IRS revokes a fraternal chapter's 501(c)(7) social-club exemption because all its revenue came from investment income, not members

Plain-English summary

A social club exempt under section 501(c)(7) (think a fraternity chapter, country club, or hobby club) is supposed to be supported mainly by its members through dues, fees, and assessments. The law lets such a club take in only a limited amount from outside its membership: no more than 35 percent of gross receipts from investment income and non-member sources combined, and within that, no more than 15 percent from the general public's use of its facilities. Here the club is a chapter that provides social and recreational activities and housing to its members. On audit, the IRS found that for the years examined, essentially all of the club's revenue came from investment income and none from members, blowing far past the 35 percent ceiling on outside income. Because the club could no longer show it was operated substantially for the pleasure and recreation of its members, the IRS proposed revocation (Form 886-A audit report and Letter 3618), the club did not provide a position or agree, and the IRS issued a final revocation (Letter 6337). The result: the club loses its tax-exempt status effective the stated date and generally must file federal income tax returns. The club can contest the revocation in Tax Court, the Court of Federal Claims, or the U.S. District Court for the District of Columbia.

Ruling snapshot

• Question: Does the club still qualify as a 501(c)(7) social club when essentially all of its revenue is investment income and none comes from members, exceeding the 35% outside-income limit?
• Outcome: Revocation (tax-exempt status revoked; club exceeded the non-member/investment income threshold on a continuing basis)
• Key authorities: IRC § 501(c)(7); Treas. Reg. § 1.501(c)(7); Pub. L. 94-568 (35%/15% limits); Rev. Rul. 66-149; Rev. Proc. 71-17

Full text (IRS public release)

Department of the Treasury Date: December 2, 2021
Internal Revenue Service
Tax Exempt and Government Entities Taxpayer ID number:

Form:
Tax periods ended:
Number: 202243018
Release Date: 10/28/2022 Person to contact:

UIL Code: 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 , 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
nonprofitable purposes and no part of the earnings inures to the benefit of any private shareholder within the
meaning of IRC Section 501(c)(7). You have exceeded the non-member income test for tax year ending

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:

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,

Sean E. O'Reilly
Director, Exempt Organizations Examinations

Enclosures:
Publication 1
Publication 594
Publication 892

Letter 6337 (12-2020)
Catalog Number 74808E

Department of the Treasury Date: March 31, 2021
Internal Revenue Service Taxpayer ID number:
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:
Telephone:
Response due date:
April 30, 2021

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
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,

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.

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

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).

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

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

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

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

ISSUE
Whether ( ) continues to qualify for exemption
under IRC Section 501(c)(7) due to excessive revenue from sources outside their membership?

FACTS
The was granted tax-exemption under IRC Section 501(c)(7) on to provide social,
recreational and other activities to its members. The was formed to of the
who are members of, or who are pledged to become members of, the

Per the Articles of Incorporation, the exempt purpose is to acquire, improve, and maintain
lands and buildings to be suitable for housing members and and to have assembly,
and and facilities available to members of the Chapter. The
currently a building to of the

The organization reported the following sources and amounts of revenue on Forms for the periods
ending . Total Revenues of $ for the tax year ending ; Total
Investment Income of $ was included in the total revenue for the tax year ending
Total Revenues of $ for the tax year ending . Total Investment Income of $
was included in the total revenue for the tax year ending

LAW

IRC Section 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.

Treas. Reg. Section 1.501(c)(7) 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 Section 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 1 www.irs.gov Form 886-A (Rev. 5-2017)

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

(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 IRC Section
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 Section 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'S POSITION

The position has not been provided.

GOVERNMENT'S POSITION

The received Total Revenues of $ all of which was from investment income for the year
ending That amount equals % of all revenues received. The exceeded the
% of revenue from sources outside of members threshold as outlined in Public Law 94-568, during tax
year ending as reported on the Form

The received Total Revenues of $ all of which was from investment income for the year
ending . That amount equals % of all revenues received. The exceeded the
% of revenue from sources outside of members threshold as outlined in Public Law 94-568, during tax
year ending as reported on the Form.

Based on the examination, the does not qualify for exemption as a social club described in IRC
Section 501(c)(7) which provides that in general, this exemption extends to social and recreation clubs
which are supported solely by membership fees, dues, and assessments.

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
Explanations of Items
Name of taxpayer Tax Identification Number (last 4 digits) | Year/Period ended

Revenue Ruling 66-149 support this position stating that a social club that derives a substantial part of its
income from sources outside of members is not exempt as an organization described under IRC Section
501(c)(7).

Accordingly, it is proposed that the tax-exempt status is revoked effective

CONCLUSION

The no longer qualifies for exemption under IRC Section 501(c)(7) due to excessive revenue
from sources outside of member income that exceeded the % threshold on a continuing basis. Therefore,
the exempt status under IRC Section 501(c)(7) is revoked effective

Should this revocation be upheld, Form must be filed starting with tax periods beginning

Catalog Number 20810W Page 3 www.irs.gov Form 886-A (Rev. 5-2017)