Social club loses 501(c)(7) exemption for too much nonmember income

Plain-English summary

The IRS revoked the section 501(c)(7) exemption of a social club that runs a clubhouse, swimming pool, and tennis courts, because too much of its income came from nonmembers. A tax-exempt social club may receive up to 35 percent of its gross receipts from outside its membership, but no more than 15 percent from the general public's use of its facilities. On audit the IRS found the club rented its clubhouse to nonmembers, let nonmember guests use the pool and tennis courts, and leased space for a cell tower, and that its nonmember income exceeded the 15 percent limit in every year examined. The club's treasurer agreed with the finding. The revocation is prospective (effective a redacted January 1), and the club must file Form 1120 going forward. As an alternative position, in case the revocation were not upheld, the IRS explained that the club's unrelated business taxable income should be increased to include the unreported nonmember pool and tennis income and the cell-tower lease income under sections 511 and 512(a)(3).

Ruling snapshot

• Question: Does a social club keep its section 501(c)(7) exemption when its nonmember (general-public) income exceeds 15 percent of gross receipts?
• Outcome: revocation (prospective; with an alternative unrelated-business-income adjustment stated if the revocation is not upheld)
• Key authorities: IRC §§ 501(c)(7), 511(a)(1), and 512(a)(3); Treas. Reg. § 1.501(c)(7); Public Law 94-568; Rev. Ruls. 66-149 and 60-324; Rev. Proc. 71-17

Full text (IRS public release)

Department of the Treasury Date: February 17, 2021
Internal Revenue Service
Tax Exempt and Government Entities

IRS Taxpayer ID number:

Form:

Tax periods ended:

Release Number: 202221012 Person to contact:

Release Date: 5/27/2022 ne on

UIL: 501.07-00 ;
Telephone:
Fax:

CERTIFIED MAIL - RETURN RECEIPT REQUESTED
Dear

Why we are sending you this letter

This is a final determination that you don’t 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
periods above. Your determination letter dated February 18,19, 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 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 years ending :

and

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.

What you must do if you disagree with this determination
If you want to contest our final determination, you have 90 days from the date this determination letter was
mailed to you to file a petition or complaint in one of the three federal courts listed below.

How to file your action for declaratory judgment

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.

Please contact the clerk of the appropriate court for rules and the appropriate forms for filing an action for
declaratory judgment by referring to the enclosed Publication 892, How to Appeal an IRS Determination on
Tax-Exempt Status. You may write to the courts at the following addresses:

United States Tax Court U.S. Court of Federal Claims U.S. District Court for the District of Columbia
400 Second Street, NW 717 Madison Place, NW 333 Constitution Ave., N.W.
Washington, DC 20217 Washington, DC 20439 Washington, DC 20001

Letter 6337 (12-2020)
Catalog Number 74808E

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.

Information about the IRS Taxpayer Advocate Service
The IRS office whose phone number appears at the top of the notice can best address and access your tax
information and help get you answers. However, you may be eligible for free help from the Taxpayer Advocate
Service (TAS) if you can't resolve your tax problem with the IRS, or you believe an IRS procedure just isn't
working as it should. TAS is an independent organization within the IRS that helps taxpayers and protects
taxpayer rights. Contact your local Taxpayer Advocate Office at:

Internal Revenue Service

Taxpayer Advocate Office

Or call TAS at 877-777-4778. For more information about TAS and your rights under the Taxpayer Bill of Rights,
go to taxpayeradvocate.irs.gov. Do not send your federal court pleading to the TAS address listed above. Use
the applicable federal court address provided earlier in the letter. Contacting TAS does not extend the time to
file an action for declaratory judgment.

Where you can find more information
Enclosed are Publication 1, Your Rights as a Taxpayer, and Publication 594, The IRS Collection Process, for
more comprehensive information.

Find tax forms or publications by visiting www.irs.gov/forms or calling 800-TAX-FORM (800-829-3676).
If you have questions, you can call the person shown at the top of this letter.

If you prefer to write, use the address shown at the top of this letter. Include your telephone number, the best
time to call, and a copy of this letter.

Keep the original letter for your records.

Sincerely,
[signature illegible]
Sean E. O'Reilly
Director, Exempt Organizations Examinations

Enclosures:
Publication 1
Publication 594
Publication 892

Letter 6337 (12-2020)
Catalog Number 74808E

Date:

Department of the Treasury September 17, 2020
Internal Revenue Service Taxpayer ID number:
IRS Tax Exempt and Government Entities
Form:

Tax periods ended:

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

4
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.

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.

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

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
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.

Enclosures:
Form 4621-A
Form 6018
Form 886-A
Pub 892
Pub 3498

w

Sincerely,

Sean E. O’Reilly
Director, Exempt Organizations
Examinations

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

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

XX-XXX
ISSUE:
Whether the tax-exempt status of ( ) an IRC Section 501(c)(7)
social club, should be revoked.
FACTS:
articles of incorporation were filed in the state of on September 12, 19xx. The

exact legal name of the organization in the articles of incorporation is

The purpose stated in the articles of incorporation were to acquire and maintain a community
house and grounds in the village of for promoting and fostering the educational
and religious purpose of the community.

The Secretary of State website indicated, was reinstated on
July 18, 20xx, its principal office address is
entity status with the State is active and in good standing.

On August 23,19 the organization submitted form 1024, Application for Recognition of
Exemption Under Section 501(a) and requested exemption as a social welfare organization
exempt under section IRC 501(c)(4). stated its purpose was to provide swimming, tennis and
basketball activities for its members. was granted exemption as a social club and exempt
under section IRC 501(c)(7). The letter of exemption as a section IRC 501(c)(7) social club was
issued on Feb. 18, 19xx.

On May 1, 20xx, filed form and form for the year ending and
reported the following revenues

1. Membership dues
2. Clubhouse rental

3. Tennis

4. Pool

5. Other

Total Revenues $

On March 5, 20xx, was contacted by letter 3611, informing the organization that its form

for 20xx had been selected form examination. The organization was informed that the
examination and request for documents was to verify the non-member usage of the club’s facilities

and the organization’s continued qualification for exemption under section IRC 501(c)(7) as a social
club.

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

- ‘ Schedule number
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
XX-XXX
On August 04, 20xx, submitted the response to information document request. The

organization submitted books, records and bank statements for the year ending December 31,
20xx.

On August 06, 20xx, the organization was informed that the examination would be expanded to

include form for the year ending and the form for the years of 20xx
and 20xx.
On August 19, 20xx, a telephone interview was conducted with the organization’s treasurer,

. As per the interview, owns its building in which its activities are
conducted. operates a club house, swimming pool and tennis court. The sources of

income are membership dues, club house rental, pool and tennis court usage.

The organization is governed by a board of directors. Different members of the board oversee the
different club activities. Membership is for one year; membership dues is normally due in
February. Memorial Day to Labor Day is the clubs busiest time. Tennis is year-round. The
organization conducts movie nights and cook outs for members. Club house rental to
nonmembers is year-round. The total number of members is between xxx to xxx. The members
include an entire family as one member. The annual membership fees are based on the number in
the family.

On August 19, 20xx, as per interview with the organization’s treasurer, nonmembers/guests can
use the pool and the tennis courts but must be accompanied by a member. For the pool use,
member pay $ per guest. For the tennis court use, members pay $ per guest. The
organization did not provide the substantiation to document the usage of the pool and the tennis
courts by nonmembers/guest.

The organization also rents out its club house to non-members. The organization submitted
journals and rental agreements with the nonmembers.

As per form , the organization reported nonmember or unrelated business income as follows:
Form
Part VIIl Statement of
Revenues
20XX 20XX 20XX
Line 2g
Unrelated Business
Revenue
Line 12

Total Revenue

Catalog Number 20810W Page 2 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) Explanations of Items
Name of taxpayer Tax Identification Number (last 4 digits) | Year/Period ended
XX-XXX
As per examination of the organization’s books, records and review of the forms and forms

filed by the organization, the following is a computation of the organization total revenue and
the nonmember percentage of the total revenue.

NONMEMBER INCOME PERCENTAGE OF TOTAL REVENUE

15% | Form 20XX 20XX 20XX
Test
Total Nonmember Income
Total gross receipts

Nonmember % cannot % % %
exceed 15%

LAW

IRC § 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 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;

Catalog Number 20810W Page 3 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) Explanations of Items
Name of taxpayer Tax Identification Number (last 4 digits) | Year/Period ended
XX-XXX

(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.

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.

Revenue Ruling 60-324 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 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 IRC §
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.

TAXPAYER POSITION

On September 11, 20xx, revenue agent spoke with organizations treasurer, treasurer agreed with
determination

GOVERNMENT POSITION

The cited Code and Regulations above provide criteria for recognition of a tax-exempt
organization under IRC 501(c)(7). Generally, an organization is to be organized and operated
exclusively for pleasure, recreation, and other nonprofit purposes. In general, this exemption
extends to social and recreation clubs which are supported solely by membership fees, dues, and
assessments.

In the case of the organization under examination, it was granted exemption in 19xx, as a social
club under IRC 501(c)(7). IRC 501(c)(7) organizations are limited to the amount of nonmember
income that it can receive and still maintain its exempt status. The nonmember income limitation is
15% of the gross revenue received.

Catalog Number 20810W Page 4 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) Explanations of Items
Name of taxpayer Tax Identification Number (last 4 digits) | Year/Period ended
XX-XXX
In the year of examination, nonmember income was % of the total income received.

The facts provided about the organization under examination shows that for the years 20xx —
20xx, the entity exceeded the nonmember income limitation.

The has exceeded the 15% nonmember limitation in all of the identified years.
The subject organization does not qualify for exemption under IRC 501(c)(7). The exemption status
should be changed and revoked.

CONCLUSION

Based on the above facts and circumstances, and considering the statutory law and rulings cited.
The organization has exceeded the 15% nonmember income limitation. The organization 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 1120, U.S. Corporation Income Tax Return should be filed for 20xx and thereafter if the
organization continues to be subject to income tax.

ALTERNATIVE POSITION

Issue

If the proposed revocation of exempt status is not upheld, the organization form should be
adjusted to include nonmember income from the usage of the pool and tennis courts and
nonmember income from the lease revenues from the cell tower.

Facts

The organization filed form and form for 20xx and 20xx timely. The organization
reported a total of unrelated nonmember income on form in the amount of $ for 20xx
and $ for 20xx.

As per interview with the treasurer on August 19, 20xx, the organization allows nonmembers to
use their pool and tennis courts, the nonmember must be accompanied by a member. The
member is required to pay $ —_ on behalf of their guest.

The organization received $ for 20xx and $ for 20xx for nonmember usage of the pool
and tennis courts.

This amount was not reported on form

Catalog Number 20810W Page 4 www.irs.gov Form 886-A {Rev. 5-201 7)

_ i Schedule number
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
XX-XXX
The organization received income from leasing its cell tower in the amount of $ , this amount

was not reported on form

As per examination of books, records, bank and financial statements. The organization did not
provide the required substantiation of Revenue Procedure 71-17 for social clubs to substantiate
nonmember usage of the club’s facilities.

LAW

IRC § 511(a)(1) imposes a tax on the unrelated business taxable income (UBTI) of organizations
described in § 501(c).

IRC § 512(a)(3)(A) defines unrelated business taxable income for IRC 501(c)(7) social clubs as
gross income excluding any exempt function income, less the deductions allowed that are directly
connected with the production of the income.

IRC § 512(a)(3)(B) Exempt function income is defined as “gross income from dues, fees,
charges, or similar amounts paid by members of the organization as consideration for providing
such members or their dependents or guests goods, facilities, or services in furtherance of the
purposes constituting the basis for the exemption of the organization to which such income is
paid.”

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 IRC §
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.

TAXPAYERS POSITION

On September 11, 20xx, discussed findings with organizations treasurer. Advised officer that the
converted return form 1120, must include the adjustments to unrelated business income not
reported on form

GOVERNMENT POSITION

The organization received nonmember income for 20xx in the amount $ and cell tower
lease revenue in the amount of $

Catalog Number 20810W Page 6 www.irs.gov Form 886-A (Rev. 5-2017)

_ i Schedule number
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
XX-XXX
The organization received nonmember income in 20XX in the amount $ and cell tower

lease revenue in the amount of $

The organization did not provide the substantiation of nonmember income as required by revenue
procedure 71-17, therefore nonmember usage of the pool and tennis court is determined to be
unrelated business income and subject to tax.

The organizations form — for 20xx and 20xx should be adjusted and taxable income should be
increased as follows:

Form Adjustment

20XX_ | 20XX

Form

Form

Difference
Cell Tower Lease
Adjustment

Tax Rate % %

Tax Due

CONCLUSION

lf revocation is not upheld, the organization form — for 20xx and 20xx should be adjusted and the
taxable income and tax liability increased.

Catalog Number 20810W Page 7 www.irs.gov Form 886-A (Rev. 5-2017)