202150022: IRS revokes a defunct fraternity chapter's 501(c)(7) status: no members for a decade, income only from investments

Plain-English summary

A local chapter of a national fraternity that had been recognized as a tax-exempt social club under Internal Revenue Code § 501(c)(7) lost that status because it no longer functioned as a club at all. The chapter folded, sold its fraternity house, and since then has done nothing but hold the mortgage note from that sale, collect the monthly payments, and invest the money, hoping to rebuild savings so the chapter can be re-established someday. It briefly reopened but closed again, and by the time of the audit it had had no members and no social events for about ten years, with income coming solely from investments. A § 501(c)(7) club must be operated substantially for the pleasure and recreation of its members, and it may receive no more than 35 percent of its gross receipts (including investment income) from outside its membership. With no members and all income from investments, the chapter blew past that limit on a recurring basis and no longer met the definition of a social club. The IRS revoked the exemption retroactively; the organization must file corporate income tax returns (Form 1120), is reminded of the special rules for membership organizations under § 277, and will have the revocation reported to state officials. The takeaway: an exempt social club that loses its members and simply manages investments is no longer a club, and its exemption can be revoked.

Ruling snapshot

• Question: Does a fraternity chapter still qualify under § 501(c)(7) when it has no members and its income comes entirely from investments outside its membership?
• Outcome: revocation, effective January 1, 20XX (Form 1120 required)
• Key authorities: IRC § 501(c)(7); Treas. Reg. § 1.501(c)(7)-1; Rev. Proc. 71-17; Public Law 94-568; IRC §§ 277, 6104

Full text (IRS public release)

This document is an OCR transcription of a scanned IRS release. Wording is preserved verbatim; obvious scanning misreads have been corrected, and page furniture and footers are transcribed as scanned. Unreadable spots are marked [illegible].

[Page 1]

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

TAX EXEMPT AND
GOVERNMENT ENTITIES
DIVISION

Date: August 6, 2020
Taxpayer ID Number:
Number: 202150022
Release Date: 12/17/2021 Form:
For Tax Period(s) Ending:
Person to Contact:
Telephone Number:
Fax Number:

UIL: 501.07-00

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.

Our adverse determination as to your exempt status was made for the following reasons:

During the tax year in question, you did not qualify for exemption as a social club
described in IRC section 501(c)(7) because you have had no members since 20XX
and your gross receipts have consistently exceeded the limitation of 35%, including
investment income, from sources outside of your membership.

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

Sincerely,

Sean E. O'Reilly
Director, EO Examinations

Enclosures:
Publication 892

[Page 2]

Department of the Treasury Date: January 21, 2020
Internal Revenue Service
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:
ID number:
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.

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

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

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,

For Maria Hooke
Director, Exempt Organizations
Examinations

Enclosures:
Form 886-A
Form 6018

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

[Page 3]

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
December 31, 20XX

ISSUE:
Whether the is still qualified for exemption under Section 501(c)(7) of the Internal Revenue
Code?

FACTS:

      was a local chapter of a national fraternity. This local chapter was originally colonized on the
      campus in           in 19XX. The organization was granted its exempt status in May 19XX as an exempt

organization under section 501(c)(7) of the Internal Revenue Code. The chapter purchased a property which became
the residence for the fraternity members for many years.

In 19XX, the chapter folded. The property was subsequently sold in . Since that time, the local chapter has been
acting as the mortgage holder and collecting the monthly payments from the sale.

The chapter was once recolonized at in 20XX, and the acted as the provider of
student housing for the fraternity members by renting another facility and charging the students a rental fee which
coincided with the semester term of the school. However, those students did not act in a responsible manner, the
chapter again closed in 20XX. Since then, the chapter has been collecting the mortgage payments and investing the
funds to build up savings so that the chapter can be recolonized at some point in the future.

The organization currently has 3 officers who oversee the funds and make investment decisions. There are no official
minutes from meeting. did not have any member or any social event in the past 10 years. The
organization's source of income has been solely from the investment since 19XX.

LAW:

Section 501(c)(7) of the Internal Revenue Code defines an exempt organization under this section as one that is
organized and operated exclusively for the pleasure, recreation, and other nonprofit purposes, for its members.

Section 1.501(c)(7)-1 of the Income Tax Regulations provides that, in general, the exemption extends to social and
recreation clubs which are supported by membership fees, dues, and assessments. However, a club which engages
in business, such as making its social and recreational facilities available to the general public, is not organized and
operated exclusively for pleasure, recreation, and other nonprofitable purposes, and is not exempt under section
501(a).

Revenue Procedure 71-17 as amended by Public Law 94-568 provides certain gross receipts safe harbors, i.e.
Social Clubs may receive up to 35% of their total gross receipts, including investment income, from sources
outside of their membership without jeopardizing their tax-exempt status. Within this 35% limit, no more than 15%
of a club's gross receipts may be derived from nonmember use of the club's facilities and/or services. If these
standards are exceeded, a Social Club will not qualify for exemption pursuant to IRC section 501(c)(7).

TAXPAYER'S POSITION:
The position of the taxpayer is unknown at this time.

GOVERNMENT'S POSITION:

      has failed to qualify to be exempt under 501(c)(7) because it has no members since 20XX

and its gross receipts has consistently exceeded the limitation of 35%, including investment income, from sources
outside of their membership. Therefore, the no longer qualifies as an organization that is
organized and operated as a Social Club as described in IRC section 501(c)(7).

Revocation of its tax-exempt status is warranted, effective January 1, 20XX.

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

[Page 4]

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
December 31, 20XX

CONCLUSION:

As a taxable entity, the organization is required to file Form 1120, U.S. Corporation Income Tax Return
beginning in the tax year ending December 31, 20XX and in all future tax years.

Additionally, the organization is reminded of the provisions of Internal Revenue Code Sec. 277 concerning
membership organizations which are not exempt organizations.

In accordance with the provisions of Internal Revenue Code Section 6104, copies of these examination
conclusions and consent to the revocation of tax exemption will be submitted to the Department of Revenue
at the conclusion of the examination.

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