IRS revokes a 501(c)(7) club's exemption where it had no members and lived entirely on investment income

Plain-English summary

The IRS revoked an organization's recognition as a tax-exempt social club under section 501(c)(7). The group had been an alumni-support fund: it held the cash value of a former chapter house in an investment account and used the dividends and investment income to pay for alumni gatherings and to help descendants of former members. On audit the IRS found it was not organized as a membership club (its own articles said it had no members), held no meetings or recreational activities, and its revenue for the years examined came entirely from investment income and trading securities. A 501(c)(7) club must have real members who commingle for social or recreational purposes, and it may draw no more than 35% of gross receipts from outside its membership (with no more than 15% from the general public). With essentially all income coming from investments and no member activity, the organization failed both the basic club test and the nonmember-income limits. The IRS proposed revocation, effective retroactively, and directed the organization to file Form 1120 corporate income tax returns. The taxpayer did not submit a position.

Ruling snapshot

• Question: Can an alumni investment fund with no members and only investment income keep its 501(c)(7) social-club exemption?
• Outcome: revocation (exemption revoked; organization directed to file Form 1120)
• Key authorities: IRC § 501(c)(7); Treas. Reg. § 1.501(c)(7)-1; Public Law 94-568 and Senate Report No. 94-1318 (15%/35% nonmember-income test); Rev. Proc. 71-17; Rev. Ruls. 58-589, 66-149, 67-428, 70-32, 74-30, 74-168; IRC §§ 170, 7428

Full text (IRS public release)

Transcriber's note: this is a scanned adverse-determination package, comprising a Letter 6337 final revocation letter, a Letter 3618 proposed-revocation letter, and a Form 886-A audit report ("Explanations of Items"). The repeating Form 886-A page-header furniture and catalog-number footers have been removed and each report page replaced with a bracketed [Page N] marker; the cover letters keep their own Letter footers. The date on the final letter and many names, dates, dollar amounts, and percentages were redacted or are OCR-garbled and appear as blanks or [illegible]; wording is otherwise reproduced as scanned, with obvious OCR misreads corrected. The Form 886-A includes a reproduced Form 990 line-item table whose values were redacted in the original.

Department of the Treasury Date: [illegible]
Internal Revenue Service

Tax Exempt and Government Entities

Taxpayer ID number:
Number: 202230012
Release Date: 7/29/2022
Tax periods ended:
Person to contact:
Name:
ID number:
Telephone:
Fax:

UIL: 501.07-00

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 is revoked.

Our adverse determination as to your exempt status was made for the following reasons: Y ou have not
established that you are operated substantially for pleasure and recreation of your members or other non-profit —
purposes and that no part of the earnings inures to the benefit of any private shareholder within the meaning of
_ IRC Section 501(c)(7). Your nonmember income has exceeded the 15%/35% nonmember threshold for tax year |
ending = - > as outlined in Public Law 94-568. ‘Therefore, your exempt status under IRC | :
Section 501(c)(7) i is revoked effective . oe

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 i in one of the three federal courts s listed below.

‘How to file your action for declaratory judgment co
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 h

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

Bees Tax-Exempt Status. You may write to ‘the courts at the following addresses:

United States Tax Court ‘US. Court of Federal Claims U.S. District Court for the District of Columbia .
400 Second Street, NW 717 Madison Place, NW = 3333 Constitution Ave., N.W. . toe
_ Washington, DC 20217 _ Washington, DC 20439  ——- Washington, DC 20001

ve | Processing of income tax returns and assessments of any taxes due will not be delayed if you file a petition for
oo _ declaratory judgment’ under IRC Section 7428. -_ .

Letter 6337 (12-2020)

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.

7 Where y you can find more information :
Enclosed are Publication 1, Your Rights as a 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 8 800-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, .

Sean E. [illegible]

Director, Exempt Organizations Examinations

Enclosures: ©

Publication 1
Publication 594.

- Publication 892 »

Letter 6337 (12-2020)

~cy Tax Exempt and Government Entities
IRS ; : . oo Form:
Tax periods ended:

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

_Manager’s contact information:
. Name:
‘ID number:
~ Telephone: .
Response due date:

. June 8, 2020
CERTIFIED MAIL - Return Receipt Requested 7
Dear

Why you’ re receiving this letter :

propose to revoke your tax-exempt Status as an “organization described in Internal Revenue Code
(IRC) Section 501(c)(7). 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 501(c)(7) for the periods above.

After we issue the final adverse determination letter, we'll announce that your organization isno
longer eligible to receive tax deductible contributions under IRC Section 170..

it you disagree

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

2... Send any information you want us to consider.

3. Filea 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.

Letter 3618 (Rev. 8-2019)

_ 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, a

, 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 i 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 i
issue a final adverse determination letter. -

Contacting the Taxpayer Advocate Office i isa taxpayer right

The Taxpayer Advocate Service (TAS) is an independent organization within the IRS S 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. taxpaveradyocate.i 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)

If you have questions, you-can contact the person shown at the top of this letter.

Enclosures:
Form 6018 ©
Form 4621-A

Publication 892

Publication 3498

Sincerely, So

Director, Exempt Organizations
Examinations :

Letter 3618 (Rev. 8-2019)

- - | or exhibi

_ ISSUES:

Whether the 7 ve ( Jis organized and operated exclusively under
Internal Revenue Code IRC) §501(c)(7) a asa social club?

‘Whether or not — activities and revenues are in furtherance or its exempt purpose under IRC
§501(c)(7)?

- FACTS:

was originally founded as and was granted exemption under a group ruling for a
501(c)(7) on re

On a a - filed an amendment with the Internal. Revenue Service (IRS) to change its
name from Pe} to — a . The IRS referenced a letter sent —
to. dated _, thatgave tax exemption under IRC §501(c)(7).

In response to the IDR issued ae . following information was received from the
organization regarding its history:

- was founded : asin in n order to purchase and maintain a
~on the of aoe , located in. _; .|t was in active operation for
years until = when | decided to reduce and eliminate on
. Since 7 owned the land the house. was located on, it didn’t purchase
~ the house or give any money to —_—_. Instead the ~ put cash equal to the value of the house
in a trust for vs In. ; requested that the trust be moved to the a
_ to be used by for educational purposes.

and its board members are all volunteer of and | oa . Since it
was originally created to support an active - onthe andthe. of the
oe ,and since. doesn't have an active cele on the —
organization spends a portion of its income each year to support functions at. ao
and — _weekends. | also provides . tooffspringof = = who -
attend — . Checks written to members of the board are reimbursements for out of pocket
expenses. Other expenses are to support the . events ( a ), tax —

_. preparation, taxes and fees as fequired. :

has its sole investments with oe - -—_; It maintains a conservative

“investment portfolio to provide funds for alumni functions in | and

- . The fund is for the benefit of the os interface with the , and to support
offspring of ==. .Anadhoc volunteer — from sis working \ with the at >
this time trying to get an active . back on © 24

. .

[Page 1]

Articles of Incorporation:

The Articles of Incorporation of states “The purpose of the corporation is to care for the
investment of money received from the sale of property, gifts, and inheritances; pay for the needs
ofthe of at. ,(the“ ”) including but not limited to fire
insurance on furnishings and property in the dormitory owned by the --orleased by the

: furnish additional furnishings over and above that furnished by ; to

- ~ pay for. ee __; finance the costs of sending delegates from the each year

to Leadership Training; fi finance cost of sending delegates fromthe each year to
Leadership Training; finance cost of sending delegates from the to the .
; to provide guidance for the -and to assure that it abides by the Constitution and Statutes of the — a . and rules and regulations of ‘andto- —
provide | to of the and such other lawful purposes under the” .
Nonprofit Corporation Act. Said organization is organized exclusively for charitable, religious, -

_ educational, and scientific purposes, including research purposes, the making of distributions to

_ organizations that qualify as exempt organizations under section 501(c)(7) of the Internal Revenue
Code or corresponding section of any future federal tax code.” .

In Exhibit A of the Articles of Incorporation Article 6 states, “The corporation shall have no»
‘members, all rights of members as set forth under the Nonprofit Corporation Law of 1988 are-
assumed by the Board of Directors pursuant to Section 5751 of said law.”

_ Article: 7 states, "No part of the net earnings of the organization shall inure to the benefit of, or be

distributable to its members, trustees, officers, or other private persons, except that the

organization shall be authorized and empowered to pay reasonable compensation for services —
~ rendered to make payments and distributions i in furtherance of the purposes set forth in the

- purpose clause hereof.”

Bylaws:
The Bylaws were adopted , amended
7 The Purpose of the Bylaws i is stated in Article IL

71.5 Purpose. The corporation is . incorporated under the _ |
for the following purpose ‘or. purposes: oe

(a) To accept donations of money for distribution to other fax-exempt,
Charitable organizations.

(b) The corporation is organized exclusively for charitable, religious,
scientific, and educational purposes as defined in Section 501(c)(7) of the Internal Revenue -
Code, Including, but not limited to any such activity which may be permitted by corporations 8

[Page 2]

formed under and pursuant to the
"Amendment of the Bylaws: a ee | a ne
The amendment to the Bylaws was adopted |
Article I, Section 1.5 is amended to state:

7. 1 1.5 Purpose. The corporation is incorporated under the
for the following purpose- -or purposes.

_ (a) To care. for the investment of money received trom the nale of property, gifts

- and inheritances,

_ (b) To pay no more than five ( -%) percent of the combined principal and interest of the

investment account, to provide = =... _ to descendants of members of the
at andother .  atany or
who are members of the me ; :
(c)Tofund functions ofthe =—<“<~Ss*é«‘C KSC‘C*‘#*rowicdecd
said functions are held within ; yo

Relationships and Activities of

owned the land the house resides on and took control of the house in
: put the cash value of the house in a trust for scholarships. took.control of the trust, -
put thet money in an investment account. They utilize the dividends and investment income to pay
for the alumni activities and the taxes for the amount invested.

Activities:
For the years underexam provided hats and paid forthe activities ‘during
ee cogs paid the taxes and fees for the accountant out of the fund for the
years under audit. In sy started paying forthe © — to
. They provided two , one for $. and one for $ to

descendants: . z
Revenue Sources:

reported the following sources ; and amounts of revenue on Form. for the periods ended

- and subsequent year

[Page 3]

990 Information.
Activities & Governance |

‘Ta Total unrelated business revenue from Part VIII, column. (),

| line 12, .

“7b | Net unrelated business taxable ir income from Form line
34 i

: “Revenue

8. Contributions and grants (Part VIII, line th) _

9 | Program service revenue (Part VIII, line 2g) .

10 Investment income (Part Vill, column (A), lines 3, 4, and 7d) .
11 Other Revenue (Part VIL, column (A), lines 5,-6d, 8c, 9e, 10c
____| and 11e)

~ 42 | Total Revenue- add lines 8 through 11 (must Saud Part vii,
column (A), line 12)

Expenses

* 13° Grants and similar. amounts paid (Part Ix, column (A), lines 1-
14 Benefits paid to or for members (Part IX, column (A), Tine 4)

15 | Salaries, other compensation, employes benefits (Part IX,
column (A), lines 5-10) _

6a Professional fundraising fees (Part IX, column (A), line 4)

16b | Total fundraising expenses (Part IX column (D), line 25)

17. | Other expenses (Part IX column (A), lines 11a-11d, 11f-24e)

‘| 18 | Total expenses Add lines 13- 17 (must equal Part IX, column

p (A), line 25) -

19 Revenue less expenses Subtract line 18 from line 12

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.

IRC 501(c)(7) further establishes that the ordinary meaning of the term "club" implies that there
_ must be club members, and that there must be a "commingling" of the members for social,
recreational, or similar purposes. The commingling requirement has been stated in Rev. Rul: 58-
589, 1958-2 C.B. 266, Rev. Rul. 70-32, 1970-1 C.B. 132, and Rev. Rul. 74-30, 1974-1 C.B. 137.
Commingling is present if such things as meetings, gatherings and regular meeting facilities are
evident.

[Page 4]

Rev. Rul. 58-589, 1958-2 C.B. 266, discusses the criteria for exemption under IRC 501(c)(7) and —

_ holds that a club must have an established membership of individuals, commingling, and

_ fellowship to be a social club within the meaning of the statute. While this does not mean that a
club cannot have artificial entities, such as corporations, as members, a federation composed
completely of artificial entities (clubs) was held to be not exempt under IRC 501(c)(7) in Rev. Rul. 67-428, 1967-2 C.B. 204. The rationale of that case was that a federation of clubs was a collection
of artificial entities not capable of the kind of commingling required of the membership of exempt
clubs. Thus, corporate memberships will not automatically disqualify a club as long as there are
sufficient individual members to provide the requisite amount of fellowship and commingling. (See
Rev. Rul. 74-168, 1974-1.C.B. 139). .

; ‘Section 1.501 (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 i 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 allowan 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; ON

(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 i income up to the full 35 percent of its gross
receipts if no income is derived from non- members’ use of club facilities.

(ec) 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 i 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 IRC §
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 IRC §.
501 (c)(7). Where nonmember i income from the usage exceeds the standard as outlined in this

[Page 5]

Revenue procedure, the conclusion reached i is that there is a non- exempt purpose and. operating in
this manner jeopardizes the organization’s exempt status.

TAXPAYER'S POSITION

_ Taxpayer's Position has not been provided.

GOVERNMENT'S POSITION

— Based on the examination results and the facts listed. under the heading of this report, -does -

- not qualify for exemption as a social club described in IRC §501(c)(7) and Treas. Reg. §1. 501(c)(7)
which provides that in general, this exemption extends to social and recreational clubs which are |
supported solely by membership fees, dues, and assessments.

The examination results and the information returns fil led by for fiscal year ended
and show that % of the revenues came from investment income and trading
securities. Therefore, it precludes the from tax exemption under IRC §1. 501(c)(7). In

_ addition, the following revenue rulings supports this: conclusion.

Rev. Rulings. 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’.

The organization has exceeded the % non- member threshold as outlined in Public Law 94- 568,
ona recurring basis during tax years ended ee Eas and.

: ‘Sources of Income:

Per revenue , reconciliation from Form return and books and records including:
—  & - accounts, we found investment income as the only source of i income
reported. The investment i income was recorded on the following two accounts:
number and i -. Account number. In , the only income came from the
investment Account.

Based on Form and analysis of gross receipts, it was noted that the organization’ s total
income received was from investments (trading securities) for both fiscal years ended

and respectively. There was no other source of income reported on return and on
the books and records. reviewed.

“Membership:

is not organized asa membership organization as stated in Exhibit A Article 6. While this
does not mean that a club cannot have artificial entities, such as corporations, as members, a

[Page 6]

OO-F orexhibit

federation composed completely of artificial entities (clubs) was held to be not exempt under IRC
$01(c)(7) in Rev. Rul. 67-428, 1967-2.C.B. 204.

- Activities: 2

is currently not operating under the meaning of IRC § 501(c)(7). There are no activities —_
currently being conducted at the club house it supposed to maintain for recreational and other _—

related activities. Trading securities as an Unrelated Business Activity precludes it from exemption
under IRC 501(c)(7).

CONCLUSION:

no longer qualifies for exemption under s 501(c)(7) of the Code s since its. nonmember income
has exceeded the 15% nonmember threshold on a continuing basis. In addition, during the years
under examination, there are no active members nor any IRC501(c)(7) exempt activities.
Therefore, it is proposed that exempt status under § 501(c)(7) of the Code be revoked

effective is required to file Form 1120 and must be filed starting with tax
periods starting Lo

[Page 7]