501(c)(7) social club loses exemption for too much investment income (over the 35% limit)

Plain-English summary

A tax-exempt social club under section 501(c)(7) (the kind of exemption used by alumni associations and similar member clubs) lost its exemption because too much of its money came from outside its membership. A 1976 law (Public Law 94-568) lets a 501(c)(7) club take in up to 35% of its gross receipts from investment income and non-member sources combined; go over that and the club is no longer "substantially" operated for the pleasure and recreation of members. Here the club had largely stopped its member activities: alumni dinners and reunions had wound down (partly due to COVID), it took in essentially no dues or member fees, and it mainly received donations and lived off investment income while issuing scholarships. Because investment income made up more than 35% of gross receipts across several years, the IRS found a pattern of non-compliance and revoked the club's exempt status. The organization did not submit a position. Going forward it must file regular income tax returns.

Ruling snapshot

• Question: Does a 501(c)(7) social club keep its exemption when its investment income exceeds the 35% limit on receipts from outside its membership across multiple years?
• Outcome: Revocation (final adverse determination)
• Key authorities: IRC § 501(c)(7); Treas. Reg. § 1.501(c)(7); Public Law 94-568 (S. Rep. No. 94-1318); Rev. Rul. 66-149; Rev. Rul. 60-324; Rev. Proc. 71-17

Full text (IRS public release)

Department of the Treasury                       Date:
Internal Revenue Service                         01/12/2023
IRS Tax Exempt and Government Entities           Taxpayer ID number (last 4 digits):

                                                 Forms:
                                                 Tax periods ended:
Release Number: 202319024

Release Date: 5/12/2023                          Person to contact:

UIL Code: 501.07-00                              Name:
                                                 ID number:
                                                 Telephone:
                                                 Fax:

                                                 Last day to file petition with United States
                                                 Tax Court: 04/12/2023

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 operated substantially for the pleasure and recreation of your members or for other
nonprofitable purposes and no part of the net earnings inures to the benefit of any private shareholder within the
meaning of IRC Section 501(c)(7) because you have exceeded the 35% limit on gross receipts for non-member
income for tax year ending       . (Public Law 94-568) Furthermore, you exceeded the permissible
35% limit on gross receipts of non-member income in the tax years ending       and
     , establishing a pattern of non-compliance.

Organizations that are not exempt under Internal Revenue Code (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 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 can file an action for declaratory judgment under the provisions
of Section 7428 of the Code in either:

* The United States Tax Court,
* The United States Court of Federal Claims, or
* The United States District Court for the District of Columbia

You must file a petition or complaint in one of these three courts within 90 days from the date we mailed this
determination letter to you. You can download a fillable petition or complaint form and get information about
filing at each respective court's website listed below or by contacting the Office of the Clerk of the Court at one
of the addresses below. Be sure to include a copy of this letter and any attachments and the applicable filing fee
with the petition or complaint.

Letter 6337 (Rev. 8-2022)
Catalog Number 74808E


You can eFile your completed U.S. Tax Court petition by following the instructions and user guides available
on the Tax Court website at ustaxcourt.gov/dawson.html. You will need to register for a DAWSON account to
do so. You may also file your petition at the address below:

United States Tax Court
400 Second Street, NW
Washington, DC 20217
ustaxcourt.gov

The websites of the U.S. Court of Federal Claims and the U.S. District Court for the District of Columbia contain
instructions about how to file your completed complaint electronically. You may also file your complaint at one of
the addresses below:

US Court of Federal Claims
717 Madison Place, NW
Washington, DC 20439
uscfc.uscourts.gov

US District Court for the District of Columbia
333 Constitution Avenue, NW
Washington, DC 20001
dcd.uscourts.gov

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 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.

Letter 6337 (Rev. 8-2022)
Catalog Number 74808E

You may fax your documents to the fax number shown above, using either a fax machine or online fax service.
Protect yourself when sending digital data by understanding the fax service's privacy and security policies.

Keep the original letter for your records.

Sincerely,

Parvin
[illegible]
Acting Director, Exempt Organizations Examinations

Enclosures:
Publication 1
Publication 594
Publication 892

Letter 6337 (Rev. 8-2022)
Catalog Number 74808E


Department of the Treasury                       March [illegible], 2022
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:

                                                 Telephone:
                                                 Response due date:

                                                 April 07, 2022

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.

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).

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

Sincerely,

Lynn A. Brinkley
Director, Exempt Organizations
Examinations

Enclosures:
Form 886-A
Form 6018

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


Form 886-A (Rev. January 1994)     EXPLANATIONS OF ITEMS          Schedule number or exhibit
Name of taxpayer          Tax Identification Number          Year/Period ended

ISSUE

Whether       , located in       ,       , continues
to qualify for exemption under Section 501(c)(7) of the Internal Revenue Code?

FACTS
The EO was granted tax-exempt status under Internal Revenue Code Section § 501(c)(7) as an
organization described in § 501(c)(7). The organization conducted its operations out of
     . According to its Bylaws, the purposes of the EO are as follows.

       This association shall not, except to an insubstantial degree, engage in
       any activities that are not in furtherance of the primary purpose of the
       association.

The organization filed Form 1024, Application for Recognition of Exemption under
Sections 501(a) and stated the organization’s purpose and activities are as follows:

       We have had parties to promote Memberships at members
       home, set up tables at numerous       , in order to sell
       memberships. Help with names and addresses of
       . Participated at
       and had a float in the       to promote
       membership.

The       originally filed for       shows the following:

Income
Investment Income                                          $
Gross amount from Sale of Securities                       $
Less: Cost or other basis and sale expense                $
Gain from sale of assets other than inventory             $
Total Income                                               $

Expenses
Grants and other similar amounts paid                      $
Professional fees                                          $
Total Expenses                                             $

Net Loss                                                  -$

Form 886-A (1-1994)   Catalog Number 20810W   Page 1   publish.no.irs.gov   Department of the Treasury-Internal Revenue Service


Form 886-A (Rev. January 1994)     EXPLANATIONS OF ITEMS          Schedule number or exhibit
Name of taxpayer          Tax identification Number          Year/Period ended

On       , the Power of Attorney provided board meetings minutes via fax which discuss
the organization's activities for periods       , to       . The board members
would meet       times a year, to provide an update on the organization's financial status and
discussion of scholarship recipients and requirements. No other documentation was provided.

On       , a telephone interview was held with the Power of Attorney. During the
interview, it was stated, “The organization’s primary activities include receiving donations and
issuing scholarships to students who attend       . Total scholarships issued to
the students would be $      to $      per year. In prior years, the organization held alumni
dinners and class reunions with members, to promote membership and to earn contributions.
Investment income is the primary source of income for the organization, contributions are winding
down and alumni dinners did not take place last year. The last alumni dinner was held       years ago.
Also, there are less in person interactions with the other members due to covid. Also, the
organization does not know whether they will continue conducting social activities”.

The organization did not receive exempt function income such as dues, fees, charges or other
amounts paid by members for the taxable year and the subsequent years the Form       was
filed.

The organization reported the following sources and amounts of revenue for the periods ending on
     ,       and       :

Total Nonmember Income                  $       $       $       $
Total Nonmember & Investment Income     $       $       $       $
Total Income                            $       $       $       $
Nonmember % - A/C                       %       %       %       %
Total Nonmember & Investment % - B/C    %       %       %       %

Based on conducting an analysis of gross receipts, it has been noted that the organization received
     % from nonmember and Investment income.

LAW

Form 886-A (1-1994)   Catalog Number 20810W   Page 2   publish.no.irs.gov   Department of the Treasury-Internal Revenue Service

Form 886-A (Rev. January 1994)     EXPLANATIONS OF ITEMS          Schedule number or exhibit
Name of taxpayer          Tax Identification Number          Year/Period ended

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:

(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.

To compute the gross receipts test, the Committee Reports that accompanied P.L. 94-568, state
that social clubs shouldn't receive, within the 15 or 35 percent allowances, any income from
nontraditional business activities. S. Rep. No. 94-1318 (1976). When an organization's
nontraditional income causes the organization to exceed the 15 or 35 percent allowances,
consider whether the organization continues to substantially operate for exempt purposes.

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.

Form 886-A (1-1994)   Catalog Number 20810W   Page 3   publish.no.irs.gov   Department of the Treasury-Internal Revenue Service


Form 886-A (Rev. January 1994)     EXPLANATIONS OF ITEMS          Schedule number or exhibit
Name of taxpayer          Tax Identification Number          Year/Period ended

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.

ORGANIZATION’S POSITIONS
Taxpayer's position has not been provided.

GOVERNMENT'S POSITION
Based on the examination, the organization 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 recreation clubs which are supported solely by membership fees, dues, and
assessments.

The organization has exceeded the 35% of non-member and investment income threshold outlined
in Public Law 94-568. The committee reports of Public Law 94-568 states a social club may received
investment income up to the full 35% of its gross receipts if no income is derived from non-members’
use of club facilities. The organization did not receive income from non-members’ use of club
facilities. However, investment income was       % of the organization’s gross receipts which exceeds
the 35% threshold of income from outside of membership.

Accordingly, it is proposed that the organization’s tax-exempt status be revoked effective
     .

CONCLUSION

The       no longer qualifies for exemption under § 501(c)(7) of the Code
as your nonmember income has exceeded the 35% of non-member and investment income
threshold on a continuing basis. Therefore, it is proposed that your exempt status under § 501(c)(7)
of the Code be revoked effective       .

Form 886-A (1-1994)   Catalog Number 20810W   Page 4   publish.no.irs.gov   Department of the Treasury-Internal Revenue Service