202150023: IRS revokes a social club's 501(c)(7) status for recurring nonmember income from renting apartments above its clubhouse

Plain-English summary

A social club recognized as tax-exempt under Internal Revenue Code § 501(c)(7) lost that status because too much of its money came from outside its membership. A § 501(c)(7) club must be operated substantially for the pleasure and recreation of its members. Under the 1976 law (Public Law 94-568), a club may take up to 35 percent of its gross receipts from outside its membership, and within that, no more than 15 percent from the general public's use of its facilities. Here the club rented out two apartments on the second floor above its clubhouse and reported that rent as investment income. The IRS examined one year, then looked at earlier years, and found the club had exceeded both the 15 percent and 35 percent thresholds on a recurring basis. Because that pattern shows the club was not operated substantially for member recreation, the IRS revoked the exemption; the club's representative indicated it would likely agree. The revocation is retroactive, and the club must file corporate income tax returns (Form 1120). The point for clubs: steady rental or other nonmember income above the statutory limits, year after year, is fatal to § 501(c)(7) exemption even if the club still functions as a club.

Ruling snapshot

• Question: Should a § 501(c)(7) social club's exemption be revoked where its nonmember income (rent from apartments above its clubhouse) recurringly exceeds the 15% and 35% limits?
• Outcome: revocation, effective January 1, 20XX (Form 1120 required)
• Key authorities: IRC § 501(c)(7); Treas. Reg. § 1.501(c)(7)-1; Public Law 94-568 (S. Rep. No. 94-1318); Rev. Rul. 66-149; Rev. Proc. 71-17

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. The final letter's date line was too garbled in the scan to read and is marked [illegible]. Dollar and percentage figures in the revenue table were redacted in the original and are shown as [redacted]. Unreadable spots are marked [illegible].

[Page 1]

DEPARTMENT OF THE TREASURY
Internal Revenue Service
TE/GE EO Examinations
1100 Commerce Street, MC 4920 DAL
Dallas, TX 75242

TAX EXEMPT AND
GOVERNMENT ENTITIES
DIVISION

Date: FEB [illegible]
Number: 202150023 Person to Contact:
Release Date: 12/17/2021 Identification Number:
Contact Telephone Number:

UIL: 501.03-00
EIN:

CERTIFIED MAIL — Return Receipt Requested

Dear

This is a final revocation letter as to your exempt status under § 501(c)(7) of the Internal
Revenue Code. The Internal Revenue Service's recognition of your organization as an
organization described in IRC § 501(c)(7) is hereby revoked effective January 1, 20XX.

We have made this determination for the following reason(s):

IRC § 501(c)(7) and Treas. Reg. § 1.501(c)(7) exempts from income tax, clubs organized for
pleasure, recreation, and other nonprofitable purposes, where substantially all activities are
for such purposes and no part of the net earnings inure to the benefit of any private
shareholder.

Public Law 94-568 provides that social clubs are permitted to receive up to 35% of their
gross receipts from sources outside of their membership without losing their tax-exempt
status, and that within that 35%, no more than 15% of gross receipts should be derived
from the use of a social club's facilities or services by members of the public. Your
organization has exceeded the fifteen percent (15%) nonmember threshold as outlined in
Public Law 94-568, on a recurring basis.

As such, you failed to meet the requirements of IRC § 501(c)(7) and Treas. Reg. § 1.501(c)(7)
and you do not qualify for exemption.

You are required to file Federal income tax returns on Form 1120. These returns should be
filed with the appropriate Service Center for the year ending December 31, 20XX, and for all
years thereafter.

Processing of income tax returns and assessment of any taxes due will not be delayed should
a petition for declaratory judgment be filed under section 7428 of the Internal Revenue
Code.

If you decide to contest this determination in court, you must initiate a suit for declaratory
judgment in the United States Tax Court, the United States Claim Court or the District
Court of the United States for the District of Columbia before the 91st day after the date
this determination was mailed to you. Contact the clerk of the appropriate court for the
rules for initiating suits for declaratory judgment. Please contact the clerk of the respective
court for rules and the appropriate forms regarding filing petitions for declaratory judgment
by referring to the enclosed Publication 892. Please note that the United States Tax Court is
the only one of these courts where a declaratory judgment action can be pursued without the
services of a lawyer. You may write to the courts at the following addresses:

United States Tax Court
400 Second Street, NW
Washington, DC 20217

US 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

You may call the IRS telephone number listed in your local directory. An IRS employee
there may be able to help you, but the contact person at the address shown on this letter is
most familiar with your case. You may also call the Internal Revenue Service Taxpayer
Advocate. The Taxpayer Advocate Service (TAS) is an independent organization within the
IRS that can help protect your taxpayer rights. We 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 our assistance, which is always free, we will do everything possible to
help you. Visit taxpayeradvocate.irs.gov or call 1-877-777-4778.

If you have any questions, please contact the person whose name and telephone number are
shown in the heading of this letter.

Sincerely yours,

Maria Hooke
Director, EO Examinations

Enclosures:
Publication 892

[Page 2]

Department of the Treasury Date: July 13, 2017
Internal Revenue Service
IRS Tax Exempt and Government Entities
Exempt Organizations Examinations

Taxpayer Identification Number:
Form:
Tax Year Ended:
Person to Contact / ID Number:
Employee ID:
Contact numbers:
Telephone:
Fax:
Manager's Name / ID Number:
Employee ID:
Manager's Contact Number:
Response Due Date:

Certified Mail — Return Receipt Requested

Dear

Why you are receiving this letter
We propose to revoke your status as an organization described in section 501(c)(7) of the
Internal Revenue Code (Code). Enclosed is our report of examination explaining the proposed
action.

What you need to do if you agree

If you agree with our proposal, please sign the enclosed Form 6018, Consent to Proposed
Action — Section 7428, and return it to the contact person at the address listed above (unless
you have already provided us a signed Form 6018). We'll issue a final revocation letter
determining that you aren't an organization described in section 501(c)(7).

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 revocation letter. Failing to respond to this proposal will adversely impact your legal
standing to seek a declaratory judgment because you failed to exhaust your administrative
remedies.

Effect of revocation status

If you receive a final revocation letter, you'll be required to file federal income tax returns for the
tax year(s) shown above as well as for subsequent tax years.

What you need to do if you disagree with the proposed revocation

If you disagree with our proposed revocation, you may request a meeting or telephone
conference with the supervisor of the IRS contact identified in the heading of this letter. You also
may file a protest with the IRS Appeals office by submitting a written request to the contact
person at the address listed above within 30 calendar days from the date of this letter.

Letter 3618 (Rev. 6-2012)
Catalog Number 34809F

The Appeals office is independent of the Exempt Organizations division and resolves most
disputes informally.

For your protest to be valid, it must contain certain specific information including a statement of
the facts, the applicable law, and arguments in support of your position. For specific information
needed for a valid protest, please refer to page one of the enclosed Publication 892, How to
Appeal an IRS Decision on Tax-Exempt Status, and page six of the enclosed Publication 3498,
The Examination Process. Publication 3498 also includes information on your rights as a
taxpayer and the IRS collection process. Please note that Fast Track Mediation referred to in
Publication 3498 generally doesn't apply after we issue this letter.

You also may request that we refer this matter for technical advice as explained in Publication

892. Please contact the individual identified on the first page of this letter if you are considering
     requesting technical advice. If we issue a determination letter to you based on a technical
     advice memorandum issued by the Exempt Organizations Rulings and Agreements office, no
     further IRS administrative appeal will be available to you.

Contacting the Taxpayer Advocate Office is a taxpayer right

You have the right to contact the office of the Taxpayer Advocate. Their assistance isn't a
substitute for established IRS procedures, such as the formal appeals process. The Taxpayer
Advocate can't reverse a legally correct tax determination or extend the time you have (fixed by
law) to file a petition in a United States court. They can, however, see that a tax matter that
hasn't been resolved through normal channels gets prompt and proper handling. You may call
toll-free 1-877-777-4778 and ask for Taxpayer Advocate assistance. If you prefer, you may
contact your local Taxpayer Advocate at:

Internal Revenue Service
Office of the Taxpayer Advocate

For additional information

If you have any questions, please call the contact person at the telephone number shown in the
heading of this letter. If you write, please provide a telephone number and the most convenient
time to call if we need to contact you.

Thank you for your cooperation.
Sincerely,

Maria Hooke
Director, EO Examinations

Enclosures:
Report of Examination
Form 6018
Form 4621-A
Publication 892
Publication 3498

Letter 3618 (Rev. 6-2012)
Catalog Number 34809F

[Page 3]

Form 886 A Department of the Treasury - Internal Revenue Service Schedule No. or
Explanation of Items Exhibit 1

Name of Taxpayer Year/Period Ended
20XX

ISSUE
Whether continues to qualify as a social club under Internal Revenue Code
(IRC) § 501(c)(7), given that its income from nonmember sources exceed the permissible
limitations.

FACTS

      was granted tax exemption under IRC § 501(c)(7) on March 14, 19XX. Per

the Club's Form 1024, application for tax exempt status, the purpose of the organization is
"promotion of social welfare of the members with daily social activities at the clubhouse, holiday
parties, and annual dinner dance." Members must be by birth or married to a spouse who
is

The organization's Form 990 was selected for examination for period ending December 31,
20XX due to the reporting of investment income that exceeds the 35% limitation.

Our examination determined that the revenue reported as investment income was derived from
the rental of two second floor apartments above the organization's clubhouse.

Inspection of the organization's filed Forms 990 for years 20XX and 20XX
discloses similar levels of revenue from nonmember sources that exceed both the 15% and 35%
limitations, as illustrated in the table below.

Reported Revenue 20XX 20XX 20XX
Membership Dues [redacted] [redacted] [redacted]
Investment Income [redacted] [redacted] [redacted]
Fundraising [redacted] [redacted] [redacted]
Total Income [redacted] [redacted] [redacted]
Nonmember Income as a Percentage of
Total Income [redacted] [redacted] [redacted]

Form 886-A (rev. 4-68) Department of the Treasury - Internal Revenue Service
Page: -1-

[Page 4]

Form 886 A Department of the Treasury - Internal Revenue Service Schedule No. or
Explanation of Items Exhibit 1

Name of Taxpayer Year/Period Ended
20XX

LAW

Internal Revenue Code § 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."

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

Revenue Procedure 71-17 sets forth the guidelines for determining the effect of gross receipts
derived from the general public's use of a social club's facilities on exemption under Internal
Revenue Code § 501(c)(7). Where nonmember income from the usage exceeds the standard as
outlined in this Revenue procedure, the conclusion reached is that there is a non-exempt purpose
and operating in this manner jeopardizes the organization's exempt status.

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

[Page 5]

Form 886 A Department of the Treasury - Internal Revenue Service Schedule No. or
Explanation of Items Exhibit 1

Name of Taxpayer Year/Period Ended
20XX

TAXPAYER'S POSITION
The taxpayer's representative indicated that the organization is most likely to agree to
revocation at this time.

GOVERNMENT'S POSITION

      has exceeded the nonmember income thresholds, permitted in Public Law

94-568 for organizations exempt under IRC § 501(c)(7), on a recurring basis during tax years
ending December 31, 20XX, December 31, 20XX, and December 31,
20XX. Consequently, revocation of the exempt status as an organization exempt
under IRC § 501(c)(7) is warranted.

CONCLUSION

Based on the above facts and circumstances, and in light of the statutory law and rulings cited,
the Club does not qualify for tax-exemption under IRC § 501(c)(7) and should be revoked. The
proposed date of the revocation is January 1, 20XX.

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