Social club exemption revoked for recurring investment income

Plain-English summary

A hunting, fishing, and recreation club held a professionally managed investment fund created from a lump-sum lease payment. For several consecutive years, investment income caused the club to receive more than the permitted share of gross receipts from sources outside its membership. The IRS found that the income was substantial and recurring, unlike a temporary investment of proceeds while a club acquires a new home. It also concluded that the income benefited members by financing club operations without dues, fees, or assessments. The club agreed with the IRS position, and the IRS revoked its section 501(c)(7) exemption.

Ruling snapshot

• Question: Did a social club remain exempt under section 501(c)(7) after repeatedly receiving substantial investment income from nonmember sources?
• Outcome: Revocation
• Key authorities: IRC § 501(c)(7); Treas. Reg. § 1.501(c)(7)-1; Rev. Rul. 66-149; Rev. Proc. 71-17

Full text (IRS public release)

Internal Revenue Service
Tax Exempt and Government Entities

IRS Taxpayer ID number:

Form:

Department of the Treasury Date: October 26, 2021

Release Number: 202243012 Tax periods ended:
Release Date: 10/28/2022

UIL Code: 501.07-00 Person to contact:
Name:

ID number:
Telephone:
Fax:

CERTIFIED MAIL - RETURN RECEIPT REQUESTED

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: You have not
established that you are operated substantially for the pleasure and recreation of your members or for other
nonprofitable purposes, and that no part of your net earnings inures to the benefit of any private shareholder
within the meaning of IRC Section 501(c)(7). You have regularly received a substantial portion of your income
from nonmember sources, and thus, you are no longer qualified for exemption under Section 501(c)(7).

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

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.

Letter 6337 (12-2020)
Catalog Number 74808E

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:

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, ,

Sean E. O'Reilly ia

Director, Exempt Organizations Examinations
Enclosures:
Publication 1

Publication 594
Publication 892

cc:

Letter 6337 (12-2020)
Catalog Number 74808E

Department of the Treasury Date: February 26, 2021

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:

Manager’s contact information:
Name:

ID number:
Response due date:

March 28, 2021

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 and _ , 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

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

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

Publications 892 and 3498

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

Form 886-A Department of the Treasury - Internal Revenue Service Schedule number or
Explanation of Items exhibit
Name of taxpayer Tax Identification Number (last 4 Year/Period ended
digits)
ISSUE(S):
Whether continues to qualify for exemption from federal income

tax under section 501(a) of the Internal Revenue Code as a social club described in Code section
501(c)(7).

FACTS:

was formed in . The organization is
located in , Where it currently owns over acres of land.
In the Internal Revenue Service granted exemption from

Federal income tax under section 501(c)(7) of the Code.

The purpose of the as stated in the Articles of Incorporation is:

a) promote and enjoy the sports of hunting and fishing and to promote social and athletic
recreation for members;

b) to cooperate with the Game Commission and the Commission
in obtaining respect for and observance of fish and game laws;

c) to acquire, sell, own, lease, operate and mortgage real estate and improvements thereon,
including water rights and rights of way;

d) all other purposes necessary and incident to those purposes already stated. The corporation does
not contemplate pecuniary gain or profit, incidental or other-wise, to its members.

According to Article III Section ofthe Amended Bylaws dated , membership to
is limited to members. However, member’s offspring who

become of age and is interested, are eligible for membership.

currently has members.

charges new members an initiation fee of $ . Aside from the
initiation fee, members are charged other dues and assessments uniformly at the organization’s
discretion.

Section 4(d) of the Amended Bylaw’s state upon termination of membership, whether by death,
resignation, or expulsion the corporation shall pay to the member or to their estate the sum of $

( dollars) which shall be complete and final settlement of their membership.

activities consists of ; , land maintenance
acquisition and improvement.

Page 1 of 5

Department of the Treasury - Internal Revenue Service Schedule number or
Form 886-A
Explanation of Items
Name of taxpayer Tax Identification Number (last 4 Year/Period ended
digits)

has an investment fund which is professionally managed by
. The funds originated from a lump sum payment received in fora -year
( , , ) Lease. The funds are used to expand, improve, and maintain the land for their
members social and recreational purposes.

The chart below shows the income received by per the Form
returns:
Form
Member Income $ $ $
Investment Income $ $
Total Revenue $. $ $
Percentage of investment income % % %

reported their investment income shown above on their Form(s)

, Exempt Organization Business Income Tax Return. has not
identified any amounts as set aside income per Form(s) -Schedule-
In , the increase in investment income was due to the organization selling a portion of their

publicly traded securities that were held in the professionally managed investment fund.

has received over % of its gross receipts, including investment
income, from sources outside of its membership for the years -

APPLICABLE LAW:

Section 501(c)(7) of the Code provides exemption from Federal income tax for clubs organized for
pleasure, recreation, and other nonprofitable purposes, substantially all 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.

The enactment of Public Law 94-568 in 1976 which changed the term “exclusively” to “substantially
all”. This change, as incorporated in the Code, allows for an insubstantial amount of income from
activities that do not further the club’s exempt purposes. Activities which constitute an unrelated
trade or business include the use of the club facilities by the general public.

Senate Report No. 94-1318 (1976), 2d Session, 1976-2 C.B. 597, at page 599 defines “substantially

all” and explains that a social club is permitted to receive up to 35% of its gross receipts, including

investment income, from sources outside of its membership without losing its tax-exempt status. It is

also intended that within this 35% not more than 15% of the gross receipts should be derived from the

use of a social club’s facilities or services by the general public (nonmembers). The Senate Report

defines the term “gross receipts” as those receipts from the traditional, normal, and usual activities of
Page 2 of 5

Department of the Treasury - Internal Revenue Service Schedule number or
Form 886-A
Explanation of Items
Name of taxpayer Tax Identification Number (last 4 Year/Period ended
digits)

the club. Gross receipts include membership fees, dues, and assessments; charges, admissions,
investment income (such as interest, dividends, rents and similar receipts) and normal recurring gains
on investments.

Treas. Reg. §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
using club facilities or in connection with club activities. A social club that opens its facilities to the
public is deemed to be not organized and operated exclusively* for pleasure, recreation, and other
nonprofitable purposes, and is not exempt under section 501(a). Solicitation by advertisement or
otherwise for public patronage of its facilities is prima facie evidence that the club is engaging in
business and is not being operated exclusively for pleasure, recreation, or social purposes. However, an
incidental sale of property will not deprive a club of its exemption. See Reg. §1.501(c)(7)-1(b).

Revenue Ruling 58-589, C.B. 1958-2, 266, sets forth the criteria for exemption under section 501(c)(7)
of the Code and provides that a club must have a membership of individuals, personal contacts, and
fellowship. A commingling of members must play a material part in the activities of the organization.
Although fellowship need not be present between each member and every other member of the club, it
must constitute a material part of the organization's activities. In this respect, statewide or nationwide
organizations made up of individuals, but broken up into local groups, satisfy the requirement if
fellowship constitutes a material part of the activities of each local group. The requirement of
individual membership derives from the requirement of personal contacts and fellowship between
members. It is evident that fellowship between members cannot play a material part in the activities of
an organization composed of artificial entities”.

Revenue Ruling 56-305, 1956-2 C.B. 307 provides that an organization that owns and operates a
building and conducts club activities for the benefit of a tax-exempt lodge may itself be exempt as a
social club.

Revenue Ruling 66-149, 1966-1 C.B. 146 provides that a social club is not exempt from Federal
income tax as an organization described in section 501(c)(7) of the Code where it regularly derives a
substantial part of its income from nonmember sources such as, for example, dividends and interest on
investments which it owns. However, a club's right to exemption under section 501(c)(7) of the Code
is not affected by the fact that for a relatively short period a substantial part of its income is derived
from investment of the proceeds of the sale of its former clubhouse pending the acquisition of a new
home for the club.

Rev. Proc. 71-17, 1971 WL 26186, 1971-1 C.B. 683 sets forth guidelines for determining the effect
gross receipts derived from use of a social club's facilities by the general public have on the club's
exemption from federal income tax under section 501(c)(7) of the Code. The club must maintain
books and records of each such use and the amount derived therefrom.

Page 3 of 5

• Department of the Treasury - Internal Revenue Service Schedule number or
  Form 886-A
  Explanation of Items
  Name of taxpayer Tax Identification Number (last 4 Year/Period ended
  digits)

While the Senate Reports mandate the application of a “facts and circumstances test” in the event that
gross receipts from nonmember and/or investment income reach the prohibited levels, they do not
specify any of the relevant facts and circumstances that should be considered. However, in Pittsburgh
Press Club v. US, 536 F.2d 572, (1976); 579 F.2d 751 (1978); and 615 F.2d 600 (1980), the court
noted certain factors to consider in determining exempt status.

Factors to consider in applying this test include:

• The actual percentage of nonmember receipts and/or investment income.

• The frequency of nonmember use of club facilities. (An unusual or single event (that is, non-
recurrent on a year to year basis) that generates all the nonmember income should be viewed
more favorably than nonmember income arising from frequent use by nonmembers).

• The number of years the percentage has been exceeded. (The record over a period of years is
also relevant. The high percentage in one year, with the other years being within the permitted
levels, should be viewed more favorably to the organization than a consistent pattern of
exceeding the limits, even by relatively small amounts).

• The purposes for which the club’s facilities were made available to nonmembers.

• Whether the nonmember income generates net profits for the organization. Profits derived
from nonmembers, unless set aside, subsidize the club’s activities for members and result in
inurement within the meaning of IRC 501(c)(7).

Section 170(c)(4) Charitable contribution defined: In the case of a contribution or gift by an individual,
a domestic fraternal society, order, or association operating under the lodge system, but only if such
contribution or gift is to be used exclusively for religious, charitable, scientific, literary, or educational
purposes, or for the prevention of cruelty to children or animals.

GOVERNMENT’S POSITION:

In the IRS granted exemption from Federal income tax under
section 501(c)(7) of the Code.

The examination of the Form return filed by reveals that
the organization derives little revenue from membership dues, assessments, or similar types of income.
main source of income is from investments.

In entered a -year ( ) Lease. From
which received a lump sum of money. The proceeds were invested
in stocks and securities. did not identify or record any set aside
amounts, nor has any amounts of the investment income received in - by

been identified as set aside income on Schedule of the Form

Page 4 of 5

. Department of the Treasury - Internal Revenue Service Schedule number or
Form 886-A
Explanation of Items
Name of taxpayer Tax Identification Number (last 4 Year/Period ended
digits)

A 501(c)(7) social club is permitted to receive up to % of its gross receipts, including investment
income, from sources outside of its membership without losing its tax-exempt status.
has exceeded this limitation for several consecutive years.

The investment income earned by is substantial, recurring, and
routinely exceeds the non-member income limitations imposed on social clubs exempt under section
501(c)(7) of the Code. See Rev. Proc. 71-17 and Pittsburgh Press Club v. U.S. See also Rev. Rul. 66-

149. Furthermore, the investment income effectively inures to the benefit of members because it
     enables the organization to finance operations without imposing dues, fees or other assessments on its
     members.

Based on the application of the law to the facts and circumstances presented herein, it is the
Government’s position that no longer qualifies for exemption as a
social club described in section 501(c)(7) of the Code.

TAXPAYER’S POSITION:

agrees with the IRS position regarding the proposed revocation
of the organization’s tax-exempt status by signing Form 6018.

CONCLUSION:
For the reasons stated above, the IRS has determined that no longer
qualifies for exemption from federal income tax under section 501(c)(7) of the Code. The IRS
proposes to revoke the tax-exempt status of effective

, the day of the tax year under examination.
Form(s) , U.S. Corporation Income Tax, should be filed for tax period ending

and thereafter.

Page 5 of 5