Social club loses exemption for public use and nonmember income

Plain-English summary

A Section 501(c)(7) social club operated a bar, gaming room, event space, and other recreational facilities that were open to the public. The club did not charge members dues or give them discounts, and it did not maintain records separating member and nonmember income. Available sign-in sheets indicated roughly equal member and nonmember use. Because the club allowed unrestricted public use and could not substantiate its nonmember receipts, the IRS treated all of its income as nonmember income, found that it exceeded the 15 percent public-use threshold, and revoked its exemption for the examined tax periods.

Ruling snapshot

• Question: Did the club continue to qualify for Section 501(c)(7) exemption while opening its facilities to the public and failing to track nonmember income?
• Outcome: Revocation. The club must file corporate income tax returns for the affected years and later taxable years.
• Key authorities: IRC §§ 501(c)(7) and 7428; Treas. Reg. § 1.501(c)(7)-1; Rev. Proc. 71-17; Rev. Ruls. 60-324 and 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
Number: 202110047 Date: September 28, 2020

Release Date: 3/12/2021 Taxpayer ID Number: [redacted]

UIL: 501.07-00
Form: [redacted]

For Tax Period(s) Ending: [redacted]

Person to Contact: [redacted]
Identification Number: [redacted]
Telephone Number: [redacted]

Fax 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. Your determination letter dated June 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 your 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 years
ending December 31, 20XX, December 31, 20XX and 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

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 20439

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, you can contact the person listed at the top of this letter.

Sincerely,

Sean E. O’Reilly
Director, Exempt Organizations Examinations

Enclosures:
Publication 892

Department of the Treasury Internal Date:
Revenue Service
April 6, 2020
Tax Exempt and Government Entities Taxpayer ID number: [redacted]

CERTIFIED MAIL — Return Receipt Requested

Dear [redacted]:

Form: [redacted]
Tax periods ended: [redacted]

Person to contact:
Name: [redacted]

ID number: [redacted]
Telephone: [redacted]
Fax: [redacted]

Address: Attn: [redacted]

Manager's contact information:
Name: [redacted]
ID number: [redacted]
Telephone: [redacted]

Response due date: [redacted]

Why you’re receiving this letter

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.
2.
3.

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

Send any information you want us to consider.

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.

Letter 3618 (Rev. 8-2019)

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,
Christopher M. Holmes

for Marie Hooke
Director, Exempt Organizations Examinations

Enclosures:
Form 886-A
Form 6018

Letter 3618 (Rev. 8-2019)

Form 886-A Department of the Treasury - Internal Revenue Service Schedule number or
exhibit
(May 2017) Explanation of Items N/A
Name of taxpayer: [redacted] Tax Identification Number (last 4 digits): [redacted] | Year/Period ended
12/31/20XX
12/31/20XX
12/31/20XX
ISSUE:
Whether (the “Club” ) continues to qualify for exemption under Section

501(c)(7) of the Internal Revenue Code (the “Code”)?

FACTS:

Background:

The Club was incorporated in the State of [redacted], on March 9, 19XX, as a nonprofit corporation. The

Club was formed as an extension of the
exempt under Section 501(c)(19) of the Code, to own and operate its social club. Article VI of the
amended supplementary Articles of Incorporation filed on September 18,19XX provides:

“...members of this corporation shall consist solely of the members in good standing
of [redacted] of the United States.....

any and all properties acquired and held, and any and all income and revenues from any
and all activities of this corporation, shall be acquired and held for the sole use and benefit

of said [redacted]

The Club received its exempt status as a social club described under Section 501(c)(7) of the Code in
June 19XX.

The assigned agent initiated an audit of the Form 990, Return of Organization Exempt Under Income
Tax, for the year ended December 31, 20XX, and expanded to the subsequent two years.

Facility and activities:

The Club owns and operates the facility located at [redacted].
The facility is a multi-level building which includes a bar, gaming room, billiards and cards area,
kitchen, hall and stage, meeting space, offices, and storage space. The Club activities include:

• Selling alcoholic and non-alcoholic drinks at the bar

• Selling snacks (microwavable, air fried) at the bar

• Holding [redacted] Wednesdays: the Club purchases [redacted] from a vendor to sell at the Club.
The Club allows takeout orders

• Selling lottery tickets

• Providing a gaming room with several slot type machines

• Pool tables for play

Catalog Number 20810W 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) Explanation of Items N/A
Name of taxpayer: [redacted] Tax Identification Number (last 4 digits): [redacted] | Year/Period ended

12/31/20XX
12/31/20XX
12/31/20XX

• Tables for card games

• Holding weekly karaoke

• Holding live music events

• Holding special events (e.g. holiday parties) and fundraisers

• Providing space for [redacted] for its activities and meetings

• Occasionally renting its hall for private use

There are no signs indicating the Club is a member only facility and no key lock system is present.
The Club posted the following operating hours on its front door:

[redacted] pm on Monday, Tuesday and Sunday
[redacted] pm on Wednesday and Thursday
[redacted] pm on Friday and Saturday

The Trustee confirmed that the Club is open to the public and does not maintain records tracking non-
member income. The Trustee explained that public monies are necessary for the financial survival of
the Club.

The Club places a sign-in notebook near each entrance and encourages everyone to sign-in. Members
sign on one side and guests on the other (clearly labeled). Guests include non-members brought in by
members, members from other posts, as well as individuals walking in from the public. The Club
could not locate sign-in sheets from 20XX and 20XX. The Club provided sign-in sheets for January
through August 20XX and January through October 20XX. They indicated that roughly 0% of visitors in
20XX and 0% of visitors in 20XX were non-members.

The Club advertises some of its activities with signs and banners on its building. Window signs

advertise [redacted] Wednesdays ($[redacted] and free pool 5-8pm) and [redacted] activities. Other
banners on the side of the building are vendor advertisement (liquor products sold at the bar). The Club
has a [redacted] account on which events are posted. Special events are advertised on radio/paper a

couple of times a year.

Members of [redacted] are also members of the Club. Members do not pay dues to the Club.
Members do not get any discount for any products sold or services provided at the Club.

The income attributable to non-members is unknown because the Club did not track this income
separately.

Catalog Number 20810W 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) Explanation of Items N/A
Name of taxpayer: [redacted] Tax Identification Number (last 4 digits): [redacted] | Year/Period ended
12/31/20XX
12/31/20XX
12/31/20XX

The Club reported the following income and expenses on its Forms 990:

12/31/20XX _12/31/20XX__12/31/20XX

Income | [redacted] [redacted] [redacted]

Expenses | [redacted] [redacted] [redacted]

Net Profit | [redacted] [redacted] [redacted]
LAW:

Internal Revenue Code

Section 501(c)(7) of the Code provides exemption from income taxes for 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.

Senate Report No. 94-1318 (1976), 2d Session, 1976-2 C.B. 597, at page 599 defines “substantially all”
and explains that a social club is permitted to receive up to 35% of its gross receipts, including
investment income, from sources outside of its membership without losing its tax-exempt status. It is
also intended that within this 35% not more than 15% of the gross receipts should be derived from the
use of a social club’s facilities or services by the general public (nonmembers).

Treasury Regulations

Section 1.501(c)(7)-1(a) of the Federal Tax Regulations (the “Regulations”) further provides that 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.

Section 1.501(c)(7)-1 of the Regulations states that a social club that opens its facilities to the public is
deemed to be 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.

[* Section 1.501(c)(7)-1 of the Regulations has not been updated to reflect P.L. 94-568 which changed “exclusively” to
“substantially all”.]

Catalog Number 20810W 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) Explanation of Items N/A
Name of taxpayer: [redacted] Tax Identification Number (last 4 digits): [redacted] | Year/Period ended
12/31/20XX
12/31/20XX
12/31/20XX

Revenue Rulings

Revenue Ruling 60-324, 1960-2 C.B. 173, states by making its social facilities available to the general
public the club cannot be treated as being operated exclusively for pleasure, recreation or other
non-profitable purposes.

Revenue Ruling 66-149, 1966-2 C.B. 146, holds a social club as not exempt as an organization
described in Section 501(c)(7) of the Code where it derives a substantial part of its income from
non-member sources.

Revenue Procedures

Revenue Procedure 71-17, 1971 WL 26186, 1971-1 C.B. 683 sets forth guidelines for determining the
effect gross receipts derived from use of a social club's facilities by the general public have on the club's
exemption from federal income tax under Section 501(c)(7) of the Code.

The club must maintain books and records of each such use and the amount derived therefrom. This
requirement applies even though the member pays initially for such use.
In each instance the record must contain the following information:

1. The date

2. The total number in the party

3. The number of nonmembers in the party

4. The total charges

5. The charges attributable to nonmembers

6. The charges paid by nonmembers

7. Where a member pays all or part of the charges attributable to nonmembers, a statement

signed by the member indicating whether he has been or will be reimbursed for such
nonmember use and, if so, the amount of the reimbursement.

8. Where the member's employer reimburses the member or makes direct payment to the club
   for the charges attributable to nonmembers, a statement signed by the member indicating
   the name of his employer; the amount of the payment attributable to the nonmember use;
   the nonmember's name and business or other relationship to the member; and the business,
   personal, or social purpose of the member served by the nonmember use.

9. Where a nonmember, other than the employer of the member, makes payment to the club or

reimburses a member and a claim is made that the amount was paid gratuitously for the

benefit of a member, a statement signed by the member indicating the donor's name and
relationship to the member, and containing information to substantiate the gratuitous nature
of the payments or reimbursement.

Catalog Number 20810W 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) Explanation of Items N/A
Name of taxpayer: [redacted] Tax Identification Number (last 4 digits): [redacted] | Year/Period ended
12/31/20XX
12/31/20XX
12/31/20XX

Exceptions to these record keeping requirements are:

1. Where a group of [redacted] or fewer individuals, at least one of whom is a member, uses club
   facilities, it will be assumed for audit purposes that the nonmembers are the guests of the
   member, provided payment for such use is received by the club directly from the member
   or the member's employer.

2. Where [redacted] percent or more of a group using club facilities are members, it will likewise be
   assumed for audit purposes that the nonmembers in the group are guests of members,
   provided payment for such use is received by the club directly from one or more of the
   members or the member's employer.

3. Solely for purposes of 1 and 2, above, payment by a member's employer will be assumed
   to be for a use that serves a direct business objective of the employee-member.

Where a club makes its facilities available to the general public to a substantial degree, the club
is not operated exclusively for pleasure, recreation, or other non-profitable purposes.

GOVERNMENT’S POSITION:

The Club does not qualify for exemption as a social club described under Section 501(c)(7) of the Code
and Regulations. These sections provide that in general, this exemption extends to social and
recreation clubs which are supported primarily by membership fees, dues, and assessments.

Revenue Rulings 66-149 and 60-324 support this position stating that a social club that opens to the
public and derives a substantial part of its income from non-member sources is not exempt as an
organization described under Section 501(c)(7) of the Code.

The Club permits unrestricted use of its facilities by the public daily. The sign-in sheets provided from
20XX and 20XX reflect roughly an equal amount of member and non-member use of the facility.

The Club did not maintain books and records identifying non-member income as required under
Revenue Procedure 71-17. Therefore, all of the Club’s income is considered non-member income.
The Club has exceeded the 15% non-member threshold as outlined in Public Law 94-568.

Accordingly, the Club’s tax-exempt status should be revoked.

TAXPAYER’S POSITION:

The Club’s position is unknown at this time.

Catalog Number 20810W 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) Explanation of Items N/A
Name of taxpayer: [redacted] Tax Identification Number (last 4 digits): [redacted] | Year/Period ended
12/31/20XX
12/31/20XX
12/31/20XX

CONCLUSION:

The Club no longer qualifies for exemption under Section 501(c)(7) of the Code because your
nonmember income has exceeded the 15% nonmember threshold on a continuing basis. Therefore,
its exempt status under Section 501(c)(7) of the Code is revoked for tax periods ending

December 31, 20XX through 20XX.

Upon revocation, the Club needs to provide a completed Form 1120, U.S. Corporation Income Tax
Return, for the year ending December 31, 20XX through 20XX. The Club is required to file Forms
1120, for any year thereafter the tax year ending December 31, 20XX, if the Club remains subject to
Federal Income Tax.

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