IRS revokes a senior social club's 501(c)(7) exemption for inadequate records and excess nonmember income

Plain-English summary

The IRS revoked the tax-exempt status of a small social club that ran a gathering place for senior citizens. The club had been recognized under section 501(c)(7), which covers social and recreation clubs supported by member dues, fees, and assessments. Such a club may take in only a limited amount of money from outside its membership, generally no more than 35% of gross receipts, with no more than 15% from use of its facilities by the general public. On audit, the IRS found the club kept almost no records: no membership roster, no dues or assessments at all (the organization said its seniors could not afford membership fees), no way to separate member income from nonmember income, no sign-in system or keys to limit access to members, and no documentation of events or attendance, with all transactions said to be in cash. Because the club could not show which income came from members, the IRS treated all of its income as nonmember income, which exceeded the 35% limit on a recurring basis. The IRS also relied on the recordkeeping duties in sections 6001 and 6033, noting that an organization unable to substantiate its operations can lose its exemption. It concluded the club no longer qualified and proposed revocation; when no protest was filed within 30 days, the revocation became final, and the organization must now file Form 1120 as a taxable corporation. The lesson: a 501(c)(7) club has to actually charge and track member dues and keep records separating member from nonmember income, or it risks losing its exemption.

Ruling snapshot

• Question: Should a social club's 501(c)(7) exemption be revoked where it charges no member dues and keeps no records separating member from nonmember income?
• Outcome: Revoked (proposed revocation became final for lack of a timely protest)
• Key authorities: IRC § 501(c)(7); Treas. Reg. § 1.501(c)(7); Pub. L. 94-568 (35% nonmember limit); IRC §§ 6001, 6033; Treas. Reg. §§ 1.6001-1, 1.6033-1(h)(2); Rev. Ruls. 58-589, 66-149, 68-119, 60-324, 59-95; Rev. Proc. 71-17

Full text (IRS public release)

(Scanned document; OCR-proofread. Obvious scan misreads were corrected; wording is preserved verbatim. This release combines the final adverse determination (Letter 4038), the proposed revocation (Letter 3618), and the audit report (Form 886-A). Blanks where identifying details, amounts, and dates were redacted appear as gaps in the original.)

Revenue Service 02/27/2023

Tax Exempt and Government Entities
IRS PO Box 2508

Cincinnati, OH 4520

Fai} Department of the Treasury Internal Date:

Employer ID number:

Form you must file:
Form 1120
Tax years:

All

Person to contact:

Release Number: 202321015
Release Date: 5/26/2023
UIL Code: 501.04-00,
501.04-07

Dear

This letter is our 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)(4). Recently, we sent
you a proposed adverse determination in response to your application. The proposed adverse determination
explained the facts, law, and basis for our conclusion, and it gave you 30 days to file a protest. Because we
didn't receive a protest within the required 30 days, the proposed determination is now final.

You must file the federal income tax forms for the tax years shown above within 30 days from the date of this
letter unless you request an extension of time to file. For further instructions, forms, and information, visit
www.irs.gov.

We'll make this final adverse determination letter and the proposed adverse determination letter available for
public inspection after deleting certain identifying information, as required by IRC Section 6110. Read the
enclosed Letter 437, Notice of Intention to Disclose - Rulings, and review the two attached letters that show our
proposed deletions. If you disagree with our proposed deletions, follow the instructions in the Letter 437 on how
to notify us. If you agree with our deletions, you don't need to take any further action.

If you have questions about this letter, you can call the contact person shown above. If you have questions
about your federal income tax status and responsibilities, call our customer service number at 800-829-1040
(TTY 800-829-4933 for deaf or hard of hearing) or customer service for businesses at 800-829-4933.

Sincerely,

Stephen A. Martin
Director, Exempt Organizations
Rulings and Agreements

Enclosures:

Letter 437

Redacted Letter 4034
Redacted Letter 4038

Letter 4038 (Rev. 11-2021)
Catalog Number 47632S

Date: September 6, 2022

Internal Revenue Service Taxpayer ID number:

Ai Department of the Treasury
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:

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).

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.

Sincerely,

Lynn A. Brinkley
Acting Director, Exempt Organizations
Examinations

Enclosures:
Form 886-A
Form 6018
Publication 892
Publication 3498

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

Form 886-A Department of the Treasury — Internal Revenue Service Schedule number
» xhibi

(May 2017) Explanations of Items

Name of taxpayer Tax Identification Number (/ast 4 digits) | Year/Period ended
ISSUE
Whether the qualifies for exemption under IRC §
501(c)(7)?
FACTS
The is currently recognized as an

exempt organization described in IRC § 501(c)(7) to provide social, recreational and other activities
to its members. The benefits provided to the members include, but are not limited to, the following
activities as reported by the organization:

e During the interview:

e In written statement sent as IDR response:

On the original Articles of Incorporation filed on , with the , the
purpose was as follows:

"The specific purpose of this corporation is to provide activities for the recreation and
pleasures of senior citizens, and other related activities under Revenue and Taxation
Code Section 23701g and Internal Revenue Code Section 501 (c) (7).”

Later the organization’s purpose was amended on , to include:

“This corporation is a nonprofit mutual benefit corporation organized under the Nonprofit
Mutual Benefit Corporation Law. The purpose of this corporation is to engage in any lawful
act or activity for which a corporation may be organized under such law."

The received its determination letter providing
the organization tax exemption on , based on the information on the Form 1024.
The letter stated the requirements for maintaining that tax exemption as a section 501(c)(7) entity.

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

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

886-A Department of the Treasury — Internal Revenue Service Schedule number

Form “ . or exhibit

(May 2017) Explanations of Items

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

Gross Receipts
Membership Dues and Assessments
Interest on savings and investments

Other Revenue

Total Nonmember & Investment Income

Total Income

Member Gross Receipts from Dues or Member Revenue %

Nonmember Gross Receipts %
While reviewing the and internal documents provided by the organization, such as
monthly bank statements, answers during the interview held on , and written
answers provided on via fax, it has been noted that the organization did not
provide a break down between member and nonmember income. The nonmember income has not
been recorded in the . There were no accounting records provided - only
the monthly bank statements. The monthly bank statements provided by the Organization for the
calendar year of came from this bank account:

The account number shows the same on all documents provided as seen above with the x’s and
the last four digits of the account. The organization did not provide the full account number, but the
banking statements looked as if they came from the original documents the organization received
from the bank on a monthly basis.

From a written answer, in an answer to IDR #2 on a fax on

“No membership fee collected. No actual or particular members. People
cannot afford those. They just want a place to gather and "gossip".

Income came in from the use the facilities for gatherings such as

There are no records as to what income came from members and what income came from non-
members. There was no membership roster provided. During the interview the organization stated
that senior members typically visiting the facility were in the range between to _ in number of
people that consistently visited the facilities. The organization also stated during the interview some
of the “members” had passed away, so group became smaller since inception in

There are three facts for this organization:

Catalog Number 20810W Page 2 www. irs.gov Form 886-A (Rev. 5-2017)

Department of the Treasury ~ Internal Revenue Service Schedule number
Form 886-A oP ry

(May 2017) Explanations of Items or exhibit

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

1) The organization does not have revenue coming from members because it does not collect
either membership fees or any membership assessments. No membership roster was provided
by the organization for the exam year or the current year.

2) The organization did not have any records to show a system for allowing only members access
to the organization’s facility and to exclude nonmembers. There are no sign-in sheets,
cards/keys for members or other measures used by 501(c)(7) organizations to exclude
nonmembers from coming into the organization’s facility. The organization also does not have a
system to have members bring in guests on to the premises.

3) The organization did not have records showing what events took place and who was in
attendance. There was no calendar of events or any documentation of the activities that they
provided.

All of the transactions are said to have been made in cash.

The organization filed a for the year ended on and did not file a

The organization was honest about saying that the people it served did not pay membership dues
or assessments. There is no information on the number of people using the facilities. During the
interview, the main income was stated to be coming in from games, but details on the amount of
people or how much they typically spent were not documented. They said they had coffee and
donuts sometimes, but it was part of what people brought in. Also, among the written answers it
says, “people cannot afford [membership fees]” because “these are seniors receiving their social
security checks from retirement and could not afford membership fees.

The organization just did not document the information necessary to fulfill the documentation
requirements of a 501(c)(7) organization.

LAW

Membership

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

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

Department of the Treasury — Internal Revenue Service Schedule number
Form 886-A P uy 0

(May 2017) Explanations of Items or exhib

Name of taxpayer Tax Identification Number (/ast 4 digits) | Year/Period ended

club that has non-member income and/or investments has to meet the nonmember gross receipts
or income limitations set by Congress which is a maximum of 35% of gross receipts.

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 Reports state 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.

(d) The Senate report also indicates that even though gross receipts from the general public
exceed this standard, it does not necessarily establish that there is a nonexempt purpose. A
conclusion that there is a nonexempt purpose will be based on all the facts and circumstances
including, but not limited to, the gross receipts factor.

Revenue Ruling 58-589 sets forth the criteria for exemption under section 501 (c)(7) of the Code
and provides that a club must have an established membership of individuals, personal contacts,
and fellowship. It also provides that, while the regulations indicate that a club may lose its
exemption if it makes its facilities available to the general public, this does not mean that any
dealings with nonmembers will automatically cause a club to lose its exemption. A club may
receive some income from the general public, that is persons other than members and their bona
fide guests or permit the general public to participate in its affairs, provided that such participation
is incidental to and in furtherance of the club's exempt purposes, such dealings with the general
public and the receipt of income therefrom does not indicate the existence of a club purpose to
make a profit, and the income does not inure to club members.

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. The statute
contemplates that clubs falling within the scope of section 501(c)(7) of the Code are designed
primarily to provide for the pleasure and recreation of members. These activities may be

Catalog Number 20810W Page 4 Www. irs.gov Form 886-A (Rev. 5-2017)

Form 886-A Department of the Treasury — Internal Revenue Service Schone number
= . or exhibi
(May 2017) Explanations of Items

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

supported by funds obtained from members, such as dues, assessments, and payment for the use
of club facilities. However, to the extent that income is derived from nonmember sources, it inures
to the benefit of the members. If such activities are other than incidental, trivial, or nonrecurrent, it
is considered that they are intended to produce income and are reflective of a purpose
inconsistent with exemption under section 501(c)(7) of the Code.

Revenue Ruling 68-119 provides that a club will not necessarily lose its exemption if it derives
income from transactions with other than bona fide members and their guests, or if the general
public on occasion is permitted to participate in its affairs, provided such participation is incidental
to and in furtherance of its general club purposes and the income therefrom does not inure to
members.

Revenue Ruling 60-324 provides that a social club that made its social facilities available to the
general public through its member-sponsorship arrangement cannot be treated as being operated
exclusively for pleasure, recreation, or other nonprofitable purposes and the club no longer
qualified for exemption under 501 (c)(7) of the Code.

Revenue Procedure 71-17 sets forth guidelines for determining the effect of gross receipts derived
from nonmember use of a social club's facilities on exemption under Internal Revenue Code
Section 501 (c)(7) and recordkeeping requirements. Revenue Procedure 71-17 requires section
501 (c)(7) organizations to substantiate the status of individuals that use the organization's facility
as either member or non-member. For groups of eight (8) people or less, the presumption is that
the non-members in that party are guests of the member provided the member or the member's
employer pays for such use of the facility. For groups larger than eight (8) persons, the
organization can substantiate the status of the non-members as guests if records are kept that
show that seventy-five percent (75%) or more of the persons in such a group are members and
that a member or the member's employer pays for such use of the facility. In either of these
circumstances described above, the activities involving the individuals is considered to be an
exempt social function carried on by the club, and the income derived by the club for the
entertainment of non-members as bona fide guests of members is not unrelated business income.
However, if the club fails to maintain these records and cannot show that the conditions set forth
above have been met, all such income derived by the club is assumed to be non-member income;
this income is subject to taxation as unrelated business income and is not considered exempt
function income.

Inadequate Records

IRC § 6001 provides that every person liable for any tax imposed by the IRC, or for the collection
thereof, shall keep adequate records as the Secretary of the Treasury or his delegate may from
time to time prescribe.

IRC § 6033(a)(1) provides, except as provided in IRC § 6033(a)(2), every organization exempt
from tax under section 501(a) shall file an annual return, stating specifically the items of gross

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

Form 886-A Department of the Treasury — Internal Revenue Service Scheciule number
“ . or exhibi
(May 2017) Explanations of Items

Name of taxpaver Tax Identification Number (last 4 digits) | Year/Period ended

income, receipts and disbursements, and such other information for the purposes of carrying out
the internal revenue laws as the Secretary may by forms or regulations prescribe, and keep such
records, render under oath such statements, make such other returns, and comply with such rules
and regulations as the Secretary may from time to time prescribe.

Treas. Reg. § 1.6001-1(a) in conjunction with Treas. Reg. § 1.6001-1(c) provides that every
organization exempt from tax under IRC § 501(a) and subject to the tax imposed by IRC § 511 on
its unrelated business income must keep such permanent books or accounts or records, including
inventories, as are sufficient to establish the amount of gross income, deduction, credits, or other
matters required to be shown by such person in any return of such tax. Such organization shall
also keep such books and records as are required to substantiate the information required by IRC
§ 6033.

Treas. Reg. § 1.6001-1(e) states that the books or records required by this section shall be kept at
all times available for inspection by authorized internal revenue officers or employees; and shall
be retained as long as the contents thereof may be material in the administration of any internal
revenue law.

Treas. Reg § 1.6033-1(h)(2) provides that every organization which has established its right to
exemption from tax, whether or not it is required to file an annual return of information, shall
submit such additional information as may be required by the district director for the purpose of
enabling him to inquire further into its exempt status and to administer the provisions of
subchapter F (section 501 and the following), chapter 1 of the Code and IRC § 6033.

Rev. Rul. 59-95, 1959-7 C.B. 627, concerns an exempt organization that was requested to
produce a financial statement and statement of its operations for a certain year. However, its
records were so incomplete that the organization was unable to furnish such statements. The
Service held that the failure or inability to file the required information return or otherwise to
comply with the provisions of IRC § 6033 and the regulations which implement it, may result in the
termination of the exempt status of an organization previously held exempt, on the grounds that
the organization has not established that it is observing the conditions required for the continuation
of exempt status.

TAXPAYER’S POSITION

Taxpayer's position has not been provided from this report. However, a partial statement from the
organization during the examination is that they did not want to charge membership fees, would
close down the 501(c)(7) and

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

Form 886-A Department of the Treasury — Internal Revenue Service Schedule number
. or exhibi
(May 2017) Explanations of Items

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

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 provide that in general, this
exemption extends to social and recreation clubs which are supported solely by membership fees,
dues, and assessments.

Since the organization does not charge any membership dues or assessments, it does not fulfill
the requirements and the limitation on non-member income for 501(c)(7) organizations. The
Organization exceeded the 35% non-member gross receipts limitation as outlined in Public Law
94-568, on a recurring basis during the tax year under examination ending

The Organization has a small . facility with a commercial lease, so only 15% of gross
receipts could come from non-member use of this space. However, there are no records and they
stated during the interview that there are about —_ people that typically gathered on a consistent
regular basis. This number of people would have to donate, contribute or buy enough
merchandise from the club of to generate about $ per member per month. Although they
stated they were all retired receiving social security checks and could not afford a membership.
The president of the club stated that they wouldn't pay for a membership, because they could not
afford it on their limited budgets. The organization did not provide a membership roster to date or
distinguish between member and non-member incomes. There were no records or a statement
that said how they prevented non-members from coming into their club facilities. The Organization
also did not file a for the year ended

If there are no records to keep track of member vs. non-member income. This organization is like
the one referenced in Rev. Rul. 59-95, in that the social club did not keep detailed enough records
to show that only members (or mostly members) contributed to the pooling of resources such as a
501(c)(7) social club is supposed to maintain.

There are also requirements when there is use of facilities by members when there is a party that
at least 75% of attendees would have to be members. But there are no records on that instances
when the facilities were used in such a manner.

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

CONCLUSION

The reason why the no longer qualifies for

exemption under § 501(c)(7) of the Code is that the organization has not kept appropriate records
and since there are no distinctions on nonmember income and member income, all income has to
be classified as the nonmember income and has exceeded the 35% nonmember limits on a
continuing basis. Therefore, it is proposed that its exempt status under § 501(c)(7) of the Code be
revoked effective

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

Form 886-A
(May 2017)

Department of the Treasury — Internal Revenue Service

Explanations of Items

Schedule number
or exhibit

Name of taxpaver

Tax Identification Number (last 4 digits)

Year/Period ended

Should this revocation be upheld,

must be filed starting with tax periods ending

Catalog Number 20810W

Page 8 WwW. irs.gov

Form 886-A (Rev. 5-2017)