Presented by: Robyn Stowell, Esq. and Mitchell Stump, CPA

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1 Think Your Club is Purely Private? What Do Your Records Of Non-Member Income Say About That? Sunday, February 10, 2013, 1:15 p.m. 2:45 p.m. Session 1349 Presented by: Robyn Stowell, Esq. and Mitchell Stump, CPA The tax rules dictate how a Club must account for its Member vs. nonmember gross receipts in its books and records. Below, are a number of published IRS rulings and positions regarding Clubs and how their income is to be classified as nonmember related. Mitchell Stump will discuss the requirement to report general public usage of a Club as nonmember related, while from a legal standpoint, Robyn Stowell will weigh in as to whether the general public usage rises to the level of a Club being found to be a public accommodation. As you will see, the term general public has been highlighted for ease of identification. TAX DEFINITION OF General Public : Revenue Procedure The term "general public" as used in this Revenue Procedure means persons other than Members of a Club or their dependents or guests. The Member's spouse is treated as a Member. Use of a Club's facilities by the general public is significant for two reasons: It may indicate the existence of a nonexempt purpose; or, If not of sufficient substantiality to result in loss of exemption, it may make the Club liable for unrelated business income tax. LEGAL DEFINITION OF Public Accommodation : Black s Law Dictionary - Within the meaning of the Civil Rights Act of 1964, which prohibits racial discrimination in such places, it is generally a business establishment, affecting interstate commerce or supported in its activities by State action, which provides lodging, food, entertainment or other services and is open to the public. Assumption: Issues for taxable Clubs under Code Section 277 can be analyzed following the Revenue Procedure used to determine whether a social Club was tax exempt under I.R.C. section 501(c)(7). TAX HISTORY OF 501(c)(7) Prior to tax years beginning before 10/20/76 Internal Revenue Code Section 501(c)(7) Clubs organized and operated exclusively for pleasure, recreation, and other nonprofitable purposes, no part of the net earnings of which inures to the benefit of any private shareholder." Internal Revenue Regulations 1.501(c)(7)-1(b) Section 1.501(c)(7)-1(b) of the regulations provides 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) of the Code. Effective for tax years beginning after 10/20/76 Internal Revenue Code Section 501 (c)(7)

2 Clubs 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. The intent of Public Law changing Internal Revenue Code Section 501(c)(7) is reflected in the Senate Finance Committee Report as follows: It is intended that these organizations 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. It is 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.... PRIOR TO 76 RULINGS Rev. Rul Commingling of Members A commingling of the members must play a material part in the life of the organization. The revenue ruling states that it is clear that a club which engages in business, such as making its social and recreational facilities available to the general public may not be considered as being organized and operated exclusively for pleasure, recreation or social purposes. A club will not be denied exemption merely because it receives income from the general public, that is, persons other than members and the bona fide guests, or because the general public on occasion is permitted to participate in its affairs, provided such participation is incidental to and in furtherance of its general club purposes and it may not be said that income therefrom is inuring to members. This is generally true where the receipts from nonmembers are no more than enough to pay their share of the expense. Rev. Rul Use By Outside Organizations A social club exempt from Federal income tax under IRC 501(c)(7) may lose its exemption if it makes its club facilities available to the general public on a regular, recurring basis since it may then no longer be considered to be organized and operated exclusively for its exempt purpose. U.S. v Ft. Worth Club of Ft. Worth, TX 4/15/ Leasing Space to the Public We face a narrow issue: was the taxpayer, the Fort Worth Club, during its fiscal year ending April 30, 1960, "organized and operated exclusively for pleasure, recreation and other non-profitable purposes", within the meaning of section 501(c)(7) of the Internal Revenue Code of 1954? A strict reading of the statute requires us to hold that the club was not so organized and operated; through a wholly owned subsidiary, the club was in the business of leasing office space to the general public. Rev. Rul Sports Car Event Admission Fee A nonprofit organization that, in conducting sports car events for the pleasure and recreation of its members, permits the general public to attend such events for a fee on a recurring basis and solicits patronage by advertising, does not qualify for exemption under IRC 501(c)(7). Rev. Rul Business of a Subsidiary The activities of a taxable subsidiary of an otherwise exempt social club are considered activities of the parent club for purposes of determining whether the parent is engaging in business with the general public for profit. Rev. Rul Public Admission Charges A social club does not jeopardize its exemption under IRC 501(c)(7) by charging the public admission to a club sporting meet if the meet is open to the general public, both as spectators and as participants,

3 and the general expenses of the meet are met from admission charges and sale of programs and refreshments, and provided participation in the meet is in furtherance of the general club purposes. Rev. Rul Subdividing and Leasing of Lots This cites section 501(c)(7) of the Code, and section 1.501(c)(7)-1(a) of the regulations, which states that a club otherwise entitled to exemption will not be disqualified because it raises revenues from members through the use of club facilities or in connection with club activities. The revenue ruling also cites section 1.501(c)(7)-1(b) of the regulations, which provides that a club which engages in business, such as selling real estate, is not organized and operated exclusively for pleasure, recreation, and other nonprofitable purposes and is not exempt under Code section 501(a). Rev. Rul then sets forth the following rationale and conclusion: The subdividing and leasing of lots in the manner described constitutes engaging in business. Although the revenues from this activity are derived from the organization's members only, the revenues are not raised from the members' use of recreational facilities, or in connection with the organization's recreational activities. The conduct of such real estate activity, whether with members only or with the general public, is not in furtherance of any purpose covered by section 501(c)(7) of the Code. Accordingly, the organization does not qualify for exemption from Federal income tax under that section. Rev. Rul Golf Tournament Admitting A country club that annually hosts a golf tournament to which the general public is admitted for a charge and uses the net income therefrom for club purposes does not qualify for exemption under section 501(c)(7) of the Code. Rev. Rul Golf Course Open A social club that regularly holds its golf course open to the general public, charging established green fees that are used for maintenance and improvement of club facilities, is not exempt under IRC 501(c)(7). Rev. Rul Charity Use of Club The club was organized to operate and maintain a country club for the pleasure and recreation of its members. The club has been asked to permit an organization exempt from Federal income tax under section 501(a) of the Code to use its facilities to raise funds for charity. The sponsoring organization will sell admission tickets to the general public. Rev. Proc Parties of 8 Rule This Revenue Procedure sets forth guidelines for determining the effect gross receipts derived from use of a social club's facilities by the general public have on the club's exemption from Federal income tax under section 501(c)(7) of the Internal Revenue Code of These guidelines will be used in connection with the examination of annual returns on Forms 990 and 990-T filed by social clubs. This Revenue Procedure also describes the records required when nonmembers use a club's facilities and the circumstances under which a host-guest relationship will be assumed, which are relevant both for purposes of determining adherence to the exemption requirements and for computing exempt function income under section 512(a)(3) of the Code. However, this Revenue Procedure does not deal with other factors bearing on the exempt status of clubs. General statement.--use of a club's facilities by the general public is significant for two reasons. It may indicate the existence of a nonexempt purpose; or, if not of sufficient substantiality to result in loss of exemption, it may make the club liable for unrelated business income tax. The term "general public" as used in this Revenue Procedure means persons other than members of a club or their dependents or guests. The member's spouse is treated as a member.

4 Nonexempt purpose.--in the examination of information returns of clubs, the problem frequently is to determine under what circumstances and to what extent the fact that a club makes its facilities available to the general public is to be relied upon by the Service as indicating the existence of a nonexempt purpose. 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. See Rev. Rul , C.B , 173; and Rev. Rul , C.B , 153. However, this does not mean that all dealings with the general public are necessarily inconsistent with the club's purposes. Minimum gross receipts standard.--a significant factor reflecting the existence of a nonexempt purpose is the amount of gross receipts derived from use of a club's facilities by the general public. As an audit standard, this factor alone will not be relied upon by the Service if annual gross receipts from the general public for such use is $2,500 or less or, if more than $2,500, where gross receipts from the general public for such use is five percent or less of total gross receipts of the organization. This minimum gross receipts standard reflects the audit experience of the Service that gross receipts at or below this level do not, standing alone, usually demonstrate a nonexempt purpose. Even though gross receipts from the general public exceed this standard, it does not necessarily establish that there is a nonexempt purpose. A conclusion that there is a nonexempt purpose will be based on all the facts and circumstances, including but not limited to the gross receipts factor. This audit standard relates only to determinations of exempt status. There is no minimum audit tolerance with respect to unrelated business taxable income. Rev. Rul Corporate Members A corporate member is a membership issued to a corporation, an artificial entity. The corporation designates which of its officers and employees may use the club's facilities. This type of membership is not within the contemplation of the statute, and a club having such membership is, in fact, dealing with the general public. Pittsburgh Press Club v. U.S., 536 F.2d 572 (1976); 579 F.2d 751 (1978); and 615 F.2d 600 (1980) Nonmember Gross Receipts 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. SUBSEQUENT TO 76 CHANGE Rev. Rul Guest Defined A guest of a nonprofit social club is an individual who is a guest of a member of the club and who ordinarily does not reimburse the member for the guest's expenses. On the other hand, amounts paid to a social club 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 such social club under a reciprocal arrangement with such other social club. Accordingly, in this case, the members of the other social clubs that attend the calcutta are not guests of the members of the host club, but are members of the general public within the meaning of Rev. Proc /10/08 IRS Letter - Reciprocal Arrangements This is in response to your request for us to consider the continuing applicability of the holding in GCM regarding the treatment of income derived by a social club under a reciprocal agreement with a

5 social club of like nature. GCM holds that income received by a section 501(c)(7) social club from members of another club, under a reciprocal agreement, is income from members of the general public. The amounts are not member income for purposes of the member income tests for exemption under section 501(c)(7). Private Letter Ruling Excess Income Issues: 1. Should the organization's exemption under section 501(c)(7) of the Internal Revenue Code be revoked for excessive income from the general public? INFO Youth Dances Youth dances and similar social activities for club members and associate members are the type of activities traditionally carried on by social clubs and would further the club's exempt purposes by promoting fellowship among its members. Opening the function to nonmembers by selling tickets to the general public, however, does not further the club's exempt purposes. Income from tickets sold to nonmembers must be included in the club's calculation of unrelated business taxable income. Unless the amounts from this nonmember source, when added to the club's other nonmember income exceeds the 15% limitation, it will not affect its exemption under section 501(c)(7). Rev. Rul Section 277 Taxable Club Offset Member Losses Against Nonmember Income Club A is a taxable social club that operates a golf course, tennis courts and a clubhouse (including a restaurant) primarily for the benefit of its members. A has significant nonmember source income from use of the clubhouse by the general public for wedding receptions, anniversary parties and special events. The nonmember use of the clubhouse is a trade or business. Private Letter Ruling Advertise To General Public During the examination, it was determined that the ORG failed to comply with the record keeping requirements of Revenue Procedure Furthermore, the organization advertised the use of its facility to the general public. This is evidenced by a number of documents, information and facts secured during the audit. Robyn Nordin Stowell, Esq., is a partner in the law firm Stinson Morrison Hecker. Her practice focuses on real estate and general business matters, including real estate leasing and finance, with a special emphasis on golf and private club matters. She has been recognized by Best Lawyers in America and by Top Lawyers in Arizona by Arizona Business Magazine. She was one of the Top People to Know in Commercial Real Estate by Arizona Commercial Real Estate Magazine in She was also recognized by BoardRoom Magazine as One of the Seventeen Most Influential Women in the Golf Club Industry" in 2009 and was the winner of its Excellence in Achievement Award for Educator of the Year in rstowell@stinson.com Mitchell L. Stump, CPA is president of Mitchell L. Stump, CPA, PA; Club Book Series, Inc.; and Club Tax Network, Inc. His consulting practice focuses primarily on Private Club matters, addressing tax, accounting and marketing issues which include authoring the quarterly updated publication Club Tax Book offered through Club Book Series, Inc. on an annual subscription basis. Through Club Tax Network, Inc., Mitch provides solutions to a variety of Club Issues, including educational seminars and webinars to CPA s and other Professionals serving the Private Club Industry and has created the Club Fraud Hotline as a tool to be used as part of a Club s whistle blower policy. mitch@clubtax.com