June 2008

Requirements for Tax-Exempt Status under IRC § 501(c)(7): A Primer for Social Clubs

17 min

Most club managers - thankfully - are not attorneys or accountants. Yet, understanding the scope and limits of the federal tax-exempt status that underlies so many cubs is critical to avoiding the significant pitfalls that might otherwise befall your club. A nuanced understanding of these rules also may offer the door to opportunities of which you were never previously aware. This article is designed to present a comprehensive overview of the complex standards and restrictions that govern tax-exempt clubs.

Internal Revenue Code ("IRC" or the "Code") § 501(c)(7) provides social and recreational clubs with an exemption from federal taxation of income derived from providing services related to its tax-exempt mission. Generally, the Code and Treasury Regulations (the "Regs") provide that entities organized and operated for pleasure, recreation, and other similar nonprofit purposes may be exempt from federal income tax.1 The nature of the activity, pastime, or hobby is not material so long as an organization exhibits the requisite social character. As one court noted:

There are doubtless more different kinds of clubs than there are clubs in a deck of cards... Some clubs feature exclusively the intellectual, or artistic; some amateur athletics and sports; and other epicurean, terpsichorean, or social side: all falling clearly within the exemption.2

Generally, the Internal Revenue Service ("IRS" or the "Service") imposes the following requirements on organizations exempt from federal income tax under IRC § 501(c)(7):

  1. The organization must be a club composed of individuals;
  2. The club must be organized for pleasure, recreation, and other nonprofit purposes;
  3. Substantially all of the organization's activities must be for pleasure, recreation, and other nonprofit purposes;
  4. No part of the organization's net earnings may inure to the benefit of a private shareholder; and
  5. The organization is prohibited from discriminating on the basis of race, color, or religion.

1) The organization must be a club composed of individuals.3

Though the term "club" is not defined, the IRM indicates that clubs have the following characteristics: membership of individuals, personal contact, commingling of members, fellowship among members, and shared interests and goals among members.4

Generally, club members should consist of individuals and not associations of other clubs.5 For purposes of determining whether a member is an individual or an organization, the Service has focused on who the membership is issued to. For instance, where membership privileges are issued to an individual subject to the social club's usual approval procedures, regardless of whether a corporation pays the membership dues, the member will be the approved individual.6 However, where membership privileges are provided to a corporation that has the right to select its representatives at club functions without regard to the club's usual member approval procedures, the member is the corporation.7

The Service has indicated that the comingling of members distinguishes tax exempt social and recreational organizations from their commercial counterparts. An organization can demonstrate commingling among members through meetings, gatherings, and the use of regular organization facilities.8 However, organizations that do not allow more than incidental contact between members are not entitled to exemption.9

2) The club must be organized for pleasure, recreation, and other nonprofit purposes.10

A social club's governing document cannot authorize the club to engage in activities beyond the scope of § 501(c)(7).11 A club whose governing documents authorize it to engage in nonexempt activities must amend its governing documents in order to satisfy the statute.12 An organization that previously operated under a disqualifying charter that has since been amended to comply with the statute will be exempt "effective the first annual accounting period in which the proscribed activity was not carried on."13

3) Substantially all of the organization's activities must be for pleasure, recreation, and other nonprofit purposes.14

In determining whether this requirement is met, the Service has examined the activities of social clubs in light of: the gross receipts test, an analysis of the facts and circumstances, and an analysis of whether the clubs were engaged in a nontraditional business activity.

a. Activities not in furtherance of pleasure, recreation, and other nonprofit purposes

In determining whether activities are in furtherance of a social club's exempt purpose, the Service has looked to the nature of the club's activities, the beneficiaries of the club's activities and facilities, and the character of the members using the facilities.

Generally, all unrelated activities fail to qualify as activities in furtherance of pleasure, recreation, and other nonprofit purposes. To this end, guidance from the Service indicates that income from such activities will not be treated as membership income under § 501(c)(7).15 In addition to the nonexempt services provided to members, exempt recreational activities for the benefit of nonmembers are also unrelated to a social club's exempt purpose. Thus, revenue derived from such activities is treated as nonmember income.16 As Sections 3(b) and (c) below explain, § 501(c)(7) contains strict limitations on how much of a club's revenue may be derived from membership services.

Revenue Procedure ("Rev. Proc.") 70-17 provides guidance regarding whether income is derived from nonmember use of club facilities. According to Rev. Proc. 70-17, the following assumptions will be made regarding the characterization of income derived from activities and services provided to nonmembers:

  1. member use is presumed where a group of eight or fewer individuals, one of whom is a member, uses the club facilities and payment for use of the facilities is provided by the member;
  2. member use is presumed where 75% or more of a group using the club facilities are members and payment for use of the facilities is provided by the member; 
  3.  when payment is made by a member's employer, it is assumed that the use of the club's facilities serve a direct business objective of the employee-member; and
  4. in all other situations it will be assumed that the facilities were used by nonmembers.

The character of a member is also a factor in determining whether receipts are derived from nonmembership sources. As stated above, proceeds derived from the general public are not derived from members and, therefore, would not be derived from exempt activities. As discussed above, the Service has ruled that corporate membership fees may be characterized as revenue derived from the general public and not from individual members.17

b. Gross receipts test

To be exempt, substantially all of an organization's activities must be for a purpose provided under § 501(c)(7). As such, a social club may receive up to 35% of its gross receipts from sources outside of its membership without risking its tax-exempt status. Within this 35%, no more that 15% of the organization's gross receipts are to be derived from the use of the club's facilities or services by the general public.18

For the purposes of this test, the term "gross receipts" means receipts from the club's normal and usual activities, including investment income. However, the term shall not include unusual amounts of income such as nonrecurring sales of property.19

c. Facts and circumstances test

If the amount of gross receipts a social club receives from nonmember activities exceeds the permissible amounts provided by the gross receipts test, then the organization will be subject to a facts and circumstances test. Though the particular facts and circumstances are not defined, guidance issued by the Service has looked to the club's use of proceeds, overall activities, and recordkeeping practices.20

d. Nontraditional business

Generally, a social club engaged in business activities is not operated for pleasure, recreation, and other nonprofitable purposes.21 In determining whether a club's activities go beyond the scope of § 501(c)(7), the Service has looked to whether the club's activities are social or service-oriented, whether the activities are incidental to its exempt purposes, and whether its business activities are recurring. The Service has used the term "nontraditional business" activities to describe such business activities. Conducting more than an insubstantial amount of nontraditional business activities will jeopardize a social club's tax-exempt status.22

Guidance provided by the Service indicates that social clubs that provide services to members are engaged in nontraditional business activities.23 Additionally, clubs that engage in both social activities for their members and non-social activities may not qualify for exemption unless the nonexempt activity is incidental to the organization's recreational activities.24

Another consideration is whether a social club engages in business activities in a more than incidental manner. The Service has determined that an club must not engage in nonmember activities for the purpose of deriving a profit.25 Further, the solicitation of public patronage through advertisements is "prima facie evidence that the club is engaged in business and is not being operated exclusively for pleasure, recreation or social purposes."26 However, public participation in club activities "is permissible if incidental to and in furtherance of the club's purpose."27

Finally, an incidental, nonrecurrent sale of property will not deprive a club of its exemption.28Citing the case of Santee Club v. White, the Service stated that nonrecurring activities such as the sale of property no longer suitable for club purposes will not affect a social club's exempt status.29 Additionally, unusual amounts of income, such as the sale of a clubhouse or similar facility, shall not be included in the social club's gross receipts for purposes of the 35% test.30

4) No part of the organization's earning may inure to the benefit of private individuals.

Generally, a social club that engages in recurring, nonincidental, profit-driven activities that result the inurement of a private benefit to its members is engaged in nonexempt activities. Therefore, social clubs engaged in such activities are not exempt under § 501(c)(7). Common types of inurement analyzed by the Service include: compensation,31 distributions to members, income from nonmember sources used to benefit members, and disproportionate payments by different classes of members.

Not all distributions to members will be characterized as inurement. Generally, a determination of whether a distribution will constitute inurement depends on the source of the proceeds and the primary purpose of the activity. A review of the source of the funds used for the distribution will determine whether the funds were derived from membership or nonmembership sources. Funds distributed to members that are derived solely from membership sources generally will not result in private inurement, while distributions of nonmembership or mixed funds may result in inurement.32 Further, if the distribution is the result of an activity not engaged for a profit, the activity may not affect the club's exempt status.33

Net earnings from nonmember sources "may inure to members in such forms as an increase in services offered by a social club without a corresponding increase in membership dues or other fees."34 This reasoning was derived from the Court's analysis in West Side Tennis Club v. Commissioner of Internal Revenue,35 in which the Court examined the activities of a tennis club that held professional tennis matches to generate revenue used for club enhancements. The Court ruled that where nonmember proceeds derived from the professional tennis matches were used for club enhancements, the tennis club's net earning inured to the benefit of its members.36 However, this ruling does not universally prohibit clubs from holding events at which public attendance is permitted, nor does it prohibit the use of such events to raise funds for club enhancements. This holding merely prohibits the use of funds obtained form nonmember sources on club enhancements without a corresponding membership expense.37

Disproportionate fees charged to different classes of members with equal rights to use the facilities of a social club may result in inurement of the club's net earnings to its members.38 However, a fee structure charging different fee amounts to different membership classes will not violate the private inurement proscription of § 501(c)(7) where the right to use club facilities is proportional to the fees charged to each membership class.39

5) The organization is prohibited from discriminating on the basis of race, color, or religion.

Generally, tax-exempt social clubs are prohibited from having a written policy of discrimination against any person on the basis of race, color, or religion.40 However, the prohibition against discrimination based on religion does not apply to: a club which, in good faith, limits its members to a particular religion in order to further the teachings of that religion; or auxiliaries of tax-exempt organizations described in § 501(c)(8) that limit membership to members of a particular religion.41 Additionally, the Service has ruled that the prohibition against racial discrimination does not extend to discrimination against ethnic groups.42

It should be noted that the discrimination prohibition provided by § 501(i) is limited to the written policies of the organization and does not extend to the organization's activities.43 Further, the Service has indicated that it will apply this section of the Code literally and that an affirmative statement of nondiscrimination is unnecessary.44

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As the summary above makes clear, the complex requirements of § 501(c)(7) can be a precarious trap for the unwary club manager. Fully understanding and paying careful attention to these rules can not only keep your club out of trouble with the IRS, but can enable it to take advantage of valuable, newly-discovered opportunities.

* * * * * 

This article is not intended to provide legal advice or opinion and should not be relied on as such. Legal advice can only be provided in response to specific fact situations.

1Reg § 1.501(c)(7)-1(a).
2Chattanooga Auto Club v. Commissioner, 182 F.2d 551 at 554.
3Internal Revenue Manual ("IRM")
4See Revenue Ruling ("Rev. Rul.") 58-589 (to qualify as a club under § 501(c)(7) the organization "must have an established membership of individuals, personal contacts and fellowship," and the commingling of members must be material to the organization); and IRM 
5Rev. Rul. 67-428 (a federation of clubs is not a club within the meaning of § 501(c)(7)).
6See Rev. Rul. 74-168 (a social club that issued memberships to individuals sponsored by corporations did not jeopardize its tax exempt status).
7See Rev. Rul. 74-489 (a country club that issued memberships to corporations was dealing with the general public).
8See Rev. Rul. 74-30 (a flying club where members gathered to fly and repair aircraft owned by the club was exempt under § 501(c)(7) because the time members spent in formal and informal meetings, cleaning and repairing the aircraft, and flying the aircraft in groups were all instances of the commingling of members); Rev. Rul. 69-635 (an auto service club that did not carry on any significant social activities did not provide for the commingling of members and was a for-profit service provider and not a tax-exempt social club); and Rev. Rul. 70-32 (a flying club that provided services but provided very little commingling of members for social or recreational purposes was not a tax-exempt social club).
9Rev. Rul. 55-716 (a television antenna service organization that furnished and serviced television antennas at the homes of members was not exempt under IRC § 501(c)(7) because it did not provide the opportunity for personal contact and fellowship among members).
14IRM  Note that Reg. § 1.501(c)(7)-1(a) requires clubs exempt under § 501(c)(7) to engage "exclusively" in activities for pleasure, recreation, and other nonprofitable purposes.  This discrepancy is due to Public Law ("Pub. L.") 94-568 (1976) which replaced the word "exclusively" in Code § 501(c)(7) with the phrase "substantially all."
15See Rev. Rul. 66-149 (investment income is derived from nonmember sources); 68-535 (selling liquor to members to be consumed off of the club’s premises is unrelated to a social club’s exempt purpose); and PLR 9212002 (the sale of take-out food to be consumed by members off of the club’s premises is unrelated to social club’s exempt purposes).
16Reg. § 501(c)(7)-1(b);  See also Rev. Rul. 65-63 (holding auto races advertised to general public was a business activity).
17See Rev. Rul. 74-489 (a country club that issued memberships to corporations received membership fees from the general public); Rev. Rul. 74-168 (a social club that issued memberships to individuals sponsored by corporations received membership fees from individual members).
18S. Rept. No. 94-1318 (Pub. L. No. 94-568).
20See PLR 8542003 (based on the facts and circumstances, revocation was not appropriate for a social club that had nonmember revenue in excess of 15% where a substantial amount of the proceeds was donated to public charities) and TAM 9815061 (a veterans organization did not qualify for exemption under § 501(c)(7) where it did not have records to substantiate that less than 15% of its revenue was derived from the use of its facilities by nonmembers).
21Reg. § 1.501(c)(7)-1(b).
22IRM  See also PLR 9212002 (an organization receiving 6.07% of its total revenue from nontraditional business activities should be revoked) and 1994 EO CPE Text, Section G (proceeds from nontraditional business activities that exceed 5% of a social club’s gross receipts may affect the social club’s exempt status).
23See Rev. Rul. 69-527 (the social and recreational activities of a social club formed to assist its members in their business ventures were incidental to the business services provided to its members); Rev. Rul. 69-635 (auto club services provided to members were not activities within the scope of § 501(c)(7)); Rev. Rul. 68-535 (social club that sold liquor to members for off-site consumption was engaged in a nontraditional business activity); Rev. Rul. 44, C.B. 1951-1,109 (social club should not be denied tax exemption because it primarily derives its income from the operation of a bar or restaurant for its members); and PLR 9212002 (selling take-out food to members for off-site consumption was a nontraditional business activity).
24See Rev. Rul. 63-190 (an organization that maintained a social and recreational club for its members and also paid sick and death benefits to its members did not qualify for tax-exempt status under § 501(c)(7)).
25Rev. Rul. 58-589 (income-producing activities that are other than incidental, trivial or nonrecurrent will defeat exemption).
26Rev. Rul. 65-63 (a recreational sports car club that held races for the pleasure and recreation of its members did not qualify for tax-exempt status because it solicited public support through advertisement of its auto racing events which the general public was permitted to attend for an admission fee).
27Rev. Rul. 65-63; See also, Rev. Rul.  58-589 (exemption will not be denied because of incidental, trivial or nonrecurrent activities); and Rev. Rul. 68-119 (a club organized to promote the enjoyment of equestrian sports did not jeopardize its tax-exempt status under § 501(c)(7) by charging the public an admission fee to its annual steeple chase where the fees charged were used to defray the cost of the event and all excess revenue was donated to a public charity).
28Reg. § 1.501(c)(7)-1(b).
29Rev. Rul. 58-589 citing Santee Club v. White, 87 Fed. 2d 5 (1936). See also PLR 200638026 (a social club’s sale of unusable land, the proceeds of which will be used to fund club enhancements, will not adversely affect the organization’s exempt status).
30S. Report No. 94-1318 (1976).
31See Rev. Rul. 80-130 (payments to members do not result in inurement of the club’s net earnings if they are reasonable compensation for performance of a necessary administrative services).
32See Rev. Rul. 74-148 (cash prizes awarded by a bowling club to winners of member bowling tournaments were not characterized as private inurement where the prizes were paid from member entry fees and dues); Rev. Rul. 56-475 (cash prizes awarded to members of by a stock car racing club that paid for the prizes from revenue received from nonmember admission race fees violates the requirements of § 501(c)(7)).
33Rev. Rul. 58-501 (a social club that distributed proceeds from the liquidating sale of its assets to its members did not confer a private benefit where the sale was made subsequent to the club’s recreational purpose becoming impracticable); Rev. Rul. 65-64 (where the proceeds from a sale of land condemned by the department of transportation for road building were distributed to members, § 501(c)(7) was not violated because the sale was an incidental activity not for the purpose of deriving a profit); and Rev. Rul. 68-639 (redeeming shares of stock for its book value at the time of redemption upon death or resignation of members did not adversely affect a club’s exemption even though the shareholders realized a gain.).
34Rev. Rul. 58-589.  See also Rev. Rul. 66-149 (a club’s net earning inured to the benefit of members where income from investment activities was used to enhance club facilities without increasing membership fees).
35111 F.2d 6 (1940).
37See West Side Tennis Club (members are permitted to conduct a profitable tournament which may have the effect of lowering their dues, so long as the earnings from the tournament are not derived from the public); Rev. Rul. 68-119 (a charitable contribution of net earnings from a steeple chase which was open to the public for an admission fee did not adversely affect a social club’s tax-exempt status).
38Rev. Rul. 70-48.
39Pittsburgh Press Club v. U.S., 536 F.2d 572 (1976).
40Code § 501(i).
42PLR 8317004 (a membership limitation based on ethnic background or national origin rather than race does not come within the intendment of § 501(i)).
43See IRM (the statute does not require racial or religious diversity, it merely prohibits social clubs from having written restrictions based on race, color, or religion).