority of the Club’s total gross revenue. The
Club reflected $0 correctly on Form 990-T and paid the Unrelated Business Income tax after
subtracting expenses.

During the examination, it was determined that the Club complied with the recordkeeping
requirements of Revenue Procedure 71-17, 1971-1 C.B. 683. The Club however received and
continues to receive the majority of its gross income from the outside catering corporation which
was classified as nonmember income and Unrelated Business Income. Based on an
examination of the Club’s Form 990 return for the period ended December 31, 20XX and review
of their books and records, the percent of gross receipts from nonmember use of facilities far
exceeded 15% for the year of the exam. The agent reviewed the prior and subsequent years,
however did not examine these years as the nonmember income derived from the outside
catering corporation also far exceeded 15% for the prior and subsequent years. These receipts
are noted in the following chart:

Year/Period Ended

% of gross receipts
from nonmember use

% of gross receipts
from investment

Total % investment
income / nonmember

income income
December 31, 20XX 0.00 0.00 0.00
December 31, 20XX 0.00 0.00 0.00
December 31, 20XX 0.00 0.00 0.00

Form 886-A (Rev. 4-68)

Department of the Treasury - Internal Revenue Service

Page: -1-

Form 886-A
Department of the Treasury - Internal Revenue Service
Explanation of Items
Schedule No. or Exhibit: [redacted]
Name of Taxpayer: [redacted]
Year/Period Ended
20XX

The examination year, year ended December 31, 20XX, reflected gross receipts from
nonmember use of $[redacted] as a result of the income received from the outside catering
organization and total gross revenue for the year of $0 which resulted in 0.00 percent from
non member use.

LAW:

Organizations exempt from federal taxes as described in IRC Section 501(c)(7) include 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.

Section 1.501(c)(7)-1 of the Income Tax Regulations, relating to the requirements of exemption
of such clubs under section 501(a), reads in part as follows:

(a) The exemption provided by section 501(a) for organizations described in section
501(c)(7) applies only to clubs which are organized and operated exclusively for
pleasure, recreation, and other nonprofitable purposes, but does not apply to any club if
its net earnings inures to the benefit of any private shareholder. In general, this
exemption extends to social and recreation clubs which 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 other products, is not
organized and operated exclusively for pleasure, recreation, and other nonprofitable
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. However, an incidental sale of property will not deprive a club of its
exemption.

Prior to its amendment in 1976, IRC Section 501(c)(7) required that social clubs be operated
exclusively for pleasure, recreation, and other non-profitable purposes. Public Law 94-568
amended the “exclusive” provision to read “substantially” in order to allow a section 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 further state:

(a) 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. 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. These percentages
supersede those provided in Revenue Ruling 71-17, 1971-1 C.B. 683.

Form 886-A (Rev. 4-68)
Department of the Treasury - Internal Revenue Service
Page: -2-

Form 886-A
Department of the Treasury - Internal Revenue Service
Explanation of Items
Schedule No. or Exhibit: [redacted]
Name of Taxpayer: [redacted]
Year/Period Ended
20XX

(b) Thus, a social club may receive investment income up to the full 35 percent of its gross
receipts if no income is received from non-members’ use of club facilities.

(c) In addition, the Committee Reports state 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.

(d) The Senate report also indicates that even though gross receipts from the general public
exceed this standard, it does not necessarily establish that there is a nonexempt
purpose. A conclusion that there is a nonexempt purpose will be based on all the facts
and circumstances including, but not limited to, the gross receipts factor.

Revenue Ruling 58-589 sets forth the criteria for exemption under section 501(c)(7) of the Code,
and provides that a club must have an established membership of individuals, personal
contacts, and fellowship. It also provides that, while the regulations indicate that a club may
lose its exemption if it makes its facilities available to the general public, this does not mean that
any dealings with nonmembers will automatically cause a club to lose its exemption. A club
may receive some income from the general public, that is, persons other than members and
their bona fide guests, or permit the general public to participate in its affairs, provided that such
participation is incidental to and in furtherance of the club’s exempt purposes, such dealings
with the general public and the receipt of income therefrom does not indicate the existence of a
club purpose to make a profit, and the income does not inure to club members.

Revenue Ruling 60-324 provides that a social club that made its social facilities available to the
general public through its member-sponsorship arrangement can not be treated as being
operated exclusively for pleasure, recreation, or other nonprofitable purposes and the club no
longer qualified for exemption under 501(c)(7) of the Code.

Revenue Ruling 66-149 provides that a social club is not exempt from federal income tax as an
organization described in section 501(c)(7) of the code if it regularly derives a substantial part of
its income from non-member sources such as, for example, dividends and interest on
investments.

Revenue Ruling 68-119 provides that a club will not necessarily lose its exemption if it derives
income from transactions with other than bona fide members and their guests, or if the general
public on occasion is permitted to participate in its affairs, provided such participation is
incidental to and in furtherance of its general club purposes and the income therefrom does not
inure to members.

Revenue Procedure 71-17 sets forth guidelines for determining the effect of gross receipts
derived from nonmember use of a social club’s facilities on exemption under Internal Revenue
Code Section 501(c)(7) and recordkeeping requirements. Failure to maintain such records or
make them available to the Service for examination will preclude use of the minimum gross
receipts standard and audit assumptions set forth in this Revenue Procedure.

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

Form 886-A
Department of the Treasury - Internal Revenue Service
Explanation of Items
Schedule No. or Exhibit: [redacted]
Name of Taxpayer: [redacted]
Year/Period Ended
20XX

If a club exceeds the 15/35% test, then it will maintain its exempt status only if it can show
through facts and circumstances that “substantially all” of its activities are for “pleasure,
recreation and other nonprofitable purposes.”

The following are important facts and circumstances to take into account to determine whether a
club may maintain its exemption under IRC 501(c)(7):

• The actual percentage of nonmember receipts and/or investment income.

• Frequency of use of the club facilities or services by nonmembers. An unusual or
single event (that is, nonrecurring on a year to year basis) that generates all the
nonmember income is viewed more favorably than nonmember income arising from
frequent use by nonmembers.

• Record of nonmember use over a period of years. A high percentage in one year by
nonmembers, with the other years being within permitted levels, is viewed more
favorably than a consistent pattern of exceeding the limits, even by relatively small
amounts. (See S. Rept. 94-1318, 2d Sess., 1976-2 C.B. 597,599).

• Purposes for which the club’s facilities were made available to nonmembers.

• Whether the nonmember income generates net profits for the organization. Profits
derived from nonmembers, unless set aside, subsidize the club’s activities for
members and result in inurement within the meaning of IRC 501(c)(7).

TAXPAYER'S POSITION:

The Club has agreed to the proposed revocation of their tax exempt status as described in
IRC section 501(c)(7).

GOVERNMENT'S POSITION:

An organization exempt from federal income taxes as described in IRC section 501(c)(7) must
meet the gross receipts test in order to maintain its exemption. In order to meet the gross
receipts test, an organization can receive up to thirty-five percent (35%) of its gross receipts,
including investment income, from sources outside its membership without losing its tax exempt
status. Within this 35% amount, not more than fifteen percent (15%) of the gross receipts
should be derived from the use of a social club’s facilities or services by non-members.

[redacted] has far exceeded the 15% gross receipts standard for nonmember income
for the examination year. A review of the prior and subsequent years indicated that
[redacted] also far exceeded the 15% gross receipt test for nonmember income. The
nonmember receipts are earned throughout the year on a monthly basis for the examination
year as well as the prior and subsequent years. There was no one single or unusual event
that caused the club to exceed the 15% threshold.

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

Form 886-A
Department of the Treasury - Internal Revenue Service
Explanation of Items
Schedule No. or Exhibit: [redacted]
Name of Taxpayer: [redacted]
Year/Period Ended
20XX

Based on the large percentages of gross nonmember income to total gross receipts of the
club, (i.e., as noted in the above table), which exceeded the limitation of 15% as set forth by
IRC 501(c)(7) for each of these years, it is the Government's position that the Club is no
longer operated exclusively for the pleasure and recreation of it’s members and is not

exempt under section 501(c)(7).

CONCLUSION:

The IRC Section 501(c)(7) tax exempt status of [redacted] should be revoked since the
nonmember income received by the Club exceeded 15% of the Club’s total gross receipts for

the year under examination.

[redacted] no longer meets the requirements to qualify as exempt from federal income tax
under IRC section 501(a) as described in section 501(c)(7). Therefore, your exempt status
under 501(c)(7) of the Internal Revenue Code will be revoked effective January 1, 20XX.

As a taxable entity, the organization is required to file Form 1120, U.S. Corporation Income
Tax Return for the periods open under statute. Under 6501(g) these periods include the year

ended December 31, 20XX and subsequent tax years.

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

Page: -5-