- 7.27.7 Computation of Unrelated Business Taxable Income for Social Clubs
- 22.214.171.124 Overview
- 126.96.36.199 Calculation of Unrelated Business Taxable Income
- 188.8.131.52.1 Gross Income
- 184.108.40.206.2 Exempt Function Income
- 220.127.116.11.3 Allowable Deductions
- 18.104.22.168.3.1 Deductions Against Investment Income
- 22.214.171.124 Treatment of Title Holding Companies
- 126.96.36.199 Gain on Sale of Assets
- 188.8.131.52 Property Used for Exempt and Nonexempt Purposes
- 184.108.40.206 Direct Use
- 220.127.116.11 Digest of Published Rulings and Procedures
- Exhibit 18.104.22.168-1 Illustration of Computation of Unrelated Business Taxable Income Where There is Exempt Function Income
- Exhibit 22.214.171.124-2 Illustration of General Computation of Unrelated Business Taxable Income Where There is a Set-Aside of Income
- Exhibit 126.96.36.199-3 Illustration of Nonrecognition of Gain on Sale of Property Used Directly In Furtherance of the Exempt Function
Part 7. Rulings and Agreements
Chapter 27. Exempt Organizations Tax Manual
Section 7. Computation of Unrelated Business Taxable Income for Social Clubs
IRC 512(a)(3) is a special rule for certain exempt organizations to calculate their unrelated business taxable income.
The following organizations are subject to IRC 512(a)(3) rather than IRC 512(a)(1):
social clubs (described in IRC 501(c)(7))
voluntary employees’ beneficiary associations (described in IRC 501(c)(9))
supplemental unemployment benefit trusts (described in IRC 501(c)(17))
group legal services organizations (described in IRC 501(c)(20))
Organizations subject to calculating their unrelated business income under IRC 512(a)(3) are taxed on all income that is not "exempt function income." Thus organizations will be taxed on income from outside their membership and investment income.
This section will explain how unrelated business taxable income is calculated under IRC 512(a)(3). Exhibits in this section will illustrate how to calculate unrelated business income.
Generally unrelated business taxable income under IRC 512(a)(3) is calculated in the following manner:
All gross income, excluding
exempt function income, less
deductions allowed by Chapter 1 of the Code which are directly connected with the production of gross income,
computed with the following modifications:
net operating losses—IRC 512(b)(6)
charitable contributions—IRC 512(b)(10), (b)(11)
standard deduction—IRC 512(b)(12)
In calculating unrelated business income under section 512(a)(3), gross income needs to be determined initially. Gross income is all income, but does not include exempt function income.
Exempt function income includes:
Amounts derived from dues, fees, charges or similar amounts of gross income from members; and
Gross income from members is considered exempt function income if it is paid by members as consideration for providing such members, their dependents, or guests with goods, facilities or services in furtherance of the exempt purposes of the organization. These items of gross income include:
charges or similar amounts.
Examples of gross income from members and thus exempt function income include:
Gross income derived by a social club from members of the club for use of the club’s golf course. H.R. Rep. No. 91–413 (Part 2), 91st Cong., 1st Sess. 23 (1969), 1969–3 C.B. 353.
Gross income derived by a voluntary employees’ beneficiary association that provides health insurance for its members and their dependents. The amounts received by the association from its members for this exempt function is exempt function income not subject to tax. S. Rep. No. 91–552, 91st Cong., 1st Sess. 67 (1969), 1969–3 C.B. 467.
Amounts paid by a member’s spouse or by a member for his or her dependent (as determined under IRC 152).
Amounts paid for the benefit of a member by the member’s employer or by a gratuitous donor, either directly to the member or to the organization. A payment is gratuitous only if it is made through detached and disinterested generosity rather than for some benefit to the payor.
Amounts paid for the benefit of a member’s guest by the member’s employer if the guest is primarily present for some personal, social or business relationship of the member rather than primarily to fulfill some purpose of the employer unrelated to the activities of the particular employee-member.
Rev. Proc. 71–17, 1971–1 C.B. 683 provides guidelines under which nonmembers who use a social club’s facilities will be assumed to be guests of members. See discussion in IRM 7.25.7 about Rev. Proc. 71–17. Also, see section 4.03 of Rev. Proc. 71–17 for a complete listing of the required information.
An illustration of the computation of unrelated business taxable income where there is exempt function income is set forth in Exhibit 1.
Set-aside income is classified as exempt function income. It is income derived by an organization which is set aside for religious, charitable, scientific, literary, or educational purposes or for the prevention of cruelty to children or animals.
In the case of IRC 501(c)(9), (17), or (20) organizations, exempt function income also includes income set aside for the payment of life, sick, accident, or other benefits, including the reasonable administration costs thereof.
If in any year an amount previously set aside is used for any other purpose, then this amount is subject to the unrelated business income tax.
Income from an unrelated trade or business described in section 512(a)(1) is not set aside income.
National organizations of college fraternities and sororities set aside income for various activities such as:
student loans, and
leadership and citizenship schools and services.
Set-aside income may be temporarily invested or accumulated (as long as the amount and duration are not unreasonable), provided that it is earmarked or placed in a separate account.
Set-aside income generally may be excluded from gross income only in the taxable year in which it is includible in gross income. However, a taxpayer may set aside amounts of gross income from a prior taxable year to the extent that such amounts could have been set aside and are actually set aside on or before the date prescribed for filing the Exempt Organization Business Income Tax Return (Form 990–T).
For example, assume that X, a social club described in IRC 501(c)(7), received $5000 dividend income which is includible in gross income in X’s taxable year ending December 31, 1991, on account of IRC 512(a)(3). Also, assume that X must file its Form 990–T for taxable year 1991 by May 15, 1992. In this case, X may elect to treat the $5000 as a set-aside on its 1991 Form 990–T if it sets aside such amount no later than May 15, 1992.
IRC 512(a)(3)(E) provides that an amount will not be considered set aside for purposes of IRC 512(a)(3)(B)(ii) to the extent it exceeds the account limit of IRC 419A(c) for life, medical, supplemental unemployment, severance or disability benefits, except that under IRC 512(a)(3)(E)(ii)(I), the limitation does not apply to existing reserves for post-retirement medical benefits or post-retirement life insurance benefits. The effect of this provision is to tax IRC 501(c)(9), (17), and (20) organizations on their investment income to the extent their asset accounts under IRC 419A are overfunded. See IRM 7.25.9 .
An illustration of these rules is set forth in Exhibit 2.
A deduction allowable under Chapter 1 of the Code will only be taken into account in computing unrelated business taxable income under IRC 512(a)(3) if it is directly connected with the production of gross income (excluding exempt function income).
Personnel expenses used both for an exempt purpose and for the production of gross income (excluding exempt function income) shall be allocated between the two uses on a reasonable basis. See Reg. 1.512(a)–1(c).
Example 1. Assume that X, a social club, pays its manager a salary of $10,000 a year and that it derives gross income other than exempt function income. If the manager devotes 10 percent of his/her time during the year to deriving X’s gross income (other than exempt function income), a deduction of $1,000 (10 percent of $10,000) would be allowable for purposes of computing X’s unrelated business taxable income.
A deduction is allowed for excess readership costs (expenses related to the editorial content of a publication) from advertising income under section 1.512(a)–(1)(f) of the Income Tax Regulations. See Chicago Metropolitan Ski Council v. Commissioner, 104 T.C. 15 (1995).
In Rolling Rock Club v. United States, 785 F.2d 93 (3rd Cir. 1986), the court held that an IRC 501(c)(7) social club was not entitled to claim the dividends received deduction under IRC 243 against its investment income.
In South End Italian Independent Club, Inc. v. Commissioner, 87 T.C. 168 (1986), acq. in result 1987–24 IRB 4, the court held that an IRC 501(c)(7) social club, which distributed its net proceeds from the operation of beano (bingo) games in accordance with state law, was not subject to the limitations imposed by IRC 512(b)(10), since the proceeds were deductible as ordinary and necessary business expenses under IRC 162, rather than as charitable contributions under IRC 170.
In Ye Mystic Krewe of Gasparilla v. Commissioner, 80 T.C. 755 (1983), an IRC 501(c)(7) social club staged a "mock invasion" of a city which was followed by a parade. The club owned the concession rights along the parade route and negotiated contracts with others to provide seats and refreshments. The club received a percentage of the net receipts from these concessions, as well as amounts derived from the sale of logbooks. The court held that the club’s gross income from the concessions and the sales of logbooks was unrelated business taxable income under IRC 512(a)(3)(A), and that the expenses of staging the invasion and parade were not directly connected with the production of income from the concessions and logbooks.
Rev. Rul. 81–69, 1981–1 C.B. 351, discusses an IRC 501(c)(7) social club that has unrelated business taxable income from investments made for profit. The club also sells food and beverages to nonmembers at prices insufficient to recover the costs of such sales. Sales of food and beverages to nonmembers have consistently over a number of years resulted only in losses, which are expected to continue. Applying IRC 512(a)(3)(A), the Rev. Rul. holds that because the club’s sales of food and beverages to nonmembers are not profit motivated, the club may not deduct losses from sales to nonmembers from its net investment income.
After extensive litigation this issue was resolved in Portland Golf Club v. Commissioner, U.S., 110 S.Ct. 2780 (1990), aff’g 876 F.2d 897 (9th Cir. 1989), rev’g and remanding without opinion T.C. 1988–76,
Facts: An IRC 501(c)(7) social club received interest income from investment activities but, under its accounting system, suffered losses from its sales of food and beverages to nonmembers.
Rationale: A section 501(c)(7) social club is allowed to offset investment income by losses incurred from sales to nonmembers only if these sales were motivated by an intent to profit. An intent to profit is determined by using the same method to allocate fixed costs to nonmember sales as that used to compute the club’s actual profit or loss. The court determined that the club failed to show that it had intended to earn gross income from nonmember sales in excess of its total costs. The club lacked the requisite profit motive with regard to this activity.
Prior to Portland Golf Club, a number of courts considered this issue. See: Cleveland Athletic Club v. United States, 779 F.2d 1160 (6th Cir. 1985); The Brook, Inc. v. Commissioner, 799 F.2d 833 (2d Cir. 1986), and North Ridge Country Club v. Commissioner, 89 T.C. 563 (1987).
IRC 512(a)(3)(C) provides that when an exempt holding company (described in IRC 501(c)(2)) pays its income to an exempt organization which is described in IRC 501(c)(7) or (9), or to an exempt organization described in IRC 501(c)(17) or (20) after December 31, 1985, the holding company is to be treated as organized and operated for the same purposes as the exempt payee organization. Thus, if the income of a holding company is payable to a social club or a voluntary employees’ beneficiary association, the holding company will be subject to tax as if it were a social club or a voluntary employees’ beneficiary association. However, the holding company will not be treated as having exempt function income unless it files a consolidated return with the payee organization.
The sale of property is taxable under IRC 512(a)(3)(A) unless the sale satisfies the nonrecognition requirements of IRC 512(a)(3)(D). If the requirements of IRC 512(a)(3)(D) are satisfied, then an organization may exclude all or a portion of the gain from the sale of property.
Requirements for an organization to exclude gain under IRC 512(a)(3)(D):
A sale of property
The property is used directly in the performance of an organization’s exempt function.
New property is purchased by the organization.
The new property is used directly in the performance of an organization’s exempt function.
The new property needs to be purchased within a four year period (beginning one year before the date of the sale of the old property and ending three years after the sale).
Gain (if any) from the sale is recognized only to the extent that the sales price of the old property exceeds the cost of the new property.
The new property purchased need not be similar in nature or in use to the property sold. The recognized gain is includible in the organization’s gross income in the year in which the gain is realized.
Example 2: A social club sells its clubhouse. The gain on the sale will not be taxed if the entire proceeds are reinvested in a new clubhouse within three years. S. Rep. No. 91–552, 91st Cong., 1st Sess. 72 (1969), 1969–3 C.B. 470.
An organization selling property used for both exempt and non-exempt purposes will only be able to not recognize the portion of the gain from the property used exclusively for exempt purposes.
The part of the amount realized from the sale allocable to property used exclusively for exempt purposes must be reinvested in other property.
An allocation is required where the amount realized upon a sale of property used exclusively for exempt purposes is reinvested in other property which is used only partly for exempt purposes.
Example 3: where the sales price of old property used exclusively for exempt purposes is $10,000 and other property, used one-half for exempt purposes, is purchased for $16,000, only $8,000 (one-half of $16,000) is considered reinvested in other property. Therefore, $2,000 of any gain realized from the sale must be recognized.
There is no definition of what is considered "used directly" for purposes of section 512(a)(3)(D).
Examples of property that are directly used, include but are not limited to:
Timber cut on a hunting or fishing club’s property.
Atlanta Athletic Club v. Commissioner, 980 F.2d 1409 (11th Cir. 1993) addressed the issue of whether property is used directly in performance of its exempt function.
Facts: The Club owned a piece of property which has a slag road for members and guest parking. A pine jogging track was built on the property but later abandoned. Club members testified that the property was the site of a number of member activities such as pasture parties, Easter egg hunts, fishing tournaments, kite flying contests, hot air balloon rides and organized foot races. Members jogged on the property, used it for archery practice and flew model airplanes.
Holding: The Court looked at the record and saw nothing to contradict the Club’s evidence that the property was used for recreational purposes. Direct use is not to be equated with dominant use or requiring that direct use have either continuity or regularity. Direct use is to be determined by looking at the activities that took place on the property and determining whether these activities constitute recreational uses by the Club. Organizations need to keep records that provide details concerning the use of the property to prove that the property sold furthered their exempt purposes.
The Tax Court in Deer Park Country Club, T.C. Memo. 1995–567 (November 28, 1995, corrected December 4, 1995) stated that land subject to IRC 512(a)(3)(D) must be used for exempt functions prior to the sale.
Facts: A country club purchased two tracts of land—one used for fishing and one as a golf course. It subsequently transferred the fishing property to the state of Illinois for cash and a 63.8 acre tract of farmland. The farmland was rented from 1981 to 1986. From 1981–1986, the club engaged a designer to develop plans for constructing an additional golf course, a swimming pool, and tennis courts. After consulting with banks regarding financing, the club agreed to devote 59 acres for recreational purposes and to subdivide the remaining 4.8 acres.
Holding: IRC 512(a)(3)(D) requires a use of assets or property that is both actual and direct in relation to the performance of its exempt function. The intention of using property in furtherance of exempt purposes is irrelevant. Although the club may have originally intended to use the land for recreational purposes, the fact that the club never used the land for exempt purposes was dispositive.
In Framingham Country Club v. United States, 659 F. Supp. 650 (D.C. Mass. 1987), the court held: An IRC 501(c)(7) social club could not utilize the nonrecognition of gain provision under IRC 512(a)(3)(D) with respect to income received from an option on the sale of property. In the court’s view, the lapse of an option is to be treated as ordinary income to the grantor and not as short-term capital gain resulting from a "sale."
An alternative adverse holding made by the court was that the club had not sufficiently demonstrated that the property was used directly in the performance of the club’s exempt function as required by IRC 512(a)(3)(D). The court noted that although the property may have been originally purchased with the intention of providing golfing facilities, it was never used for that purpose. The use of a home for a greenskeeper and the storage of large equipment on the property did not directly facilitate the club’s exempt function.
In Tamarisk Country Club v. Commissioner, 84 T.C. 756 (1985), the court held: The gain realized by an IRC 501(c)(7) social club from the sale of real property was unrelated business taxable income because the club’s sales price less selling expenses exceeded the cost of the new property by more than the amount of gain realized on the sale.
The court rejected the club’s argument that it was entitled to nonrecognition of gain to the extent its equity or profit was reinvested in other qualifying property.
Exhibit 3 illustrates an example of non-recognition of gain on the sale of property used directly in furtherance of an organization’s exempt purpose.
Nonmember Use of Social Club’s Facilities.—Guidelines are provided for determining the effect the general public’s use of a social club’s facility has on the club’s tax-exempt status or liability for unrelated business income tax under IRC 511(a). Recordkeeping requirements are also described when nonmembers use a club’s facility and circumstances under which a host-guest relationship will be assumed for purposes of computing exempt function income under IRC 512(a)(3) are set forth. See. Rev. Proc. 71–17, 1971–1 C.B. 683.
Interest on obligations issued by a State.—Interest received by a social club on obligations issued by a State is not included in gross income for the purpose of computing unrelated business taxable income under IRC 512(a)(3). See Rev. Rul. 76–337, 1976–2 C.B. 177.
Losses from nonprofit activity.—In determining its unrelated business taxable income, a social club may not reduce its net investment income by the losses from the sales of food and beverages to nonmembers. See Rev. Rul. 81–69, 1981–1 C.B. 351.
|S, a social club, operates a restaurant and bar for members and their guests. Nonmembers are admitted to the restaurant and bar only if accompanied by a member. S is supported by annual dues and amounts received in consideration for food and beverages. S does not normally receive payment for food and beverages at the time they are furnished but, rather, bills its members monthly for such items. Because some members prefer not to be billed, S has facilities for receiving cash payments. Although most cash payments are made by the members and include all expenses incurred by themselves and their guests, some nonmembers insist on paying their own expenses. S did not set aside any amounts under section 512(a)(3)(B). During the year, S received the following amounts of gross income:|
|Receipts from members from sale of food and beverages||195,000|
|Receipts from nonmembers from sale of food and beverages||5,000|
|S incurred expenses during the year of $180,000 from the operation of the restaurant and bar and $72,000 from the performance of other exempt activities. The portion of the expenses directly connected with the furnishing of food and beverages to nonmembers who pay their own bills was $4,500. No expenses were incurred with respect to the interest income. S computes its unrelated business taxable income as follows:|
|Reduced by exempt function income:|
|Gross income from members dues||$ 55,000|
|Gross receipts from members||195,000||250,000|
|Gross income (excluding exempt function income)||5,500|
|Expenses directly connected therewith||$4,500|
|Specific deduction allowed by IRC 512(b)(12)||1,000||5,500|
|Unrelated business taxable income||0|
|An exempt social club described in IRC 501(c)(7) derived income and incurred expenses during the year in the following manner:|
|Gross income from:|
|Deductions directly connected with gross income from:|
|Income set aside for educational purposes||2,000|
|This organization’s unrelated business taxable income is computed as follows:|
|Reduced by exempt function income:|
|Gross income from members||$225,000|
|Income set aside||2,000||227,000|
|Gross income (excluding exempt function income)||7,500|
|Deductions for debt-financed property||4,000|
|Deductions for investments||200||4,200|
|Less: Specific deduction allowed by IRC 512(b)(12)||1,000|
|Unrelated business taxable income||2,300|
|N, a social club, purchased a building and land for use as a golf course in 1950 for $100,000. On April 1, 1972, N sold the entire tract, in one transaction, for $250,000 and purchased another tract for $120,000. N then spent $105,000 constructing a golf course and club house on the new tract. Construction was completed in 1972. Between February 1, 1971, and April 1, 1971, N incurred $4,000 of expenses in negotiating the sale of its old property and $1,000 of noncapital expenses for work performed on the old property to assist in its sale. The club computes its recognizable gain from the sale of the property as follows:|
|Proceeds from sale of old property||$250,000|
|Less: selling expenses||4,000|
|Less: fixing-up expenses||1,000|
|Cost of purchasing other property||225,000|
|Gain realized but not recognized||126,000|
|N computes its adjusted basis in the other property as follows:|
|Cost of purchasing other property||$225,000|
|Less: gain realized but not recognized||126,000|
|Adjusted basis of other property||99,000|