The Lawletter Vol 37 No 6
In recent years, recreational and social clubs have experienced declines in membership and the corresponding reductions in revenues that they derive from their members' dues and other payments. As a result, these clubs have begun allowing nonmembers to use their facilities. Currently, clubs receive significant revenues from the use of their facilities by nonmembers. The tax question that arises when a club decides to supplement its income by allowing nonmembers to use its facilities is how much revenue it can receive from nonmembers before it loses its tax-exempt status.
The Internal Revenue Code (the "Code") provides that "[c]lubs organized for pleasure, recreation, and other nonprofitable purposes, substantially all of the activities of which are for such purposes and no part of the net earnings of which inures to the benefit of any private shareholder," 26 U.S.C. § 501(c)(7) (Westlaw current through P.L. 112‑142 (excluding P.L. 112‑140 and 112‑141) approved 7‑9‑12) (emphasis added), are "exempt from taxation under this subtitle unless such exemption is denied under section 502 or 503," id. § 501(a). Notwithstanding the "substantially all" language of § 501(c)(7) of the Code, the Treasury Regulations currently state that "[t]he exemption provided by section 501(a) for organizations described in section 501(c)(7) applies only to clubs which are organized and operated exclusively for pleasure, recreation, and other nonprofitable purposes[.] " 26 C.F.R. § 1.501(c)(7)-1(a) (Westlaw current through Sept. 6, 2012; 77 FR 54838) (emphasis added). The current Regulations also say that "[a] club which engages in business, such as making its social and recreational facilities available to the general public or by selling real estate, timber, or other products, is not organized and operated exclusively for pleasure, recreation, and other nonprofitable purposes, and is not exempt under section 501(a)." Id. § 1.501(c)(7)-1(b) (emphasis added).
Even though the Regulations still say that a recreational or social club must be organized and operated exclusively for pleasure, recreation, and other nonprofitable purposes, the less stringent current language of the Code, which provides that such a club is tax-exempt if substantially all of the activities are for pleasure, recreation, and other nonprofitable purposes, must be given effect by the Internal Revenue Service ("IRS"). In 1976, Congress passed Pub. L. No. 94-568, 90 Stat. 2697 (Oct. 20, 1976) (effective for taxable years beginning after the date of enactment), for the express purpose of removing the term "exclusively" from § 501(c)(7) of the Code and adding the term "substantially" to the statute in its place. By changing the language of § 501(c)(7), Congress intended that recreational and social clubs "be permitted to receive up to 35 percent of their gross receipts, including investment income, from sources outside of their membership without losing their tax‑exempt status." S. Rep. No. 94‑1318 (1976), reprinted in 1976 U.S.C.C.A.N. 6051, 6054. Congress "also intended that within this 35‑percent amount not more than 15 percent of the gross receipts should be derived from the use of a social club's facilities or services by the general public." Id.
In a very recent Private Letter Ruling, the IRS applied the above-described 35%-15% test to what appears to be a country club that has a golf course, swimming pools, tennis courts, and dining and other social-use facilities. I.R.S. Priv. Ltr. Rul. ("P.L.R.") 2012-25-018 (June 22, 2012). Since the facts of the case suggested that the club in question was receiving approximately 71% of its income from nonmembers who paid to use the club's facilities, the IRS concluded that the club was no longer exempt from federal income tax under § 501(c)(7).
For a more detailed discussion of P.L.R. 2012-25-018, see Country Club Loses Tax‑Exempt Status Due to 71% of Gross Receipts Deriving from Nonmembers, 53 Tax Mgmt. Mem. (BNA) 287, 307-08 (July 30, 2012) (visit http://www.bna.com/www.bnatax.com). The reader is cautioned that under 26 U.S.C. § 6110(k)(3), "[u]nless the Secretary otherwise establishes by regulations, a written determination [such as a P.L.R.] may not be used or cited as precedent."
The decision in P.L.R. 2012-25-018 indicates that professionals who advise recreational and social clubs should emphasize to their clients (1) the importance of following the guidelines for determining the effect on the clubs' exemption under § 501(c)(7) of gross receipts derived from nonmember use of the clubs' facilities, and (2) the recordkeeping requirements for clubs set forth in Rev. Proc. 71‑17, 1971‑1 C.B. 683 (note that the post-1976 35%-15% test applies to Revenue Procedure 71‑17).