Social club lost exemption after gas rights income exceeded the nonmember limit

Plain-English summary

A social and recreation club entered an agreement to sell its gas and mineral rights. The resulting investment income and royalties consistently exceeded 35 percent of the club's total income, the limit for income from nonmember sources described in the audit report. The IRS concluded that the club's gas leasing activity was substantial and did not further its exempt purposes under section 501(c)(7). It revoked the club's exemption effective January 1, 2023, and required the club to file corporate income tax returns. The analysis relied on section 501(c)(7), Treasury Regulation section 1.501(c)(7)-1, Public Law 94-568, Revenue Ruling 66-149, and court decisions involving clubs with substantial timber, oil, gas, or other nonmember income.

Ruling snapshot

• Question: Could the social club retain section 501(c)(7) status after gas and mineral rights income repeatedly exceeded the 35 percent nonmember income limit?
• Outcome: revocation
• Key authorities: IRC §§ 501(a), 501(c)(7), 7428; Treas. Reg. § 1.501(c)(7)-1; Rev. Rul. 66-149; P.L. 94-568

Full text (IRS public release)

Department of the Treasury
Internal Revenue Service
IRS Independent Office of Appeals

Release Number: 202401018
Release Date: 1/5/2024

Date: OCT 12 2023

Person to contact:
Name:
Employee ID Number:
Phone:
Fax:
Employer ID number:

Uniform Issue List (UIL):
501.07-05

Certified Mail

Dear :

This is a final adverse determination that you do not 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).

We have hereby revoked the favorable determination letter to you dated and you are no longer exempt under
IRC Section 501(a) effective 01/01/2023.

We made the adverse determination for the following reasons:

You are not organized for pleasure, recreation, and other nonprofitable purposes because a substantial amount
of your activities (gas leasing) is not in furtherance of exempt purpose under IRC section 501(c)(7), regulations,
and applicable revenue rulings, and may have caused inurement.

You're required to file federal income tax returns on Forms 1120, U.S. Corporation Income Tax Return. Mail
your form to the appropriate Internal Revenue Service Center per the form's instructions. You can get forms and
instructions by visiting our website at IRS.gov/forms or by calling 800-TAX-FORM (800-829-3676).

We'll make this letter and the proposed adverse determination letter available for public inspection under IRC
Section 6110 after deleting certain identifying information. We provided to you, in a separate mailing, Notice 437,
Notice of Intention to Disclose. Please review the Notice 437 and the documents attached that show our proposed
deletions. If you disagree with our proposed deletions, follow the instructions in Notice 437.

If you decide to contest this determination, you can file an action for declaratory judgment under the provisions
of IRC Section 7428 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

Letter 1371 (Rev. 9-2022)
Catalog Number 40683R

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.

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:

U.S. Court of Federal Claims

717 Madison Place, NW

Washington, DC 20439

uscfc.uscourts.gov

U.S. District Court for the District of Columbia

333 Constitution Avenue, NW

Washington, DC 20001

dcd.uscourts.gov

Note: We will not delay processing income tax returns and assessing any taxes due even if you file a petition for
declaratory judgment under IRC Section 7428.

Taxpayer rights and sources for assistance

The Internal Revenue Code (IRC) gives taxpayers specific rights. The Taxpayer Bill of Rights groups these into
10 fundamental rights. See IRC Section 7803(a)(3). IRS employees are responsible for being familiar with and
following these rights. For additional information about your taxpayer rights, please see the enclosed Publication 1,
Your Rights as a Taxpayer, or visit IRS.gov/taxpayer-bill-of-rights.

The Taxpayer Advocate Service (TAS) is an independent organization within the IRS that helps taxpayers and
protects taxpayers’ rights. TAS can offer you help if your tax problem is causing a financial difficulty, you've
tried but been unable to resolve your issue with the IRS, or you believe an IRS system, process, or procedure
isn't working as it should. If you qualify for TAS assistance, which is always free, TAS will do everything
possible to help you. To learn more, visit taxpayeradvocate.IRS.gov or call 877-777-4778.

Tax professionals who are independent from the IRS may be able to help you.

Low Income Taxpayer Clinics (LITCs) can represent low-income persons before the IRS or in court. LITCs can
also help persons who speak English as a second language. Any services provided by an LITC must be for free
or a small fee. To find an LITC near you:

• Go to taxpayeradvocate.IRS.gov/litcmap;
• Download IRS Publication 4134, Low Income Taxpayer Clinic List, available at IRS.gov/forms; or
• Call the IRS toll-free at 800-829-3676 and ask for a copy of Publication 4134.

Letter 1371 (Rev. 9-2022)
Catalog Number 40683R

State bar associations, state or local societies of accountants or enrolled agents, or other nonprofit tax professional
organizations may also be able to provide referrals.

TAS assistance is not a substitute for established IRS procedures, such as the formal appeals process. TAS
cannot reverse a legally correct tax determination, or extend the time fixed by law that you have to file a petition
in a United States Court.

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

Sincerely,

Doug O'Donnell
Acting Commissioner
By

Appeals Team Manager

Enclosures:
Publication 1
IRS Appeals Survey

cc:

Letter 1371 (Rev. 9-2022)
Catalog Number 40683R

Department of the Treasury
Internal Revenue Service
IRS Tax Exempt and Government Entities

Date:
October 27, 2021

Taxpayer ID number:

Form:

Tax periods ended:

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

Manager's contact information:
Name:
ID number:
Telephone:
Response due date:
November 12, 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
(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,

For:

Sean E. O’Reilly
Director, Exempt Organizations Examinations

Enclosures:
Form 886-A
Form 6018

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

Form 886-A
(May 2017)
Department of the Treasury - Internal Revenue Service
Explanations of Items

Name of taxpayer
Tax Identification Number
Year/Period ended
Schedule number or exhibit

Issue:

has failed to meet the eligibility requirements under Internal
Revenue Code Section 501(c)(7) as the organization’s investment income has exceeded the limit of non-
member income imposed by the Code. Because the organization has consistently exceeded the 35-percent
non-member income limit, should the organization retain its tax-exempt status under the Internal Revenue
Code 501(c)(7)?

Facts:

was organized under State Law on

filed form 1024 for exemption under IRC 501(c)(7) on

received Determination Letter 948 (DO/CG) on
, granting the organization tax exempt status under IRC Section 501(c)(7).

primary purpose is promoting the conservation of forests,
fields and streams of the State of , promoting better fishing and hunting in the State.

maintains a property in , in
. The organization’s members meet and conduct the club’s activities on this property.

had approximately members during the year under
examination.

has filed a for the tax years ending
through .

has filed a for the tax years ending
through tax year ending .

The Service has reviewed the and reporting period starting and
ending .

In , the organization entered into an agreement to sell their gas / mineral rights.

The income received from the promissory note has been reported on their and for
the period of through .

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

Form 886-A
(May 2017)
Department of the Treasury - Internal Revenue Service
Explanations of Items

Name of taxpayer
Tax Identification Number
Year/Period ended
Schedule number or exhibit

Facts (Continued):
The organization has reported the following amounts for Investment Income and Royalties (Non-Member
sourced Income) on their books and records and on their and returns for the Tax
Year Ending:

, Non-member Income of $ which is -percent of the total income of $ .
, Non-member Income of $ which is -percent of the total income of $ .
, Non-member Income of $ which is -percent of the total income of $ .

Law:

Internal Revenue Code § 501(c)(7) - Social Clubs
Clubs organized for pleasure, recreation, and other nonprofitable purposes, substantially all of 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.

Treasury Regulation 1.501(c)(7)-1 Social Clubs

(a) The exemption provided by section 501(a) for organizations described in section 501(c)(7) applies only
to clubs which are organized and operated exclusively for pleasure, recreation, and other nonprofitable
purposes, but does not apply to any club if any part of its net earnings inures to the benefit of any private
shareholder. 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 through the use of club facilities or in connection with
club activities.

(b) A club which engages in business, such as making its social and recreational facilities available to the
general public or by selling real estate, timber, or other products, is 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.

P.L. 94-568

Before 1976, IRC Section 501(c)(7) required a tax-exempt club to be organized and operated “exclusively”
for pleasure, recreation, and other nonprofitable purposes. P.L. 94-568 amended IRC Section 501(c)(7) to
require that “substantially all” of a tax-exempt club’s activities are dedicated for pleasure, recreation, and
other nonprofitable purposes. The amendment was intended to allow IRC Section 501(c)(7) organizations
to receive up to 35 percent of their gross receipts, including investment income, from sources outside their
membership without losing their exempt status. See S. Rep. No. 94-1318 (1976). Within the 35 percent, no
more than 15 percent of gross receipts should come from the general public’s use of the social club's
facilities or services. If an organization has outside income over the 35-percent or 15-percent limit, the
organization is in jeopardy of losing their tax-exempt status.

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

Form 886-A
(May 2017)
Department of the Treasury - Internal Revenue Service
Explanations of Items

Name of taxpayer
Tax Identification Number
Year/Period ended
Schedule number or exhibit

Law (Continued):

Revenue Ruling 66-149

Rev. Rul. 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.

Adirondack League Club, Petitioner v. C.I.R. Respondent

Petitioner is a nonprofit New York membership corporation organized and operated for: (1) The
preservation and conservation of the Adirondack forests and the proper protection of game and fish in the
Adirondack Region. (2) The establishment and promotion of an improved system of forestry. (3) The
maintenance of an ample preserve for the benefit of its members for the purpose of hunting, fishing, rest,
and recreation. Petitioner lost its tax-exempt status as of 1943 upon respondent's determination that
petitioner received a substantial amount of income from timber operations conducted on its property. Aside
from its timber income, petitioner collected membership dues and charged fees for the facilities and services
used by members and their guests. The expenses incurred in maintaining and providing the facilities and
services exceeded the membership dues and fees charged for them and petitioner offset the excess expenses
against the timber income with the result that petitioner reported no taxable income during the years in issue.
Held, to the extent the expenses incurred in maintaining and providing facilities and services for members
exceeded the income received therefrom, they are not deductible under sec. 162(a), since they did not arise
from the ‘carrying on of any trade or business' within the intendment of that section.

Coastal Club, Inc., 43 T.C. 783 (1965)

By transactions entered into for profit petitioner, a corporation, organized as a duck hunting club, repeatedly
leased its property for the exploration for and production of oil and gas. During the years in issue the oil and
gas income predominantly exceeded the amounts received from its members in the form of dues, and service
and guest charges, and supplied from in excess of two-thirds to as much as four-fifths of the amounts
required and expended for operations, repairs, maintenance, and improvements. And not only that but
through such income plus the interest from U.S. Government bonds in which the oil and gas income
remaining after payment of club costs had been invested, petitioner built its accumulated surplus. It was
held, that respondent did not err in his determination that petitioner, during the taxable years, was not
exempt from tax under section 501(c)(7) of the Internal Revenue Code. It was further held, that respondent
did not abuse his discretion in revoking his prior ruling of exemption.

West Side Tennis Club v. Commissioner (111 F.2d 6)

The court determined that more than an insubstantial amount of income received from non-members would
jeopardize the tax-exempt status of an organization described in IRC § 501(c)(7).

Taxpayer Position:
The taxpayer has not provided a position at this time.

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

Form 886-A
(May 2017)
Department of the Treasury - Internal Revenue Service
Explanations of Items

Name of taxpayer
Tax Identification Number
Year/Period ended
Schedule number or exhibit

Government Position:

investment income has consistently exceeded the 35-
percent non-member income limit imposed by the Code. The organization entered into an agreement to sell
their gas / mineral rights. The organization has been reporting the investment income on their
and .

The organization has consistently exceeded the 35-percent limit imposed under the Code. The Service has
provided the information reported on the organization’s returns for the periods starting on
and ending on .

Below are the calculations of the Percentage of Total Revenue for all income sources for

MEMBER INCOME
Contributions / Grants
Program Service Revenue
Other Income
Member Sourced Income
Member Income Percent

NON-MEMBER INCOME
Investment Income
Royalties
Non-Member Sourced Income
Non-Member Income Percent

TOTAL REVENUE

Using the information obtained from the organization’s records and the information previously reported on
filed returns, the Investment Income and Royalties as a
percentage of Total Revenue, the organization has consistently exceeded the 35-percent non-member
income limit imposed by the Internal Revenue Code.

Social clubs are permitted to receive income from non-member sources, but when that income exceeds 35-
percent, the organization’s exemption is in jeopardy of being revoked. As the organization has consistently
exceeded the limits imposed by the Internal Revenue Code, the Treasury Regulations, and further specified
in Public Law 94-568. Also, as per the terms of the agreement, the organization’s investment income and
royalties will continue to exceed the Code limits for the foreseeable future.

As the organization has egregiously exceeded the non-member limits imposed by the code there is no way
that the organization can retain its tax-exempt status. The organization has reported non-member income
that has averaged approximately -percent of their total income during the period examined.

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

Form 886-A
(May 2017)
Department of the Treasury - Internal Revenue Service
Explanations of Items

Name of taxpayer
Tax Identification Number
Year/Period ended
Schedule number or exhibit

Conclusion:
The action of entering into an agreement to sell their gas
and mineral rights has led to the generation of non-member investment income and royalties. The income
generated on the sale of the drilling rights, as evidenced on the in the agreement, made by the organization,
has caused the organization to consistently exceed the 35-percent non-member income limit imposed by the
Internal Revenue Code.

This has led to the determination that the organization is no longer qualified under Internal Revenue Code
Section 501(c)(7), and the organization’s tax-exempt status must be revoked.

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