The Enduring Relevance of Rev. Proc. 71-17 on IRC Section 501(c)(7) Organizations

Non-member income is an important consideration for IRC Section 501(c)(7) organizations. Non-member income results in unrelated business taxable income and could result in disqualification for exemption. For over 45 years, Revenue Procedure 71-17 has provided meaningful guidance on determining the effects of non-member income derived from the general public on 501(c)(7) exemption. Over that time, it remains relevant even though the tax law has changed and additional guidance has augmented its guidance. This issue snapshot reviews the meaningful guidance the revenue procedure provides for IRC Section 501(c)(7) organizations and notes how other precedential and non-precedential guidance have clarified and augmented its guidance over time.

IRC Section and Treas. Regulation

  • IRC Section 501(c)(7): Clubs organized for pleasure, recreation, and other non-profitable purposes.
  • IRC Section 512(a)(3)(B): Exempt function income defined.
  • Treas. Reg. Section 1.501(c)(7)-1: Social Clubs

Resources (Court Cases, Chief Counsel Advice, Revenue Rulings, Internal Resources)

P.L. 94-568, 1976-2 C.B. 596, changed the language of IRC Section 501(c)(7) from “operated exclusively for” to “substantially all” allowing IRC Section 501(c)(7) organizations to receive some outside income without losing their exempt status.

Rev. Proc. 71-17, 1971-1 C.B. 683, sets forth guidelines for determining the effect of gross receipts derived from public use of the club’s facilities on exemption and liability for unrelated business income tax; it describes the record-keeping requirements for social clubs exempt under IRC Section 501(c)(7) with respect to nonmember use of the club’s facilities.

Pittsburgh Press Club v. U.S., 615 F.2d 600 (1980), held that the Commissioner properly revoked the club's tax exemption because of the club's trade with nonmembers. The Press club had an obligation to maintain records adequate to establish its right to tax exemption as social club.

Rev. Rul. 67-428, 1967-2 C.B. 204, held that a federation of clubs does not qualify for exemption from Federal income tax under IRC Section 501(c)(7).

Rev. Rul. 74-168, 1974-1 C.B. 136, held that an exempt social club does not jeopardize its status by admitting corporation sponsored individuals who have the same rights and privileges as regular individual members, who must be approved by the membership committee as provided in the club's bylaws, and whose corporate sponsor is not entitled to vote, has no control over the club management, and enjoys no ownership rights.

Rev. Rul. 74-489, 1974-1 C.B.169, found that a country club that issues corporate membership is dealing with the general public in the form of the corporations' employees. Gross receipts from such members will be a factor in determining whether the club qualifies as a social club under IRC Section 501(c)(7).

Rev. Rul. 79-145, 1979-1 C.B. 360, found that amounts paid to a social club for participation in a calcutta by visiting members of another social club are amounts paid by nonmembers, even though both clubs are of like nature and the amounts paid are for goods, facilities, or services provided by the host club under a reciprocal arrangement with the visiting members’ social club.

GCM 36623 (1976) considered whether a club operating a golf tournament qualified for exemption under IRC Section 501(c)(7). The memo concluded the club did not qualify for exemption, since the manner in which it hosted the tournament showed that the club conducted the tournament for profit, thus violating the requirement that an exempt club must be operated exclusively for nonprofitable purposes.

GCM 37490 (1978) concludes that actual use of the facilities of a social club by the membership should be irrelevant in determining whether inurement of net earnings by reason of a varied dues schedule exists when all members have equal right to use of such facilities. It further concludes that, both for purposes of determining that proscribed inurement exists and for purposes of applying a de minimis rule, the amount of net earnings said to inure to members should be examined at the organization level rather than at the individual level.

GCM 39115 (1984) concludes that if a social club is conducting nontraditional business to more than a de minimus extent the club’s exemption should be revoked.

GCM 39343 (1985) concludes that amounts paid to a social club by visiting members of another social club are amounts paid by nonmembers even if both clubs are similar in nature and the amounts paid are pursuant to a reciprocal arrangement agreed to by both entities.

GCM 39773 (1989) concludes that contributions from a former employer to a retiree organization formed for social, recreational and educational purposes constitute ‘exempt function income’ under IRC Section 512(a)(3)(B) and the organization may therefore qualify for exemption as a social club described in Section 501(c)(7).

TAM 9811003 concludes that an organization failed to establish qualification for tax-exempt status IRC Section 501(c)(7) during the years in question because it did not maintain adequate records.

TAM 9815061 considered whether an organization conducting social activities, gambling activities, social welfare activities, and operating a bar could be reclassified under IRC Section 501(c)(7). The memo concluded that an organization failed to establish qualification for tax-exempt status IRC Section 501(c)(7) during the years in question because it did not maintain adequate records.

TAM 199912033 concludes that an organization operating a bar and restaurant and conducting social welfare activities failed to establish qualification for tax-exempt status IRC Section 501(c)(7) during the years in question because it did not maintain adequate records.

Analysis

Rev. Proc. 71-17, Section 2 – Background

Clubs organized and operated exclusively for pleasure, recreation, and other nonprofitable purposes were originally granted exemption from federal income tax in the Revenue Act of 1916.

In 1976 Congress amended IRC Section 501(c)(7) to liberalize prior limitations on the amount of income social clubs could receive from nonmember sources without jeopardizing their exempt status. Public Law 94-568 changed the language of IRC Section 501(c)(7) from “operated exclusively for” to “substantially all” allowing IRC Section 501(c)(7) organizations to receive some outside income without losing their exempt status.

In determining whether an organization is organized and operated exclusively for pleasure, recreation, and other nonprofitable purposes, it is important to determine under what circumstances and to what extent a club makes its facilities available to the general public. Rev. Proc. 71-17, Section 2 states that the use of a club's facilities by the general public is significant because it may indicate the existence of a nonexempt purpose or, may make the club liable for unrelated business income tax.

Where a club makes its facilities available to the general public to a substantial degree, the club is not operated exclusively for pleasure, recreation, or other nonprofitable purposes. Specifically, social clubs can receive up to 35 percent of their gross receipts, including investment income, from sources outside their membership. 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). If a club exceeds the 35/15 percent test, facts and circumstances are applied to determine if substantially all of its activities are for pleasure, recreation and other nonprofitable purposes.

If a club’s income from nonmember sources exceeds the 35/15 percent limitations, then evaluate all relevant facts and circumstances to determine if substantially all of the club’s activities are for pleasure, recreation and other nonprofitable purposes. Consider the following factors:

  • Actual percentage of nonmember gross receipts or investment income
  • Frequency of use of club facilities or services by nonmembers and the net income from such use (Note: An unusual or single event that generates all of the nonmember income would be viewed more favorably than nonmember income arising from frequent use by nonmembers.)
  • Record over a period of years
  • Purpose for which a club's facilities are made available to nonmembers
  • Whether or not the nonmember income generates net profits for the organization

In Pittsburgh Press Club v. U.S., 536 F.2d 572 (1976), 579 F.2d 751 (1978), and 615 F.2d 600 (1980), the court found that a substantial portion of the club’s total gross receipts was from nonmember use of club facilities (determined to be between 11–17% of gross income). This indicated to the court that the club was engaged in business with the general public. Other factors noted by the court to consider in addition to the level of nonmember income include the purposes for which the club’s facilities were made available to nonmember groups, the frequency of use of the club facilities by nonmembers, and the amount of net profits derived from the nonmember income.

The 35/15 percent limitations and the facts and circumstances analysis noted above apply only to nonmember use of club facilities. Senate Report 94-1318, which explains Public Law 94-568, states that “it is not intended that [social clubs] be permitted to receive, within the 15- or 35- percent allowances, income from the active conduct of business not traditionally carried on by these organizations.”

Social club activities can be categorized as either traditional or non-traditional activities. Traditional activities are those that further a social club’s exempt purposes. Nontraditional activities do not further the exempt purposes of a social club even when conducted solely on a membership basis.

The sale of food and beverages at a club’s facility for on premises consumption is an example of a permitted traditional business activity. The sale of package liquor to members for off premises consumption is an example of a non-traditional activity.

As further clarification to the revenue procedure, GCM 39115 discusses that as a practical matter it’s appropriate to allow a de minimis amount of nontraditional income and notes that more than de minimis amount of nontraditional income will result in revocation. 

Rev. Proc. 71-17, Section 3 – Guidelines

A common question that arises with IRC Section 501(c)(7) organizations is whether an individual or a group is a true guest of a member. Rev. Proc. 71-17, Section 3 sets forth guidelines for determining the effect of gross receipts derived from public use of the club’s facilities on exemption and describes circumstances under which nonmembers who use a club’s facilities will be assumed to be guests of members. A guest-host relationship will be assumed if:

  • The group consists of eight people or fewer, at least one of whom is a member, and payment for use is received by the club directly from the member or the member's employer; or
  • 75% or more of a group of any size using club facilities are members and payment for use is received by the club directly from one or more of the members or the member's employer. 

While income from bona-fide guests is treated as member income, amounts paid to a social club by visiting members of another social club are amounts paid by nonmembers. This is true even though both clubs are of like nature and the amounts paid are for goods, facilities, or services are provided by the host club under a reciprocal arrangement with the visiting members’ social club. See Rev. Rul. 79-145 and GCM 39343.

Prior to the revenue procedure, Rev. Rul. 67-428 held that an organization whose membership consists entirely of artificial entities does not qualify for exemption under IRC Section 501 (c) (7). The ruling points out that fellowship between members cannot play a material part in the activities of an organization if membership is composed of artificial entities.

After the revenue procedure, Rev. Rul. 74-489 established that a country club that issues corporate memberships is dealing with the general public. The organization in this ruling issued membership to both individuals and corporations. Corporate members designated which of their officers and employees could use the club’s facilities. These designated individuals had no connection to the club and thus gross receipts from corporate memberships were considered nonmember income.

Adding to the discussion of employer related memberships, GCM 39773 considered whether contributions from a former employer to a retiree organization formed for social, recreational and educational purposes constitute "exempt function income. GCM 39773 provides that “if an employer makes payments to a social club on behalf of employee-members and those payments directly serve the purposes of the employee-members, then the payments will be considered ‘exempt function income’ under section 512(a)(3)(B).”

Similarly, a social club will not jeopardize its exempt status by admitting corporation sponsored individuals who have the same rights and privileges as regular individual members, who must be approved by the membership committee as provided in the club's bylaws, and whose corporate sponsor is not entitled to vote, has no control over the club management, and enjoys no ownership. See Rev. Rul. 74-168.

Social clubs must maintain specific records as to the use of its facilities in order to substantiate a guest-host relationship for determining member versus nonmember usage. Recordkeeping requirements are outlined in Rev. Proc. 71-17, Section 4.

Rev. Proc. 71-17, Section 4 – Recordkeeping Requirements

A club relying on the eight people or fewer assumption outlined in Rev. Proc. 71-17, Section 3 must maintain adequate records to substantiate that the group was comprised of eight or fewer individuals, that at least one of them was a member, and that payment was received by the club directly from members or their employers. A club relying on the 75 percent or more member assumption must maintain adequate records to substantiate that 75 percent or more of the persons in the group were, in fact, members of the club at the time of such use and that payment was received by the club directly from members or their employers. Where payment is made directly to the club by the member, the club is under no obligation to inquire about reimbursement.

Additionally, a club must maintain books and records for all instances involving use by nonmembers where the guest-host relationship cannot be assumed. In each instance, the record must contain the following information:

  • The date
  • The total number in the party
  • The nonmembers in the party
  • The total charges
  • The charges attributable to nonmembers
  • The charges paid by nonmembers
  •  A signed statement by the member as to the amount of reimbursement from nonmembers
  •  A signed statement by the member when the member's employer makes payment for nonmembers indicating the name of the employer, the amount paid for the nonmember, the nonmember's name and relationship to the member and purpose served
  • A member signed statement for nonmember gratuitous payment for a member including the amount, donor's name and relationship and the nature of the payment

Failure to maintain records or make them available to the Service for inspection will preclude use of the minimum gross receipts standard and audit assumptions outlined in Rev. Proc. 71-17. All income derived from the use club facilities may be considered unrelated business income and subject to income tax. Further, all income that cannot be traced to members is considered to be from nonmember sources and may be considered unrelated business income and subject to income tax.

A club may lose its tax-exempt status, if it does not keep adequate books and records to show that it qualifies for exemption. For example, the organization revoked in Pittsburgh Press Club v. U.S., supra did not maintain records adequate to establish its right to tax exemption as a social club.

The importance of keeping adequate records is illustrated in TAM 199912033, which considered whether an organization operating a bar and restaurant and conducting social welfare activities could be reclassified under IRC Section 501(c)(7). The memo explained that in order to be reclassified under IRC 501(c)(7) the organization would need to produce records showing the use of the club’s facility activity by category (member, auxiliary member, bona fide guest, and nonmember use). Since records were not maintained and the organization generated nonmember income in excess of the 15% limitation, the memo concluded that the organization could not be reclassified as organization described in IRC Section 501(c)(7). See also TAM  9811003 and TAM 9815061.

Another issue to consider when gross receipts are derived from nonmembers is whether net earnings inures to the benefit of any private shareholder. Rev. Proc. 71-17 and supplemental guidance can be used to indirectly determine inurement.

Using Rev. Proc. 71-17 to Indirectly Determine Inurement

In GCM 36623, Rev. Proc. 71-17 helped determine non-member income which, in turn, helped determine there was inurement. The memo also points out that there are two independent tests under IRC Section 501(c)(7). The club must be organized and operated for pleasure, recreation, and other non-profitable purposes (nonprofitable purpose test) and no part of the net earnings may inure to the benefit of any private shareholder (inurement test). Failure to meet either test disqualifies an organization for exemption.

A common form of inurement is using profits derived from the general public for capital improvements, or to pay club expenses. If the gross receipts are merely used to cover costs attributable to the public's incidental use of club facilities, there is no inurement to members. But if the club retains profits derived from the public and uses those profits to pay for things that would otherwise be paid for by the club members, the profits inure to the benefit of the club members.

Similarly, GCM 37490 states “that the language of section 501(c)(7) supports a strict reading of the inurement proscription since it exempts only those clubs ‘no part of the net earnings of which inures to the benefit of any private shareholder.’ Thus, the proscription should operate to deny exemption to a club in which only one person, e.g. an over-compensated manager, reaps a share of the club's net earnings; and to a club in which all members share, although indirectly and to a lesser extent, in the club's net earnings.”

The memo concludes that a de minimis rule should be applied in section 501(c)(7) inurement cases and “in dealing with the issue of inurement from nonmember receipts, the cases have indicated that where the activity in question generates income that is incidental, trifling, or nonrecurrent, exemption will not be lost by reason of such income.” However, the GCM also points out that the Service can reasonably and justifiably continue to challenge the right of such clubs to be recognized as tax exempt on the ground that there is in fact significant inurement to certain classes of membership.

Issue Indicators or Audit Tips

Audit Tips:

Social clubs must maintain adequate books and records to show that they qualify for exemption. When conducting an audit:

  • Review income accounts identifying potential nonmember income.
  • 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.
  • Review records maintained by the organization for parties where the host-guest relationship is not assumed.
  • Tour the facilities noting any indications of possible nonmembers sales, such as package liquor or “to-go” sales.
  • 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, website, reciprocal agreements, and other records maintained by the club to determine nonmember income.
  • Consider whether the gross receipts standards and audit assumptions should be used in cases where the records are inadequate or unavailable. See Rev. Proc. 71-17, sections 3 & 4.
  • Consider sending an “Inadequate Records Notice” to place taxpayer on notice that their record keeping practices are deficient and must be improved to meet the requirements of the law in cases where the records are inadequate or unavailable.
  • See the Audit Technique Guide - Social and Recreational Clubs - IRC Section 501(c)(7) (PDF) for additional information.