IRS revokes a social club's § 501(c)(7) status because investment income exceeded the 35% limit and it stopped operating

Plain-English summary

A membership social club had been recognized as tax-exempt under Section 501(c)(7), which covers clubs operated substantially for the pleasure and recreation of their members. A social club can take in only a limited amount from outside its membership: under Public Law 94-568, no more than 35% of gross receipts (including investment income) may come from non-member sources without losing exemption. On audit for a year ending April 30, the club's only income was investment income, which far exceeded the 35% cap. The club had also sold its clubhouse and stopped conducting any social or recreational activities, and its representative agreed with the proposed revocation. Because the club no longer operated for member recreation and its outside income blew past the 35% limit (following Rev. Rul. 66-149), the IRS revoked its exemption effective May 1 of the redacted year. The club must file corporate income tax returns (Form 1120) going forward. Note: the ruling explains that truly unusual income, like proceeds from selling the clubhouse itself, is left out of the 35% formula, but here the recurring investment income was the disqualifying problem.

Ruling snapshot

• Question: Does a social club keep its § 501(c)(7) exemption when its investment income exceeds 35% of gross receipts and it no longer conducts member activities?
• Outcome: revocation (final adverse determination; exemption revoked)
• Key authorities: IRC § 501(c)(7); Treas. Reg. § 1.501(c)(7)-1(a); Pub. L. 94-568 (S. Rep. No. 94-1318); Rev. Rul. 66-149

Full text (IRS public release)

Transcription note: This is a scanned document, made up of the final adverse
determination letter, the enclosed proposed adverse determination (Letter 3618), and the
Form 886-A "Explanations of Items" audit report. Per the runbook's OCR proofreading duty,
obvious scanning misreads have been corrected and the repeating Form 886-A page
furniture has been replaced with [Page N] markers; genuinely unreadable spots are marked
[illegible]; blanks where the IRS redacted identifying details (including the dollar figures
and percentages in the investment-income tables) are left as gaps. Wording is otherwise
reproduced verbatim.

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

TAX EXEMPT AND

GOVERNMENT ENTITIES
DIVISION

Number: 202216021 Date:

Release Date: 4/22/2022 March 3, 2021
Taxpayer iD Number:
Form:
For Tax Period(s) Ending:
Person to Contact
identification Number:
Telephone 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 periad(s) above. Your determination letter dated May 19 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 year
ending April 30, 2018.

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

Enclosures: Sincerely,

Publication 892 ot
rd bene J, CA

Sean E. O'Reilly
Director, Exempt Organizations Examinations

Date:

ge Department of the Treasury August 3, 2020
y Internal Revenue Service Taxpayer ID number:
IRS Tax Exempt and Government Entities

Form:

Tax periods ended:

Person to contact:
Name:
ID number:
Telephone:
Fax:
Hours:

Manager's contact information:
Name:
ID number:
Telephone:

Response due dale:

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.

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.

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

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

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,

Sean E. O’Reilly
Director, Exempt Organizations
Examinations

Enclosures:
Form 886-A
Form 6018
Publication 892
Publication 3498

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

ISSUE

Whether the organization continues to qualify for exemption under Internal Revenue Code section
501(c)(7) if its investment income is greater than 35% of its gross receipts?

FACTS

Organizational Structure

The organization, ( }, was incorporated on May 24,
in the state of

The Certificate of Incorporation states that the purpose of the organization is to own, operate, and
maintain a membership club, clubhouses, club rooms, recreation centers, and reception and
assembly rooms for the purpose of providing for the members’ entertainment, sport, recreation,
and amusement of all kinds; to furnish, equip, decorate, and fit up such clubs and club rooms; to
promote social and friendly intercourse among the members of such club or among their guests;
to provide and supply any and all appurtenances that may be necessary, useful or convenient for
the carrying on of sports, recreations and diversions of all kinds and description for the
entertainment, welfare and convenience of the members and their guests and friends. To promote
friendship among its members; to inculcate in them a high sense of loyalty to each other; to
stimulate their intellectual advancement and to hold meetings and social gatherings for the better
realization of such purposes.

Form 990-EZ and Form 990-T
The was examined for the tax year ending April 30,20 . The name of the organization
listed on Form 990-EZ is:

The reported $ In total gross receipts for the year ending April 30,20. The following
is a breakdown of revenues reported in Part |, Revenue, Expenses, and Changes in Net Assets or
Fund Balances, of the Form 990-EZ:

Part 1 — Revenue, Expenses, and Changes in Net Assets or Fund Balances
Line # Description Amount

4. Investment Income $

9. Total (lines 1, 2, 3, 4, 5c, 6d, 7c, and 8) $

The organization’s primary exempt purpose stated in Part Ill, Statement of Program Service

Accomplishments, is “Fraternal Organization.”

The Form 990-T was viewed but not examined for the year ending April 30,20 .The
reported Unrelated Trade or Business Income on Form 990-T as 4 n Part 1, Unrelated

Trade or Business Income, as follows:

[Page 1]

Part 1 - Unrelated Trade or Business Income | Column A | Column B]{ Column C
Line # Description Income Expenses Net

8. Interest, annuities, royalties, and
rents from controlled organizations 3 $ |
13. | Total (lines 3 through 12) $ $ a
Initial Contact
Revenue Agent was first contacted by , the power of attorney (POA), for the
The POA indicated that the organization no longer conducts any activities and all the income
received is derived from a -year note receivable for the sale of the clubhouse in 20

Initial Appointment
A field examination was not scheduled as the POA stated the sold its clubhouse in

and since stopped conducting any operations. The examination was conducted through
correspondence.

Membership
The Club did not receive any income other than investment income as verified on the bank
statements provided.

Facility

As explained by the POA over the phone, the clubhouse has been sold on July 15

to an unrelated entity. Revenue Agent received a signed statement by the POA stating that the
entity that bought the clubhouse was not related and are not former members of the

Social and Recreational Activities

The POA stated that the no longer conducts any social and recreational activities and will
move forward to dissolving the

LAW

Internal Revenue Code (IRC)

IRC §501(c)(7) 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.

Treasury Regulation

Treasury Regulation §1.501(c)(7)-1{a) 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.

[Page 2]

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 36
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

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, for
example, dividends and interest on investment it owns.

TAXPAYER’S POSITION
Revenue Agent discussed the proposed revocation with POA, explained the requirements
of an organization exempt under IRC section 501(c)(7), and why the no longer meets those

requirements. The POA stated that he agrees with the proposed revocation.

GOVERNMENT'S POSITION

As a result of the examination, the fails to establish that it is a social and recreational club
that qualifies for exemption from federal income tax under section 501(c)(7) of the IRC and section
1.501(c)(7)-1 of the Treasury Regulations because its investment income exceeds the allowable
35% investment income limitation. Furthermore, the is no longer conducting any social and
recreational activities.

{Continued on next page]

[Page 3]

The received % of its income for tax year ending April 30, from investment
income, calculated in the following table:
April 30, TOTAL
Club Activities-Member $ - $ -
Club Activities-Nonmember $ - $ -
Membership Dues and Assessments $ - $ -
Investment Income f
Total Nonmember Income $ - $ - A
Tolal hivestment Income $ B
Total Income $ Cc
Nonmember Income % - (Divide A by C) 0.0% 0.0%
Investment Income % - (Divide B by C) % %o
The investment income exceeds the 35% threshold permissible for an organization tax-

exempt under section 501({c)(7) of the IRC.

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%, not more than 15% of gross receipts should be derived from the use of a social
club’s facilities or services by the general public.

The is like the organization in Revenue Ruling 66-149, in that the derives a
substantial part of its income from non-member sources; % of the income is
investment income.

CONCLUSION

As a result of the examination, the is not a club organized for pleasure, recreation, and
other nonprofitable purposes because its investment income exceeds the allowable 35%
investment income for organizations under section 501(c){7) of the IRC. Moreover, the no
longer conducts any social and recreational activities.

The should no longer be tax-exempt under section 501(c)(7) of the IRC. Therefore, it is
proposed that the tax exempt status under section 501(c)(7) of the IRC be revoked
effective May 1,20 . The organization will be required to file Form 1120 for all tax periods
subsequent to the revocation of their exempt status.

lf you agree with this conclusion, please sign the attached forms. !f you disagree, please submit a
statement of your position.

[Page 4]