PART VII THE CLUB AND ITS TAX-EXEMPT STATUS
YOUR CLUB AND THE LAW
Part VII The Club and Its Tax-Exempt Status Table of Contents
Chapter 1
Chapter 2 Chapter 3
Chapter 4
Introduction to the Social Club Tax Exemption
Policy Behind the “Social Club” Tax Exemption . . . . VII-1-1 What is a Social Club?. . . . . . . . . . . . . . . . . . . . . . . VII-1-2
The “Club” . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . VII-2-1 The Club’s Purpose and Activities Commingling of Members. . . . . . . . . . . . . . . . . . . . VII-3-1 Engaging in Business. . . . . . . . . . . . . . . . . . . . . . . . VII-3-2
Prohibition on Private Benefit to the Club’s Members . . . . . . . . . . . . . . . . . . . . . . . . . . . . VII-4-1
Part VII — Table of Contents
1
YOUR CLUB AND THE LAW
Chapter 5
Chapter 6 Chapter 7
Appendix
2
The Club’s Membership Issues
Limited Membership . . . . . . . . . . . . . . . . . . . . . . . . VII-5-1 Rights of Members. . . . . . . . . . . . . . . . . . . . . . . . . . VII-5-1 Membership Structure . . . . . . . . . . . . . . . . . . . . . . . VII-5-2 Corporate Membership or Corporate Sponsorship. . . . . . . . . . . . . . . . . . . . . . . VII-5-3 Membership Donations to the Club . . . . . . . . . . . . . VII-5-4
Prohibition Against Discrimination . . . . . . . . . . . . . . . . VII-6-1 Limitation on the Club’s Outside Income Unrelated Business Income Tax. . . . . . . . . . . . . . . . VII-7-2 Member Income. . . . . . . . . . . . . . . . . . . . . . . . . . . . VII-7-2 15/35 Percent Test . . . . . . . . . . . . . . . . . . . . . . . . . . VII-7-3 Record-Keeping Requirements . . . . . . . . . . . . . . . . VII-7-3
Member Function Questionnaire
. . . . . . . . . . . VII-Appendix-1
Part VII — Table of Contents
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Chapter 1 Introduction to the Social Club Tax Exemption One of the significant characteristics of any club is its tax status. Many clubs may qualify for federal tax-exemption under the Internal Revenue Code as a §501(c)(7) social and recreational club. If a club is eligible under this provision, it should file Form 1024 to apply for recognition of the exemption from federal tax. This Part provides a basic discussion of some of the more important aspects involved in qualifying for, and maintaining, your club’s tax-exempt status.
Policy Behind the “Social Club” Tax Exemption
As mentioned, certain types of clubs are exempt from federal tax. Generally, these clubs are referred to as “social” or “recreational” clubs. The policy and purpose behind the creation of the social club tax-exemption is to ensure that the club’s members are not subject to any tax disadvantages as a consequence of their decision to collectively pool their resources for the purchase and maintenance of social and recreational facilities and services.
Chapter 1 — Introduction to the Social Club Tax Exemption
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You should keep this policy in mind while reading the following chapters in order to gain a full understanding and appreciation of the numerous requirements and restrictions placed on a social club’s tax-exempt status. Among many other crucial distinctions raised below, this policy helps to explain why the (c)(7) exemption earns a social club the right to claim an exemption from federal tax for the support paid into the club by its members, but not, however, the right to be exempt from tax on the many other potential sources of income to the club, including investment income and income garnered from nonmember payments.
What is a Social Club?
The types of clubs that may fit into the framework established by the social club tax exemption are seemingly endless. Dining clubs, fraternities, amateur sport clubs, garden clubs, variety clubs, hobby clubs, certain community associations and country clubs are just a few of the more prevalent examples. Yet while the exemption may be applied to a diverse variety and wide range of clubs, the scope of the exemption is not without its defined limits. The following chapters will highlight and explore some of the significant issues that must be addressed in making the determination of whether a club constitutes a “social” club, and thus can claim a (c)(7) tax exemption. The starting point for making this assessment and determination is the framework for qualification under the social club tax-exemption as established by the Internal Revenue Code. This framework sets forth the following major requirements for obtaining and maintaining the social club tax-exemption: • There must be a “club”; • The club must be organized for pleasure, recreation and other non-profitable purposes; • “Substantially all” of the club’s activities must be conducted for the purpose of pleasure, recreation or other non-profitable purpose; • No part of the net earnings of the club may inure to the benefit of any private shareholder in the club; The club must not have any written policy that discriminates against individ• uals seeking membership on the basis of race, color or religion.
Each of these important considerations will be presented in more detail in the following chapters. VII-1-2
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Chapter 2 The “Club” The Internal Revenue Code does not define the term “club.” As such, it is often easier to understand what a club is by expressing what it is not. In general, what the club may not be is a vehicle for carrying on an active business with the public, or for circumventing any type of federal, state and local laws and regulations. What constitutes “carrying on” or “engaging in” business is explained in detail in a subsequent chapter. Some of the regulations that are most often involved in attempted circumvention are liquor laws, zoning ordinances, and civil rights legislation. There exist certain organizational characteristics of a club that may be treated as evidence that the “club” is in fact operating for one of the above mentioned non-exempt purposes. These characteristics, which obviously should be avoided to the extent possible, include: • Broad and vaguely stated membership requirements; • Initiation fees so low that one-time or transient use of the facilities is encouraged; Management that actively pursues the expansion of club membership; • • Management that has the means to effectively perpetuate itself in its position.
Chapter 2 — The “Club”
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These characteristics are not by themselves necessarily damaging to a club’s taxexempt status. However, combined with other factors, and especially with other evidence of being operated for a non-exempt purpose, the existence of these characteristics can be damaging to a club’s maintenance of its tax-exempt status. Obviously, the easiest way to avoid problems in this area is to avoid operating your club for any of the non-exempt purposes described above. But as an additional safeguard, your club should take steps to ensure that none of the above mentioned characteristics are applicable in relation to your club.
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Chapter 3 The Club’s Purpose and Activities For a social club to qualify for the (c)(7) federal tax exemption, “substantially all” of the club’s operations must be conducted for the pleasure, recreation or other nonprofitable purpose of the club’s members. Two extremely significant considerations are involved in determining whether a club is in compliance with this mandate. One consideration – commingling – centers on the types of activities the club should be conducting, while the other consideration – engaging in business – focuses on the types of activities the club should avoid.
Commingling of Members
To show that your club maintains the characteristics of a “club” within the meaning of (c)(7), your club may be required to show that personal contact and fellowship are a material part in the overall life of the club. This “commingling of members” requirement exists because the IRS has determined that a lack of social interaction of club members reflects a purpose of providing services or facilities to the club’s membership in a manner more consistent with public and commercial business entities, rather than as a true social club. When a club is denied, or loses, its (c)(7) taxexempt status, the result frequently is brought about by the fact that the club’s membership did not exhibit sufficient social “commingling.”
Chapter 3 — The Club’s Purpose and Activities
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The commingling standard requires personal contact and fellowship among the club’s members to be the significant purpose of the club. Stated another way, to maintain its tax-exempt status, the social commingling of members must be the major feature of a club. What constitutes evidence of membership commingling? Anything that provides some evidence of either actual or potential social interaction among club members can be evidence of commingling. To specifically address this issue, a club, in both its long- and short-term planning, should focus upon ways it can increase both the actual and potential opportunities arising from the club for face-to-face contact and interaction among the club’s membership. Regularly scheduled meetings or group activities that club members attend is an example of actual commingling. The existence of numerous open facilities on the premises of the club is a good example of evidence of encouraging commingling. Remember, commingling of members must be considered the primary purpose of the club. Where these social aspects of a club are merely minor or incidental aspects of the club, the club does not meet the requirements set by this standard. Commingling that takes place only as an incidental effect of some other primary purpose will not satisfy the test for the social club tax-exemption. The importance of keeping this in mind throughout all of the club’s planning and day-to-day operations cannot be overly stressed. Even if the club operates solely for non-profitable purposes, and even if it does not distribute any benefit to any of its shareholders, it nonetheless will fail to qualify for the social club exemption if it does not have as its primary purpose the commingling and fellowship of its members. This is the premise behind the limitation on corporate members, which will be discussed later. A corporation cannot commingle.
Engaging in Business
Obviously, if a club is being operated and managed with the sole purpose of earning a profit, it does not fall within the scope of the (c)(7) social club exemption. But there exist numerous less obvious ways in which a club may find itself unintentionally running afoul of the prohibition against “engaging in business.” One way clubs often find themselves to be in violation of this prohibition is by allowing certain services provided by the club to become the primary purpose of the
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club, at the expense of the social commingling of its members. The availability and provision of any non-social services to a club’s membership should be kept to a minimum, in both a quantitative and qualitative sense. At all times, the social aspects and commingling activities of the club must be the primary purpose and focus of the club’s operations, and any non-social activities that take place on the club’s premises must exist and occur merely as an incident to the primary social activity. A good example of how a shift in the primary purpose of a club can occur over time is found in the area of travel and automobile clubs, many of which were originally established as social clubs for interested persons to travel together and to share travel information. As many of these clubs grew in size, however, they transformed themselves into associations, which existed primarily to provide maps and create itineraries, at the expense of promoting the social interaction of their members. When this social interaction became secondary, many of these clubs began to be determined to essentially be “engaging in business,” and thus lost their social club tax-exemption based on this transformation. Another way clubs frequently get into trouble in the “engaging in business” area is by opening up their social and recreational facilities to the general public. A club’s tax-exemption may be revoked pursuant to this limitation when its facilities are regularly rented to nonmembers, or when its primary source of income comes from such nonmember rentals and bar receipts. It is important to note that this prohibition is against regular use; it is not a total ban on nonmember use of a club’s services and facilities. Subject to certain limitations described below, public use of the club’s facilities and services may be, at times, completely consistent with the club’s tax-exempt purposes. In the past, there was one particular activity, however, which a club absolutely had to avoid if it desired to maintain its tax exemption: namely, advertising of club facilities and services to the general public. The thought was that promoting nonmember business would create a strong presumption that the club was violating the prohibition against “engaging in business.” In 2003, the IRS stated that a 501(c)(7) membership organization could, in certain instances, advertise for members and for nonmember business. The total prohibition Chapter 3 — The Club’s Purpose and Activities
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on advertising contained in proposed regulations that were never adopted no longer applies because of the ability of a club to have a minimal amount of nonmember business. Since a club can have up to 15 percent of gross receipts from the nonmember use of club facilities, the IRS indicated that it would make sense that you could advertise. It is important to note that the tax and the privacy issue are two different topics. The more you advertise, the higher your nonmember business and the more you look like a business, the more difficult it will be to argue that you are truly private. Loss of private status can be more devastating to a club than its tax status. One exception to the stringent policy against a social club “engaging in business” involves a club that conducts sales or other transactions in the ordinary course of its existence. For instance, if a club sells some of its property because the property is no longer of use to the club, that sale likely will not be considered “engaging in business,” and the club’s exemption will not be affected. An example of when such a sale, even for a substantial profit, fits into this exception is when a country club that is originally established in an underdeveloped area outside of a city eventually finds itself in the midst of suburban sprawl. If the club’s members have continued to move away from the club, or the property taxes have become too high, a club may sell its property without losing its tax exemption. The key to avoiding problems in these types of situations is to ensure that all sales made by the club occur only as incidental effects of the pursuit of the club’s exempt purposes. In other words, a club should avoid engaging in transactions simply because it can get a good deal. Transactions entered into by the club should be driven solely by the needs and demands of the club’s exempt purposes. This fact is especially true when a sale by the club results in a profit. A club sale for a profit, especially a substantial one, is very likely to be scrutinized; to protect against the loss of its tax exemption, the club must be both ready and able to justify the fact that the earning of a profit was merely incidental to the club’s primary purpose and motivation in deciding to enter into the transaction.
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While a club is subject to tax on the gain on the sale of its property, a limited exception is provided assuming the property sold was used in the exempt function of the club. If property used directly in the performance of the exempt function of a club is sold, and within a period beginning one year before the date of such sale, and ending three years after such date, other property is purchased and used by the club directly in the performance of its exempt function, gain (if any) from the sale shall be recognized only to the extent that the sales price of the old property exceeds the new property purchased. This can be a very valuable exception, which could save the club up to 40 percent of the sales proceeds if tax need not be paid. However, the IRS does look at these issues and it is important to be able to demonstrate that the property was used directly in the exempt function of the club. As a brief footnote to this discussion of sales in the ordinary course, it is worth making the common sense observation that as the number of sales that any one club makes increases, so does the strength of the implication that such sales are no longer being made “in the ordinary course.” Indeed, the IRS has noted that recurrent or consistent sales of property, especially when made for a profit, are evidence that the club is “engaging in business.” Profitable activities on the part of a club will not necessarily result in revocation of the club’s tax exemption, but the club must take every measure possible to ensure that the profits derived from such activities result only as an incidental effect of carrying on or promoting the exempt purposes of the club. One major situation in which this issue often arises surrounds a club’s dining or bar services. A social club may maintain a dining area that caters to its members and their guests. A club may also maintain a bar for its members and their guests. Because both of these activities promote the purpose of the club – social interaction of the club’s members – the club will not even be penalized by the fact that this source of income may become the primary source of income to the club. Keep in mind, however, that the meals and refreshments must be served in the spirit of the club’s exempt purposes. Thus, providing substantial services for food to be eaten off-premises, even if sold solely to club members, may be treated as a nontraditional activity. The same obviously applies to liquor sold by the club for off-premises consumption. More than a deminimus amount of revenue from nontraditional activities could result in loss of tax-exempt status. Chapter 3 — The Club’s Purpose and Activities
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Opening a club up to the general public to watch a tournament or special event on the club’s premises is another situation that arises quite often. The staging of this type of event will typically not result in any negative implications in regard to the club’s tax-exempt status, as long as the club, in planning and staging the event, realizes that the event must necessarily be only one part of the club’s overall exempt purpose. In other words, a club will run into trouble if its sole purpose is to hold one open tournament each year. To protect against the charge of “engaging in business” when a club holds open events, it should focus on keeping these events to a minimum, and ensuring that the events have some relation to the specific purposes for which the club operates. Additionally, where the public is invited into the club, for a fee, the fee should be the same for both members and the general public. This protects against the “private benefit” prohibition discussed later in this section. A key here, as in all of these situations involving “profits” and “engaging in business,” is to never let the club’s exempt purposes out of sight. If a club makes all of its decisions with its exempt purposes primarily on the mind, this will prove to be an effective way to ensure that if any “business” occurs at all, the business will occur solely as an incidental effect of the club’s primary activities, and the level of business activity will be kept to a minimum. Another effective way to ensure that the all of the club’s purpose and operational requirements and limitations are complied with is to spell out the requirements and limitations in the club’s governing documents. These purposes and requirements should already be drafted into the club documents, but a quick check to be certain is worth the minimal effort required to do so. In addition, while you are re-examining your club’s governing documents, it is a good idea to check to see that your governing documents do not specifically authorize the club to engage in activities beyond the permitted scope of a social club. If they do, you must remove them. Clubs with powers stated in their governing documents beyond what is allowed by the tax law stand to lose their tax exemption.
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Chapter 4 Prohibition on Private Benefit to the Club’s Members Another crucial requirement to acquiring and maintaining tax-exempt status is the prohibition on the inurement of private benefit to any of the club’s shareholders or members. The scope of “private benefit” is quite expansive and includes not only financial benefit, but other less obvious and less direct forms of personal benefit as well. Club management must keep this limitation in mind in relation to just about any and every activity conducted by the club. If any part of the club’s earnings inure to the benefit of any member, the tax exemption may be lost. Obvious examples of the types of private benefits precluded by this limitation include dividend or bonus payments, excessive and unreasonable salaries, and entering into transactions with members at less than arm’s length. One area where this rule is consistently tested involves club tournament prizes. The awarding of prizes to club tournament winners will not typically run afoul of this limitation, as long as the awards are reasonable.
Chapter 4 — Prohibition on Private Benefit to the Club’s Members
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The club manager needs to be keenly aware of the situation in which money generated from payments made by nonmembers is used solely to reduce the cost of providing the club’s services to its members. In this situation, it is possible that the prohibition against private benefit is violated. The IRS has taken the position that when the club’s profits (earned from nonmembers) are used to reduce the costs of membership for the club’s members, this reduction is essentially the same in its overall effect as a direct payment from the club to the club member. As such, it is likely to run afoul of the “private benefit” prohibition. Similarly, this type of situation often arises when the club utilizes tiered memberships. If a club has a certain class of member, which is required to pay a higher or lower membership rate or fee than another class of member, each distinct class must be given membership rights which correlate to the level of its membership contribution. If a club has two sets of membership classes, each paying the same fees, but not possessing the same membership rights (or each paying different membership rates but possessing identical rights) the class of members who are paying more but getting less can be said to be more or less subsidizing the other class. This subsidy is likely to be construed as creating private gain. This is not to say that any mere difference among membership classes in dues, fees or membership rights will automatically result in a finding of prohibited private gain. Obviously, membership classes are a staple of many clubs. The key to creating and maintaining separate membership classes that do not offend the private benefit limitation is to ensure that there is a demonstrable and reasonable basis behind the differences in fees, rates, and membership rights. Finally, the IRS has determined that fixed fee payments to members who bring new members into the club is not prohibited private inurement, provided that the payments made to the member are considered to be reasonable compensation for the performance of a necessary administrative service of the club.
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Chapter 5 The Club’s Membership Issues Limited Membership
In order to qualify for exemption under (c)(7), membership in the club must be limited. A tax-exempt social club may not be open to the public at-large. To avoid this potential problem, your club needs to ensure that it develops, and follows, guidelines and limitations on admission to the club.
Rights of Members
It is probably wise to begin this section with the caveat that, contrary to the following description, there really is no such thing as a typical “regular” or “associate” member of a club. The diverse range of clubs and potential classes of members within those clubs precludes any concrete identification of exactly what must constitute a “regular” or “associate” club member. This being said, there are certain characteristics of club membership which occur often enough, and have been from time to time viewed by the IRS as validating characteristics of club membership, that it is useful to a certain extent to discuss them.
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Thus, a “regular” member of the club typically has some right to vote and determine the club’s management and operation. A club member typically has some mechanism available by which he or she can address or question the active control of the club. Additionally, a club member typically will have the right to share in the assets of the club in the event of the club’s dissolution. An “associate” member of the club typically does not possess a right to vote, and likewise does not generally have the right of participation to share in the club’s assets upon dissolution. As mentioned in the chapter above, the diminution in the membership rights of “associate” members typically must coincide with a lower membership fee.
Membership Structure
As mentioned in the previous chapter, clubs may establish more than one class of membership. Such classes as regular, associate and corporate-sponsored are typical, but not limiting. If the club has more than one class of membership, the club must ensure that each membership class has clearly established eligibility requirements and a standard formal admittance procedure. This is especially true if one of the classes of membership has no voting rights or other meaningful voice in the control and direction of the club. Establishing these procedures is particularly important for any non-voting class because of the (c)(7) exemption requirement that all members of a club must be real members. If a club member does not have membership rights such as voting or eligibility to hold office, the existence of formal procedures for membership eligibility, acceptance, and admittance help show the legitimacy of the membership. Simply granting the title of “member” to any individual from the public at-large who uses the club will not get a club around the requirements of this limitation because this is exactly the type of situation the IRS is looking to prevent; namely, a situation where a club is actually open to the public, and simply allows anyone to use its facilities by calling them “members,” although they have no continual interest in the club. Such an operation runs counter to the purposes of the social club exemption, and is not likely to go unnoticed.
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To protect your club against being targeted as a club that may be carrying on this type of operation, your club policy and procedures should be carefully drafted (and of course adhered to) so as to serve to provide a basis for establishing that your non-voting membership classes nonetheless are legitimate members of your club, and that the nonvoting status attached to the membership is not a type of subterfuge for conducting a regular business operation. A similar problem of which to be aware is having a class of member whose membership terms provide for the right to use the club’s facilities for the payment of nominal annual dues, plus additional charges for all services utilized. In this case, the problem once again is that this class of member is difficult to distinguish from the general public. As such, it may be determined that the club is operating a business of selling services for profit to the unlimited general public.
Corporate Membership or Corporate Sponsorship
The club’s members must be individuals. A club’s membership may not consist of artificial persons (like corporations) or member clubs. The types of “clubs” that allow membership to corporations or members clubs may be tax-exempt under other provisions of the federal tax code, but for the purposes of maintaining the “social club” exemption, the club must not allow any business entities or other associations to be members. So called “corporate membership” is clearly in violation of the provisions of the (c)(7) tax exemption. This is not to say that business entities and other associations or organizations cannot sponsor individual membership to your club. Corporate entities may pay for individual memberships without running afoul of this prohibition. The critical distinction to be made here is between a “corporate membership,” whereby a club grants a membership to an entity, and then the entity dictates which of its employees or officers may use the facilities for any given period of time, and a “corporate sponsorship,” whereby a business entity simply pays the membership fees for a regularly admitted individual member of the club.
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The former type of arrangement, because it does not limit the number of persons who could potentially use the membership privileges, is considered to be open to the public, rather than a true membership, and, thus, can result in the loss of a club’s tax exemption. The “corporate sponsorship” arrangement, however, is clearly allowable under the social club tax-exemption scheme.
Membership Donations to the Club
An important point in relation to members of a club is that donations and contributions to an exempt social club are not tax-deductible on the donor’s federal income tax return. Members often confuse the “social club” tax-exemption with the “charitable” exemption, thus believing that, like charitable contributions, their contributions to the club are tax-deductible. A club is required to take steps to inform its members of the non-deductible status of membership fees. Clubs must make this disclosure in a “clear and conspicuous manner” on any statement to a member other than one solely for services provided. The statement would be on any invoice that includes dues. For practical purposes, it should be on every monthly statement.
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Chapter 6 Prohibition Against Discrimination A club will lose its tax exemption for any taxable year in which, for any amount of time during that year, the club’s charter, bylaws or any other written policy statement of the club contains a provision that provides for discrimination against any person on the basis of race, color or religion. There are several exceptions to this rule allowing certain religious clubs and societies to limit their membership to their own particular religion, so if your club is organized along these lines, you should consult these exceptions. Beyond the limitations listed above, a club typically will, for (c)(7) tax-exemption purposes, be allowed to discriminate based upon other criteria, even if those criteria do not relate directly to social or recreational purposes or to the club’s activities. For example, a club is likely to be permitted to discriminate as to political party affiliation. That being said, discrimination on a basis not prohibited by (c)(7), gender for example, may create other legal problems, outside the scope of this section, for the club. Avoiding tax-exemption problems in this area is easy. A club must simply keep these discriminatory provisions out of its documents, and follows up its commitment to nondiscrimination with the appropriate action.
Chapter 6 — Prohibition Against Discrimination
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If, in checking your club’s already existing governing documents, you find that your club’s documents have language that runs afoul of this prohibition, you may be able to cure the potential problem. As long as your club has been conducting itself in a nondiscriminatory and, thus, tax-exempt fashion, the IRS will likely allow your club to amend the problematic document or documents. Once that amendment is accomplished, the IRS will allow the tax exemption to relate back for as long as the club’s operations have been compliant with the non-discrimination standards.
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Chapter 7 Limitation on the Club’s Outside Income A caveat: This chapter deals briefly with several of the more complex legal and tax issues, which are important to any discussion of a (c)(7) social club and its tax exemption. The information in this and previous chapters, while accurate, nonetheless represents a simplified portrayal of these tax issues. The goal in raising these issues here is simply to alert the club and its managers to the existence of these limitations and requirements, so that in planning the day-to-day and year-to-year operations of the club, considerations can be made for soliciting professional advice when these complex legal, accounting and tax issues present themselves. The federal tax law governing clubs previously required that the club be operated exclusively for pleasure, recreation or other non-profitable purpose. As noted above, this requirement has been somewhat relaxed, as the club must now only be operated so that substantially all of its activities further this purpose. What this means for a club today is that the possibility of receiving some income in the form of either investment income and income from nonmember use of its club facilities exists, and such income will not jeopardize the club’s tax-exempt status.
Chapter 7 — Limitation on the Club’s Outside Income
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Unrelated Business Income Tax (UBIT)
While a club may be tax-exempt, it may be subject to tax on its unrelated business activities. A club’s unrelated business income includes all gross income except: 1. Dues, fees, charges or similar amounts paid by members for services provided them, their dependents or their guests; 2. Investment income set aside for charitable purposes; and, 3. Gain on the sale of property used by the club for exempt purposes to the extent that the proceeds are reinvested in similar property within a period beginning one year before and ending three years after the date of sale. The gain may also be used for capital improvements to other club property used for exempt purposes.
Expenses “directly connected” with the production of the unrelated business income are deductible. However, the “dividends-received deduction” normally available to corporations is not available to tax-exempt clubs. A $1,000 specific deduction is allowed against unrelated business income.
Member Income
Gross income from members includes: dues, fees, charges or similar amounts paid by members of the club as consideration for the club providing goods, facilities, or services to the members, their dependents or their guests in furtherance of the exempt purposes of the club. Member income is specifically excluded from the definition of unrelated business income. A member’s spouse is treated as a member. Generally, membership income does not include any amount paid to the club by nonmembers. However, certain payments made by nonmembers directly to the club or reimbursements paid to a member may be considered to have been paid by the member. Generally, this is limited to situations where the payment was made gratuitously to, or on behalf of, a member, or under certain circumstances, by the member’s employer either directly to the club or to the member as reimbursement for payments made directly to the club. Employer payments or reimbursements are considered member income if the guests are present due to some personal or social purpose of the employee-member or to some direct business objective or relationship of the employee-member in his work for the employer. If the purpose or objective of the employer is primarily unrelated to the activities of the particular employee-member, it will not be considered member income.
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PART VII
15/35 Percent Test
For clubs to retain tax-exempt status, the club must not receive investment and nonmember income exceeding 35 percent of the gross receipts. Gross receipts are defined for this purpose as receipts from normal and usual activities of the club including charges, admissions, membership fees, dues, assessments, investment income (dividends, rents, etc.) and normal recurring capital gains on investments, but excluding initiation fees and capital contributions. A further restriction applies: no more than 15 percent of the club’s gross receipts may be from the use of its facilities or services by nonmembers. If exceeded, a facts and circumstances test is applied to determine if the club’s tax-exempt status should be revoked. Receipts of unusual amounts from the sale of a clubhouse or similar facility are not included in calculating the 15 or 35 percent limitations. Income received from members of other clubs using your club under a reciprocal agreement is nonmember income and is subject to the 15 percent limit as well as UBI tax.
Clubs may not engage in a nontraditional activity. This can, in and of itself, jeopardize the tax-exempt status. However, the IRS has provided an unofficial five percent safe harbor for nontraditional activities. This five percent is part of the 15 percent mentioned above. For an example, the sale of alcoholic beverages by a club for off-premises consumption is nontraditional.
Record-Keeping Requirements
The IRS requires clubs to keep detailed records on the extent of nonmember use and has set forth certain situations where, for audit purposes, a host-guest relationship will be assumed. Two safe harbors are provided. If payment is made directly to the club by a member or the member’s employer, a host-guest relationship will be assumed: 1. Where a group of eight or fewer individuals, at least one of which is a member, uses the club’s facilities. 2. Where 75 percent or more of a group using club facilities are members. In all other situations, a host-guest relationship must be substantiated by the club. The classic example of this is where a controller of a corporation hosts a meeting of his accounting staff at his club and his employer pays the cost of the meeting. In this
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situation, the staff members are guests of the member because their presence is related to a direct business objective of the employee-member. Alternatively, if the controller sponsors a meeting of his corporation’s board of directors at the club, the persons invited are not guests of the member since the directors’ presence is not related to a direct business objective of the particular employee-member. Adequate records must be maintained to substantiate that there was, in fact, a member in a group of eight or fewer or that 75 percent of a larger group were members and that payment was made directly by members or their employers. The club need not inquire about reimbursement where payment is made directly by the member. The information that must be obtained in all situations involving groups of more than eight (even if a member pays the club directly) includes the date; total number and number of nonmembers in the party; total charges; charges attributable to and paid by nonmembers; as well as a statement signed by the member indicating: • Whether the member has been or will be reimbursed for such nonmember use and, if so, the amount of the reimbursement; • The name of his employer; amount of the payment attributable to the nonmember use; the nonmember’s name and business or other relationship to the member; and, the business, personal, or social purpose of the member served by the nonmember use where the member’s employer reimburses the member or makes direct payments to the club. If a large number of nonmembers are involved and they are readily identifiable as a particular class of individuals, the class rather than the individual names of the nonmembers may be recorded; and, • The donor’s name and relationship with sufficient information to substantiate the gratuitous nature of the payment or reimbursement where a nonmember, other than the employer of the member, makes payment to the club or reimburses the member and a claim is made that the amount is paid gratuitously for the benefit of a member. A “Member Function Questionnaire” follows in the Appendix. The questionnaire gathers the information required by the Internal Revenue Service. Remember, this document is related only to the federal income tax aspects. Discrimination on the basis of sex, having nonmember business, or allowing corporate checks may cause severe problems in dealing with any local public accommodation legislation.
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MEMBER FUNCTION QUESTIONNAIRE To comply with Internal Revenue Service guidelines, the following information must be obtained for all functions of more than eight persons. Host Member’s Name
Account Number
___________________________
Date of Function
___________________________ ____________________________
Total Number in Group
_____________
Total Charges
$ _________________
Number of Nonmembers in Group
_____________
Nonmember Charges
$ _________________
THE FOLLOWING QUESTIONS MUST BE ANSWERED BY THE HOST MEMBER 1.
NO
❏
❏
❏
❏
I have paid for the services and will not be reimbursed. If yes, please sign and return this form If no, please continue
2.
YES
I will be reimbursed by nonmembers, other than my employer, or they wil pay the club directly. a.
If yes, indicate the amount paid by nonmembers
b.
If this is a gratuitous payment for your benefit, indicate donor’s name and your relationship to the donor
$ _________________
Donor’s Name & Relationship ___________________________________________________ Reason Why Gratuitous ________________________________________________________ 3.
❏
I will be reimbursed by my employer, or he/she will pay the club directly.
❏
If yes, complete the following: a.
Employer’s Name & Address _______________________________________________
b.
Indicate the amount of the payment attributable to nonmember use
c.
If a large number of nonmembers is involved and they are readily identifiable as a particular class of individuals, please indicate such class and the business or other relationship to the member or indicate each nonmember’s name and business or other relationships to the member on the back of this form.
$ _________________
Class of Individuals _______________________________________________________ Relationship to Member ___________________________________________________ d.
Were your business, personal or social purposes served by this nonmember use?
❏
❏
Member’s position in company _____________________________________________ Purpose served __________________________________________________________ Signature of Member ________________________________________________________ Date _____________ ©Pannell Kerr Forster PC Use allowed with attribution
Appendix
VII-Appendix-1
