4.76.16  Social and Recreational Clubs - IRC §501(c)(7)  (04-01-2003)

  1. This IRM contains specific examination guidelines for an organization recognized as exempt from Federal income tax as an organization described in IRC § 501(c)(7). It provides examination techniques effective in identifying and developing issues commonly encountered during the examination of an IRC § 501(c)(7) organization.

  2. These guidelines provide specific assistance for the examination of an IRC § 501(c)(7) organization and are not all-inclusive. The purpose is to supplement the guidelines contained in IRM sections 4.75.10 through 4.75.13. The intent is not to restrict the examiner in identifying issues or using examination techniques not included herein.

  3. This IRM does not contain detailed technical information regarding IRC § 501(c)(7) organizations. The examiner should review the technical information contained in IRM 7.25.7, Social and Recreational Clubs.  (04-01-2003)
Background Information

  1. IRC § 501(c)(7) exempts social and recreational clubs from Federal income tax. Generally, social clubs are membership organizations supported by dues, fees, charges or other funds paid by their members.

  2. Typical organizations that may qualify for exemption under IRC § 501(c)(7) are:

    1. College fraternities and sororities

    2. Country clubs

    3. Amateur hunting, fishing, tennis, swimming and other sport clubs

    4. Hobby clubs

    5. Ethnic clubs

    6. Yacht clubs  (04-01-2003)
Examination Objectives

  1. One objective of an examination of a social or recreational club is to determine whether the organization is organized and operating in accordance with the exempt purposes of IRC § 501(c)(7). The examiner will determine the following:

    1. The organizational requirements of IRC § 501(c)(7) have been met.

    2. The members are bound together by a common objective directed toward pleasure, recreation or similar nonprofit purposes.

    3. The activities are in furtherance of pleasure, recreation or other similar nonprofit purposes.

    4. There is no inurement of income.

    5. All unrelated trade or business income has been properly reported on the Form 990-T, Exempt Organizations Business Income Tax Return.  (04-01-2003)
Organizational Requirements

  1. A social club must be organized for pleasure, recreation and other similar nonprofitable purposes.

  2. A club must not have a written policy that discriminates on the basis of race, color or religion. The exceptions to the nondiscrimination requirement are as follows:

    1. IRC § 501(i)(1) provides an exception for certain auxiliaries of IRC § 501(c)(8) fraternal beneficiary societies that limit their membership to the members of a particular religion.

    2. IRC § 501(i)(2) provides an exception for a club which in good faith limits its membership to the members of a particular religion in order to further the teachings or principles of that religion, and not to exclude individuals of a particular race or color.

    3. A club's governing instruments may limit its membership to individuals of a particular national origin without jeopardizing its exemption.

    4. The membership can be restricted to a particular political party or to homeowners in a specific housing development.  (04-01-2003)
Examination Guidelines

  1. Review the governing instruments, i.e., articles of organization, bylaws, and any policy statements to determine the following:

    1. The club is organized for pleasure, recreation and other similar nonprofitable purposes.

    2. There are no activities expressly authorized that are beyond the scope of IRC § 501(c)(7).

    3. There are no written provisions limiting membership on the basis of race, color or religion.


      An affirmative statement of nondiscrimination is not required.  (04-01-2003)
Membership Requirements

  1. A social club must provide the opportunity for personal contact between its members and the members must be bound together by a common objective.  (04-01-2003)
Examination Guidelines

  1. Review membership requirements to determine if there are prerequisite conditions or limitations imposed on members, such as an interest in a particular hobby. Examples of social organizations that share a common goal or mutuality of interests could include flying and gardening clubs.

  2. Review bylaws, club handbook, brochures and newsletters to determine if members have the opportunity for fellowship, commingling or other personal contact. Commingling is present if such things as meetings, social gatherings and recreational facilities are available for the membership. Generally, the lack of commingling of members is an indication the basic purpose of the organization is to provide personal services and goods in a manner similar to commercial enterprises.

  3. Review membership applications, club handbooks and any brochures or other information provided to prospective members to determine requirements and procedures for obtaining membership. Determine the types of memberships available and whether they include corporations. Corporate memberships do not automatically disqualify a club, as long as there are sufficient individual members to provide the requisite amount of fellowship and commingling required by IRC § 501(c)(7). See Rev. Rul. 74-489, 1974-2 C.B. 169.


    A social club does not jeopardize its exemption under IRC § 501(c)(7) by admitting corporation sponsored individuals who have the same rights and privileges as regular individual members and who must be approved by the membership committee. See Rev. Rul. 74-168, 1974-1 CB 139

    .  (04-01-2003)
Operational Requirements

  1. Substantially all of a club's activities must be for pleasure, recreation and other nonprofitable purposes with members. The examining agent must:

    1. Ensure the provision of pleasure and recreational activities are not conducted on a commercial basis.

    2. Identify nontraditional business activities and determine the percentage of gross income from these activities.

    3. Ensure the club does not exceed the income limitations, i.e., no more than 35 percent of gross receipts including investment income from sources outside the membership and within the 35 percent no more than 15 percent of gross receipts derived from nonmember use of club facilities.

    4. Apply the facts and circumstances test in cases where the 15 or 35 percent limitations have been exceeded.  (04-01-2003)
Commercial Activities

  1. An exempt social club can not provide pleasure and recreation on a commercial basis.  (04-01-2003)
Examination Guidelines

  1. Tour the facilities noting any signs placed on club property inviting the general public to patronize its facilities or functions. Also, note the presence or absence of signs restricting admittance to "members only."

  2. Review admittance procedures to determine if facilities are open to the general public. A club should have some system in place, such as key-cards or a membership log that restricts use of its facilities to members and their guests.

  3. Review brochures, applications, policy statements and governing instruments to determine if membership requirements are broad or vaguely stated. Members must have a common objective. A club should have established membership criteria, which effectively precludes the general public at large from becoming a member in the organization. The criteria may include such things as requiring an interest in a particular hobby or other recreational activity, or requiring new members to be selected and approved by the club's membership.

  4. Review the minutes for discussions of proposed activities or restricted membership that may violate exempt purposes.

  5. Review the club's liquor license. Some states issue limited liquor licenses to social clubs, restricting liquor sales to club members and their guests. See Rev. Rul. 69-68, 1969-1 C.B. 153.

  6. Review gaming license(s) noting any information that might indicate the games are open to the public. Generally, gambling engaged in by members and guests of a social club is considered a recreational activity for purposes of IRC § 501(c)(7). This is regardless of the legality of the gaming activity. See Rev. Rul. 69-68.

  7. Review contracts with any taxable corporations. If a club is operated as an integral part of a taxable organization's business, it probably is not being operated exclusively for IRC § 501(c)(7) purposes.

  8. Review management contracts to identify any relationships the club may have with the manager or management company. Agreements that provide for more than general administrative responsibilities should be scrutinized closely. The club may be operated as a commercial venture if the management company establishes the dues or fees and is responsible for the selection and expulsion of members.

  9. Analyze the initiation charges or dues to ensure the amount charged is not so low that one time or transient use of the facilities by the general public is encouraged.

  10. Analyze disbursements for advertising to ascertain if public patronage has been solicited.

  11. Review newspaper, yellow page advertisements, and vacation guides and other publications printed by the chamber of commerce or visitors bureau.  (04-01-2003)
Nontraditional Business Activities

  1. Activities that are not in furtherance of a social club's exempt purpose are referred to as nontraditional business activities.

  2. A social club is prohibited from conducting more than an insubstantial amount of nontraditional business activities.

  3. The prohibition against the conduct of nontraditional business activities applies equally to business with members and nonmembers.  (04-01-2003)
Examination Guidelines

  1. Tour the club's facilities noting any activities which might generate nontraditional income.

  2. Analyze the club's income to identify any revenue sources, which were not generated from recreational, social or similar services.

  3. Examples of nontraditional income that may jeopardize a social club's exempt status are:

    • Sale of package liquor

    • Long-term rental of rooms

    • Take out and catering activities

    • Commuter use of parking facilities

    • Advertising income

    • Provision of personal services, such as the operation of a gas station, or barber shop

  4. Determine the percentage of income the club received from nontraditional activities.

  5. Determine the effect of nontraditional activities on the Club's exempt status by considering the percentage of nontraditional income, whether the percentage is rising and any other relevant factors. Court cases and service rulings have not established a fixed standard for determining whether a club's nontraditional business activities are insubstantial.


    In Santa Barbara Club v. Commissioner 68 TC 200 (1974), the Court found gross receipts from nontraditional business activities of 25% to be too much. Although not citable authorities, the Service found in General Counsel Memorandum 39115 (1984) and Technical Advice Memorandum 9212002 (1991), percentages of 13 and 4.28 to 6.07 to be too much and the 1994 Exempt Organizations Continuing Professional Education (CPE) textbook indicated gross receipts in excess of 5% could jeopardize exemption.  (04-01-2003)
Gross Receipts Test

  1. IRC § 501(c)(7) organizations can receive up to 35 percent of their gross receipts, including investment income, from sources outside their membership without losing their exempt status.

  2. Within the 35 percent, not more than 15 percent of gross receipts should be derived from the use of the social club's facilities or services by the general public (nonmembers).

  3. Rev. Proc. 71-17, 1971-1 C.B. 683, describes the circumstances under which nonmembers who use a club's facilities will be assumed to be guests of members. The host-guest relationship will be presumed as follows, provided that payment is received directly from the member or the member's employer:

    • A group of 8 or fewer individuals and at least one of the group is a member.

    • An unlimited number of individuals and at least 75% of the group are members.

  4. Clubs relying on either of the host-guest assumptions described above are required to maintain adequate records to substantiate the appropriate facts.

  5. For all other occasions involving use by nonmembers, the club must maintain books and records of each use and the amount of income earned. This requirement applies even if the member pays initially for the use.


    The Rev. Proc. 71-17 has not been updated to reflect the percentage changes (15% and 35% receipts requirements) made by P.L. 94-568, 1976-2 C.B. 596.

  6. For organizations exceeding the 35% and 15% percent limitations a facts and circumstances test must be applied.  (04-01-2003)
Examination Guidelines

  1. Determine the potential for nonmember income and set the examination scope in this area accordingly.


    If key-cards are used to restrict entry to members only and all other facts indicate the club is used solely by members, the examiner can consider limiting the work in this area. Workpapers must adequately support the conclusion that the club has no nonmember income.

  2. Interview the club manager about the following:

    • Cash sales

    • Credit card sales

    • Availability of reservation book, banquet book, party function sheets, and other Rev. Proc. 71-17 records

    • Member sponsorship of parties

    • Dates and seasons when club is closed

    • Reciprocal use of the club

    • Sales of food and liquor for off premise consumption

  3. Review income accounts identifying potential nonmember income. Common sources include:

    • Cash sales


      Cash sales may be assumed to be nonmember if they cannot be traced to members.

    • Credit card sales

    • Reciprocal use of club

    • Parties over 8 individuals

    • Club functions

  4. Review records maintained by a club to substantiate parties in which a host-guest relationship is assumed. Determine whether requirements of Rev. Proc. 71-17 have been met for host-guest relationship.

  5. The following examples illustrate two situations in which the host-guest relationship will be presumed.


    Mr. Y is a member of the X Country Club. Mr. Y hosts a small party at the club for himself and 7 friends. They play a round of golf and then eat lunch in the main dining room. After lunch, Mr. Y signs his name and member number on a food/drink voucher (sometimes referred to as a chit). In order to document that the income from Mr. Y's party was member income, the club must keep records showing that 8 persons were in the party, Mr. Y was a member in attendance and Mr. Y paid the club for the total amount due. Most clubs will simply keep the voucher, which shows the first two requirements. The member's monthly statement will show the billing and cash receipts will show that Mr. Y paid the bill. As long as Mr. Y pays the club directly, the club does not have to ask Mr. Y if his friends are reimbursing him because the host-guest relationship is assumed. The examiner will not need to ask this either. However, if there is evidence to show that the friends paid the club directly, then the income would be considered nonmember.


    The M Club holds a Memorial Day Party for its members. Members are required to make advance reservations and are billed for the number of persons in their party. Some members bring a guest to the party. The club should retain the vouchers for the day, which show all of the individuals attending. As an alternative, the club can maintain the reservation sheet, which shows the number of members and guests attending the party. As long as 75% or more of the persons attending the party are members and payment was received directly from the members, a host-guest relationship will be assumed. Again, as long as the members pay the club directly, the club need not ask if the guests reimbursed the member.

  6. Review records maintained by the organization for parties where the host-guest relationship is not assumed. Rev. Proc. 71-17 requires the following information to be maintained for each function involving use by nonmembers:

    • Date

    • Total number in party

    • Total number of nonmembers in party

    • Total charges

    • Charges attributable to nonmembers

    • Charges paid by nonmembers

    • Member signed statement regarding reimbursement

    • Member signed statement regarding employer reimbursements

    • Member signed statement regarding gratuitous reimbursements

  7. The following two examples illustrate situations where the host-guest relationship can not be assumed and the club must maintain adequate records to support the club's classification of a nonmember as a guest.


    Mr. Z, Vice President of Marketing, holds a business luncheon meeting at the X Club for the marketing department of his company. Mr. Z is a member of the X Club, but none of the other 25 persons in the group are members. At the end of the luncheon, Mr. Z signs his name and member number on the vouchers. The club manager also hands him an additional form to complete, which asks for all of the information in Section 4.03 of Rev. Proc. 71-17. Mr. Z completes the form and the club maintains the form along with the others from the period. Upon examination, the EO Specialist will verify that the form is properly completed. The Specialist will specifically verify that the meeting served a business, personal, or social purpose of the member.


    Mr. A and Ms. B decide to get married at the X Club. Mr. A is a member, but Ms. B is not. They invite 200 guests and plan to pay for the wedding themselves. After the wedding is over, Ms. B's parents present their gift to the newlyweds. They propose to pay for the wedding right then and there. Mr. A signs the voucher and completes the form stating that his new in-laws paid the bill. This is an example of a gratuitous payment by a nonmember. As long as the club maintains a properly completed form, this event will be considered member income because the Rev. Proc. 71-17 requirement under section 4.03-9 has been met to establish a host-guest relationship.

  8. Reconstruct nonmember income in cases where the club's classification is not correct. Inspect and analyze the reservation book(s), membership rosters, party function sheets, monthly member billings and other records maintained by the club to determine nonmember income.

  9. Consider whether the gross receipts standards and audit assumptions should be used in cases where the records are inadequate or unavailable.

  10. Calculate the gross receipts test (total nonmember gross receipts divided by total gross receipts). Total gross receipts include charges, admissions, membership fees, membership dues and member assessments. It does not include unusual amounts of income, such as the sale of a clubhouse.

  11. Calculate the percentage of gross receipts from investment income. Set-aside income should be included in this computation.


    For purposes of computing the gross receipts test, the Committee Reports that accompanied P.L. 94-568, state that social clubs should not be permitted to receive, within the 15 or 35 percent allowances, any income from a business not traditionally carried on by IRC § 501(c)(7) organizations. In cases where an organization's nontraditional income would cause the organization to exceed the 15 or 35 percent allowances, consideration should be given as to whether the organization continues to be substantially operated for IRC § 501(c)(7) purposes. An article on social clubs in the 1996 EO CPE indicates that nontraditional income should be taken into account in determining whether the overall limits on outside income have been exceeded. The article states that to do otherwise would allow organizations with nontraditional income to have a greater percentage of their total income from unrelated activities and this would be contrary to the intent of Congress.

  12. Apply the facts and circumstances test in cases where outside income exceeds the 35% or 15% limitations. Factors to be considered in applying this test include:

    • The actual percentage of nonmember receipts and/or investment income.

    • The frequency of nonmember use of club facilities.

    • The number of years the percentage has been exceeded.


      A high percentage of nonmember income in one year should be viewed more favorably than a pattern of consistently exceeding the limits. For example, a high percentage of nonmember receipts in 3 consecutive years is more likely to indicate the existence of a nonexempt purpose than the receipt of a high percentage of nonmember receipts in 1 year out of 3 years.

    • The use of net profits generated from the nonmember activities.  (04-01-2003)

  1. A social club can not have any part of its net earnings inuring to a shareholder or member.  (04-01-2003)
Examination Guidelines

  1. During the initial interview, ask whether the club manager, a director, or an officer receives a percentage of gross or net profit.

  2. Analyze distributions to identify any dividends or bonuses. Distributions of condemnation proceeds and fees paid to bring in new members were not found to constitute inurement. See Rev. Rul. 65-64, 1965-1 C.B. 241 and Rev. Rul. 80-130, 1980-1 C.B. 117.

  3. Review classes of membership to determine if nonvoting members pay disproportionately more for services or benefits. Pay particular attention to memberships with varied dues structures or clubs with voting and nonvoting classes having different fee schedules. Determine if a reasonable basis exists for the difference in dues and/or fees charged. See Rev. Rul. 70-48, 1970-1 C.B. 133.

  4. Review fee schedules to determine whether any class of member is favored.  (04-01-2003)
Revocation Considerations

  1. IRC § 277 provides that nonexempt membership organizations are not allowed to offset losses from membership activities against income derived from investments or other nonmember sources to produce little or no taxable income. This is to ensure that nonexempt clubs do not receive more favorable tax treatment than those recognized as exempt.  (04-01-2003)
Examination Guidelines

  1. Consider the impact of IRC § 277 when reviewing converted forms 1120 or when calculating a revoked club's taxable income.


    Discuss the impact of IRC § 277 with the club before an agreement to revocation is secured. The club may think being nonexempt would yield less tax liability when in fact due to IRC § 277 this would not be the case.  (04-01-2003)
Unrelated Business Taxable Income

  1. IRC § 512(a)(3)(A) defines unrelated business taxable income for social clubs as all gross income that is not exempt function income.

  2. Exempt function income consists of gross income from dues, fees or other charges paid by members for normal and usual social and recreational purposes and set-aside income.  (04-01-2003)
Common Sources of Unrelated Business Income

  1. A social club is generally taxed on income derived from the following sources:

    • Nonmember use of facilities, including income from reciprocal use of the club

    • Investment income, including royalty income

    • Nontraditional business activities, including those with members

    • Sales of property

    • Activities which are not in furtherance of its exempt purpose, including those with members


    Investment income received from members for an exempt purpose, e.g., interest on members' delinquent accounts resulting from charges for the use of the club's facilities or initiation fees paid in installments, is not unrelated business income.  (04-01-2003)
Examination Guidelines

  1. Examine cash receipts journal and related supporting documents to determine the size, extent, and nature of the club's income and whether it is related to the organization's exempt purpose.

  2. Review assets reported on the balance sheet to identify any that might produce investment income. Investment income that is not set aside is generally taxable.


    Interest received by a social club on obligations issued by a State is not taxable. See Rev. Rul. 76-337, 1976-2 C.B. 177.

  3. Review comparative balance sheets and notes to financial statement to identify any sales of assets. IRC § 512(a)(3)(D) provides for nonrecognition of gains from certain sales where the proceeds are reinvested in property used exclusively for exempt IRC § 501(c)(7) purposes.

  4. Identify any income from nonmembers or the general public. Amounts paid by a member's spouse or by a member for his or her dependent is considered exempt function income. Also, amounts paid for the benefit of a member by the member's employer or by a gratuitous donor, typically would constitute exempt function income.

  5. Be sure to identify green fees paid for any golf rounds played by bona fide guests that may be included in the total green fees. Even though green fees are usually only paid by or for nonmembers, the entire amount is not necessarily nonmember income as some of the green fees may be paid by members for bona fide guests.

  6. Analyze the club's treatment of nonmembers as guests. Ensure that the treatment is proper and that the club has complied with the record keeping requirements of Rev. Proc. 71-17.

  7. Identify any income from nontraditional business activities. All income from these activities would be considered unrelated. This would be true even if the activity is conducted with members; e.g. the sale of package liquor to members for off-premise use and the sale of advertising space in the organization's newsletter to members and nonmembers.

  8. Make certain all unrelated business income is properly reported on Form 990-T and on Form 990.  (04-01-2003)
Set Aside Income

  1. A social club can set aside its investment income to be used for religious, charitable, scientific, literary, and educational and other purposes specified in IRC § 170(c)(4). If the investment income is properly set aside, it is not subject to the tax on unrelated business income but must be reported on Forms 990 and 990-T.  (04-01-2003)
Examination Guidelines

  1. Review action, e.g., resolution by club's board of directors, describing the income set aside. Ensure the funds are set aside for a IRC § 170(c)(4) purpose.

  2. Ensure income is set aside timely. To be excluded, income must be set aside during the year it would have been taxable or if the organization elects, set aside on or before the due date for filing the Form 990-T, including extensions.

  3. Identify any amounts set aside that are later used for a non-IRC § 170(c)(4) purpose. The amount diverted is includible in unrelated business income for the year of diversion.

  4. Analyze the sources of income set aside and ensure the income is eligible to be set aside. Examples of eligible income are dividends, interest, capital gains, royalties, rents from real property, and income from a volunteer or irregular activity.


    Income from an unrelated trade or business determined under the general definition of IRC § 512(a)(1) can not be set aside.  (04-01-2003)
Computation of Taxable Unrelated Business Income

  1. Taxable unrelated business income is gross unrelated business income less those deductions allowed by chapter 1 of the IRC which are directly connected with the carrying on of such trade or business, subject to certain modifications referred to in Treas. Reg. § 1.512(b)(1). To be "directly connected with" the conduct of a unrelated business for purposes of IRC § 512, an item of deduction must have a proximate and primary relationship to the carrying on of that business. See Treas. Reg. § 1.512(a)-1(a).

  2. Expenses deductible from gross unrelated business income fall into two general categories:

    1. Direct expenses which are expenses attributable solely to the unrelated business activities. See Treas. Reg. § 1.512(a)-1(b).

    2. Allocable expenses which are expenses attributable to both exempt function and unrelated business activities, e.g., expenses related to facilities used for both exempt function and unrelated business activities. See Treas. Reg. § 1.512(a)-1(c).

  3. Losses on unrelated business activities lacking a profit motive can not be used to reduce taxable unrelated business income from investments or activities entered into for a profit. See Rev. Rul. 81-69, 1981-1 CB 351 and Portland Golf Club v. Commissioner, 497 U.S. 154, 169 (1990).  (04-01-2003)
Examination Guidelines

  1. Determine whether the expenses deducted from unrelated business income are related to unrelated business activities and are deductible under chapter 1 of the IRC.

  2. Analyze all losses used to offset investment and/or other taxable income in a club's calculation of its unrelated business taxable income. Ensure the activity generating the loss has a profit motive and is unrelated. Factors to consider in determining whether a profit motive exists can be found in Treas. Reg. § 1.183-2(b) and include:

    • The manner in which the taxpayer carries on the activity;

    • The expertise of the taxpayer or his advisors;

    • The time and effort expended by the taxpayer in carrying on the activity;

    • The expectation that assets used in activity may appreciate;

    • The taxpayer's history of income or losses with respect to the activity;

    • The amount of occasional profits, if any, which are earned;  (04-01-2003)
Expense Allocations

  1. A club can use any method to allocate expenses possessing a proximate and primary relationship to the unrelated trade or business income they are allocated against, so long as the allocation method is reasonable. See Treas. Reg. § 1.512(a)-1(c). By definition, the "reasonableness" standard indicates that more than one method of allocation may be reasonable. Thus, a reasonable method of allocating expenses must be allowed even though it may not be the best method.

  2. The Service has generally classified expenses in three categories as follows:

    Direct Expenses which increase in direct proportion to the volume of the activity and would not have been incurred otherwise, e.g., cost of goods sold, or expenses incurred for specific events, e.g., payments for extra labor, perishable decorations and entertainment for a specific event. Direct expenses incurred for specific events are deductible in full from the event receipts and therefore, do not have to be allocated.
    Variable Expenses that vary in proportion to the actual use of the facility but can not be identified with a particular activity, e.g. salaries, utilities, maintenance, cleaning, uniforms, laundry, telephone, postage, printing, and professional fees.
    Fixed Expenses that do not vary in proportion to the actual use of the facility, e.g. depreciation, interest, real estate taxes, property insurance, and permits.


    In some cases, the services and the courts have used different terms to identify the categories of expenses. Therefore, close attention should be paid to how these terms are used in any particular case.

  3. One method of allocation frequently used is the allocation of all three categories of expenses based on gross receipts. This allocation method is commonly referred to as the "Gross Receipts Allocation Method " . The "Gross Receipts Allocation Method" is seldom a "reasonable" method for allocating variable or fixed expenses. Also, the "Gross Receipts Allocation Method" would not be reasonable for the allocation of direct expenses if:

    1. The fees for the use of the facility is included in the members' dues.


      Only nonmembers or guests typically pay green fees. An allocation of expenses based on the ratio that nonmember green fees bears to total green fees would not yield a reasonable approximation of nonmember expenses, since the calculation does not include members' dues which are also used to operate the golf course. A more appropriate allocation method may be to allocate the expenses based on the ratio of the number of rounds of golf played by nonmember to the total number of rounds of golf played.

    2. Nonmembers are charged more than members.


      An equal number of members and nonmembers are served the same meal in a club's dining room. Members pay $15.00 and nonmembers pay $20.00.

    3. Nonmembers are charged additional fees not charged to members.


      Nonmember who use the clubs facilities for private parties are charged a rental fee of $500. Members are not required to pay a rental fee for private parties.

  4. A example of a "reasonable" method of allocation was published by the Service in 1975 in supplemental instructions for completing Form 990, Package 990 Supplement (Section 501(c)(7)). The hypothetical organization in the Package 990 Supplement was named "The Big Divot Country Club, Inc." This allocation method became commonly known as " The Big Divot Allocation Method." An example of the " Big Divot Allocation Method" has been included in the IRM since 1984. Using the "Big Divot Allocation Method," the expenses are allocated as follows:

    Direct Cost of goods sold are allocated based on the ratio of nonmember sales to total sales.
    Variable Variable expenses are allocated based on the ratio of estimated hours of nonmember use during the year to the total hours the facility was used during the year.
    Fixed Fixed expenses are allocated based on the ratio of the estimated hours of nonmember use during the year to the total hours in the year.

  5. The use of the "Big Divot Allocation Method" for fixed expenses was litigated in Rensselaer Polytechnic Institute v. Commissioner, 732 F.2d 1048 (2nd Circuit 1984). In Rensselaer taxpayer argued that fixed expenses should be allocated on the same basis as variable expenses, the ratio of the estimated hours of nonmember use to the total hours the facility was used during the year instead of the ratio of the estimated hours of nonmember use to the total hours in the year as proposed by the Service. The Court held for the taxpayer stating an allocation based on the time of actual use is "reasonable" within the meaning of Treas. Reg. § 1.512(a)-1(c).


    As set forth in the Action on Decision on Rensselaer, A.O.D. 1438 (June 18, 1987), the Service continues to take the position that under the circumstances described in Rensselaer where the dual use of the facility was near maximum use, fixed expenses should not be allocated on the basis of actual usage. In the Service's view, an allocation based on the total available time is the method of allocating fixed expenses that meets the "reasonableness" standard of Treas. Reg. § 1.512(a)-1(c), The Action on Decision also states that this issue should not be litigated until the "reasonableness " test of Treas. Reg. § 1.512(a)-1(c) is amended.

  6. Exhibits 4.76.16-2 through 4.76.16-4 show the computation of the net profit from nonmember use of a club's restaurant and bar based on the facts stated in Exhibit 4.76.16-1. Exhibit 4.76.16-2 shows the computation of net profit using the "Gross Receipts Allocation Method." Exhibit 4.76.16-3; shows the computation of net profit using the allocation method upheld by the Court in Rensselaer. This allocation method is referred to in the Exhibits as the "Actual Usage Allocation Method." Exhibit 4.76.16-4 shows the computation of net profit using the "Big Divot Allocation Method."  (04-01-2003)
Examination Guidelines

  1. Determine whether the expenses allocated to nonmember income have a proximate and primary relationship to the activity that produces the nonmember income.


    A club receives nonmember income from the operation of its restaurant and bar. The club manager is paid a salary of $30,000 per year. The Club manager devotes approximately 35% of his time to the operation of the restaurant and bar. Only $10,500 (35% of 30,000) of his salary would have a proximate and primary relationship to the restaurant and bar and would be included in the total restaurant and bar expenses to be allocated between member and nonmember expenses.


    A club receives nonmember income from the operation of its golf course. The club had a total interest expense of $40,000. Of the $40,000 interest expense, $30,000 was attributable to a loan to build a new swimming pool, $5,000 for a loan to purchase golf carts and $5,000 for a loan to repair the tennis courts. Only $5,000, the interest expense attributable to the purchase of golf carts, would have a proximate and primary relationship to the operation of the golf course and would be included in the golf course expenses to be allocated between member and nonmember income.

  2. Review the method used to allocate expenses to member and nonmember income to determine reasonableness and accuracy.


    Be especially alert to expense allocations based in whole or in part, on the "Gross Receipts Allocation Method."

  3. Review allocation of advertising expenses. The Tax Court held that Treas. Reg. § 1.512(a)-1(f) applies to organizations described in IRC § 501(c)(7). See Chicago Metropolitan Ski Council v. Commissioner, 104 T.C. 341 (1995). If the organization has deducted editorial expenses, the examiner should determine the Service's current position in this area.  (04-01-2003)
Employment Taxes

  1. IRC § 501(c)(7) organizations are generally subject to employment taxes.

  2. For additional information on employment taxes refer to IRM 4.23 Employment Taxes.  (04-01-2003)
Service-Based Exception

  1. IRC §§ 3121(b)(2), 3306(c)(2) and 3306(a)(3) provides an exception from the definition of employment or employer for FICA, FUTA and income tax withholding purposes for certain domestic service in local college clubs or local chapters of a college fraternity or sorority.

  2. The FICA exemption extends to students enrolled and regularly attending classes at a school, college or university.

  3. The FUTA exemption covers any such service, but only if cash remuneration to all individuals employed in such service is less than $1,000 in any calendar quarter during the current or preceding calendar year.

  4. The regulations provide that excepted services are those "of a household nature in or about the club rooms or house" and include services rendered by "cooks, waiters, butlers, maids, janitors, laundresses, furnace men, handymen, gardeners, housekeepers and housemothers." Treas. Reg. § 31.3121(b)(2)-1(b) (FICA); Treas. Reg. § 31.3306(c)(2)-1(b)(2) (FUTA); and Treas. Reg. § 31.3401(a)(3)-1(b)(2) (ITW).

  5. See also Rev. Rul. 72-174, 1972-1 C.B. 315 where the Service held that services performed by students in a university women's club, were not excepted. Also see Rev. Rul. 68-448, 1968-2 C.B. 481, which held that payments to a sorority "housemother" for services performed during a university's summer term when the house was primarily used to accommodate nonmembers were not within this exception.  (04-01-2003)
Tip Income

  1. Social clubs that employ waiters, waitresses, or any other employees receiving tips as part of their compensation are generally subject to certain withholding and reporting requirements.

  2. For additional information on the proper reporting and withholding of tip income refer to IRM 4.23 Employment Taxes  (04-01-2003)
Examination Guidelines

  1. Interview the club manager and determine if any compensation, particularly casual labor, is paid in cash and whether any workers receive tips.

  2. Review service contracts to identify any potential misclassifications of workers as independent contractors.

  3. Identify any workers meeting the service-based exceptions described above in IRM

Exhibit 4.76.16-1  (04-01-2003)
Computation of Net Profit on Nonmember Income- Facts

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Exhibit 4.76.16-2  (04-01-2003)
Computation of Net Profit on Nonmember Income Using the " Gross Receipts Allocation Method"

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Exhibit 4.76.16-3  (04-01-2003)
Computation of Net Profit on Nonmember Income Using the " Actual Usage Allocation Method."

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Exhibit 4.76.16-4  (04-01-2003)
Computation of Net Profit on Nonmember Income Using the " Big Divot Allocation Method"

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