Social clubs have long served as a defining characteristic of American society. While the nature of the hobbies, recreational interests, and other ties that inspire people to bond together continues to change significantly, the social club itself remains. For people wishing to join with others and carry out shared interests in an organized way, the group should understand the tax benefits afforded social clubs. Specifically, Section 501(c)(7) of the Internal Revenue Code provides an exemption from federal income tax if certain requirements are met. In this article we discuss:
- Legal benefits and requirements implicated by tax-exempt social clubs.
- General principles and best practices to help members of social clubs understand, to legally operate them well.
1. What are the basic requirements for a Section 501(c)(7) social club?
Section 501(c) of the IRC establishes 28 different categories of organizations that are exempt from federal income tax. By far the most common type of tax-exempt organization is the 501(c)(3) charitable organization. However, the 28 different categories of tax-exempt entities are subject to special tax treatment and in the requirements for them to take advantage of that tax treatment. In a sense, the IRS has defined a “lane” for each type of tax-exempt entity to “drive.” If they deviate from their lane, organizations may lose their favorable tax treatment. Section 501(c)(7) social clubs have many unique characteristics that define their lane.
Social clubs must stay within that lane to take full advantage of and maintain their tax-exempt status.
More specifically, Section 501(c)(7) permits social clubs to organize “for pleasure, recreation, and other nonprofitable purposes.” “[S]ubstantially all of the activities” of social clubs must be for their exempt purposes. Additionally, “no part of the net earnings of” a social club may “inure[] to the benefit of any private shareholder.” Organizations qualifying under this provision include “(1) college fraternities operating chapter houses for students; (2) country clubs; (3) amateur hunting, fishing, tennis, swimming, and other sport clubs; (4) dinner clubs that provide a meeting place, library, and dining room for members; (5) variety clubs; (6) community associations; and (7) hobby clubs.” Social clubs provide important benefits in the lives of many people, and the legal requirements for them are equally important.
2. Why are social clubs tax-exempt?
Why does the IRS recognize an exemption to these organizations? Consider the example of a group of parents in a Chicago suburb who form a soccer club to provide their kids with an opportunity to play soccer. The club exists to help the kids enjoy the game and to improve their skills. The club benefits only members’ kids, and the club will not compete as a team. The parents pay dues, which help to buy the kids’ equipment, to lease practice fields, and to bring in a coach to help improve the kids’ soccer skills. Sometimes the dues are used for picnics and other outings.
In this case, the club does not appear to be generating income. The parents are simply pooling their money (paying dues) for their kids’ benefit, and the money they use to pay the dues has already been subject to income taxation. Additionally, taxing dues paid to the club would discourage the club’s formation. This is the basic rationale that justifies the 501(c)(7) exemption. As one author puts it, “The purpose of exempting social clubs is to permit individuals to pursue common interests through an organization without paying a second level of tax on the money they contribute to such organization. Dues or other contributions to a social club are not deductible, so all amounts received by social clubs are subject to one level of tax [Income tax at the taxpayer level].”[1]
3. Are contributions to social clubs tax-deductible under Section 170?
Donations or dues paid to Section 501(c)(7) corporations are not tax-deductible. This advantageous provision of the tax code applies only to Section 501(c)(3) charities. Thus, donors to social clubs may not claim a charitable deduction under Section 170. They also may not generally claim that the dues or other amount paid to a social club constitutes a deduction as a business expense.
4. Do we need to apply to the IRS for tax-exempt recognition?
One of the desirable features of IRC Section 501(c)(7) organizations is that they do not need to apply for initial tax exemption with the IRS; but simply identify themselves as such and provide notice to the IRS through annual Form 990s, as discussed below. Of course, formally applying for recognition of tax-exempt status may provide helpful clarity, but doing so is not legally required. Social clubs that choose to request formal recognition from the IRS may do so by filing an IRS Form 1024 application for recognition of tax-exempt status.
5. Do we have to incorporate?
Social clubs typically, although not universally, form as nonprofit corporations under state law, with Section 501(c)(7) being an accompanying tax status for income tax purposes. With such corporate status, the social club can generally enjoy corporate liability protection, make contracts in its own name, and open its own corporate bank account. Developing a nonprofit corporation entails filing articles of incorporation, preparing bylaws for governance, and filing periodic reports as required under applicable state law.
6. Are there any other reporting requirements?
Section 501(c)(7) social clubs must still file an annual IRS Form 990 informational return. These returns come in three versions, and must be filed by the 15th day of the fifth month after the end of the organization’s accounting period. A social club whose accounting system follows the calendar year must thus file its Form 990 by May 15th. The gross receipts and total assets of the social club determine which form it must file. Social clubs with either annual gross receipts (discussed below) of at least $200,000 or total assets of at least $500,000 must file the most complicated Form 990. Social clubs with less than $200,000 in annual gross receipts AND less than $500,000 in total assets may file Form 990-EZ, which, as its name suggests, is easier to file than the regular Form 990.
Social clubs that “normally” have no more than $50,000 in annual gross receipts may file Form 990-N online, also known as the e-Post-card for its simplicity.
Since social clubs can self-report their tax-exempt status, it might be tempting for them to not file their requisite annual return. However, failure to file a Form 990 for three consecutive years will subject social clubs to automatic revocation of their tax-exempt status. A social club corporation that loses its tax-exempt status will be required to file an IRS Form 1120 and to pay taxes on net income for the years it failed to file a Form 990 and for future years. Alternatively, as explained below, a social club that automatically loses its tax-exempt status may seek retroactive recognition of its tax-exempt status.
7. Do social clubs need to actually be “social?”
As one might guess from their name, to maintain their tax-exempt status, social clubs require a purpose that is, well, social. Unlike other Section 501(c) corporations, the purpose of social clubs must include mingling of the members; the members cannot merely share some interest. For example, two similar cases involving social clubs centered around flying aircraft. In one case, the club provided facilities that members could use to fly their own aircraft. The members did not socialize, or even know each other, and were only using the social club as a vehicle to achieve economical access to flight facilities.[2] In the other case, a social club owned a number of small aircraft. The members regularly met to do maintenance and repair work on the aircraft together and flew in small groups.[3]
The IRS denied tax-exempt status to the former club but granted it to the latter club, largely because the group’s different activities. The first club’s true purpose was to gain access to economical flying facilities, which members could use for personal or business use, while the second club’s purpose was to provide its members with pleasure and recreation associated with group use of aircraft.
These cases show that per Section 501(c)(7), “substantially all of the activities” of a social club must be done to further its pleasurable or recreational purpose. Accordingly, automotive clubs that used their size to acquire group discounts on roadside assistance have been denied social club status. Similarly, social clubs that provide recreational facilities to members in certain housing communities are generally denied social club status if they also perform functions such as enforcing covenants. If the soccer club described above also enforced a community covenant that grass be mowed to less than 3.5 inches, it would risk losing its social club qualification. Additional limits on social club activities that result from their specific, social purpose will be discussed below.
8. Just how exclusive can we be?
Social clubs may not discriminate on the basis of “race, color, or religion” in determining their members in any written policy or document. This restriction on discrimination is notable more for what it omits rather than what it includes. For instance, discrimination on the basis of sex is permitted to some extent, allowing sororities and fraternities to limit their membership to men or women. Additionally, social clubs can discriminate on the basis of age. This permits clubs to exclude the young whipper-snappers, the ancient geezers, or both
Social clubs may limit their membership based on religious beliefs in two cases. The first exception permits social clubs to limit membership to adherents of a particular religion if the club seeks, in good faith, to advance the teachings or principles of that religion. Thus, a social club that provided a venue for its members to play doubles table tennis could not limit membership to Hindus as a back-door means of excluding Hispanics. The second exception permits social clubs to limit membership to adherents of a particular religion if the club functions as an auxiliary to a fraternal benefit society (another type of tax-exempt organization with its own unique requirements) that limits its membership to adherents of a particular religion.
9. May we make money for our members?
As mentioned above, the Tax Code prohibits social clubs from providing any improper private benefit. Consider the soccer club example described above. The soccer club turns out to be a tremendous success. The kids enjoy playing soccer together and develop skill in the sport. As word of this spreads, families from the surrounding communities want their kids to take part. A few ambitious parents who are already members of the soccer club see the opportunity for further personal gain.They propose allowing children from the surrounding area to participate in the club for a fee, with the profits from those fees going to the members of the club. However, such a distribution of fee revenue constitutes impermissible private benefit to the members. Accordingly, if the club takes such action, it leaves its lane and will likely lose its 501(c)(7) status.
“Fine,” the parents respond, “we’ll just use the profits from the outside participation to lower our membership dues.” Such an action will likely have the same legal result. Although it is less direct, the parents are still receiving an impermissible private benefit in the form of a reduction of dues. Each of these actions is prohibited under 501(c)(7) and would subject a social club to revocation of its tax-exempt status.
10. May our club open its doors to the public?
One of the distinguishing features of social clubs is that they cannot open their facilities generally to the public without losing their tax-exemption. This counterintuitive IRS position seeks to protect taxed enterprises from untaxed competition and keep the proverbial playing field level. If social clubs are providing services or facilities to the general public, they arguably compete with taxable enterprises, which are burdened by taxation.
However, there are exceptions to the limits on public access to social club facilities. Social clubs are generally not at risk of losing their tax-exempt status when they allow public use of their facilities in one-off situations, as the IRS does not see these limited uses as a significant deviation from social clubs’ tax-exempt lane. In one example, a country club that was organized as a social club permitted the general public to use its golf courses when the nearby publicly-owned golf course was closed for renovations. The IRS permitted the country club to keep its tax-exempt status, in part because it generally was not open to the public, and was merely doing so to a limited extent in this unusual case as an accommodation to the municipality rather than an effort to gain additional revenue from the public.[4]
Additionally, members of a social club may bring guests to the club without risking the club’s tax-exempt status. In fact, safe harbor provisions provide parameters according to which the hosting of guests will not jeopardize the club’s tax-exempt status. Where eight or fewer people use the club’s resources as a group, and the paying member of the group is a member of the club, the IRS will presume that the other seven people are guests of the member. Additionally, if a larger group using the club’s facilities is comprised at least 25% of members, and that 25% is paying for the group’s use of the club’s facilities, the IRS will also allow the rest of the group’s members as guests. Social clubs must keep detailed enough records to prove that these safe harbor requirements are satisfied. Where clubs keep detailed records to prove guest relationships, even occasional guest visits outside of these safe harbors generally will not jeopardize the club’s tax-exempt status.
What if our example soccer club considered allowing anyone with a child under age 18 to join the club as a member or associate (non-voting) member? Not a good idea. The IRS is skeptical of social clubs with too large a membership. Social clubs should establish criteria for becoming a member that genuinely limit who can join the club and should avoid having membership criteria that is too broad. Clubs may lose their tax-exempt status for having too many members or a too broadly defined membership eligibility.
11. May our club do anything other than provide services to members?
As just described, social clubs can host guests, and may even provide services to paying non-members. However, this practice must be minimized to ensure that “substantially all of the activities” of the club are advancing the club’s pleasurable or recreational purpose. Safe harbors protect clubs that have some small measure of non-exempt activities. A social club meets the requirements of these safe harbors if it receives no more than 15% of its gross receipts from the sale of goods and services to non-members and if it receives no more than 35% of its gross receipts from any source other than the fees, dues, etc. of members. The 35% limit includes receipts from non-members, so if 15% of the gross receipts come from the sale of goods and services to non-members, only 20% of the gross receipts may come from other non-member sources.
In this context, gross receipts are only receipts from the “normal and usual activities of the club.” Receipts from initiation fees, capital contributions, or the unusual sale of club property (such as a country club selling its clubhouse) are not included in calculating gross receipts. Amounts arising from the sale of property may be regarded as incidental to the club’s purpose, and thus trigger no concerns about the club pursuing its pleasurable or recreational purpose.
Additionally, as these percentage limits are safe harbors, a social club’s failure to meet them does not automatically invalidate its tax-exempt status. If a social club fails to meet the safe harbor requirements, the IRS will look at other facts and circumstances pertaining to the club’s operations. The IRS will consider frequency of non-member use of the social club’s resources, the purpose for permitting such use, the good faith beliefs of the club leadership about such use, and other factors.
As for a social club’s revenues from non-member sources, almost all are subject to taxation as unrelated taxable business income. The IRS views the unrelated taxable business income of social clubs as being their gross income (excluding exempt income) less allowed deductions for business expenses directly connected with producing that income. Any unrelated taxable business income is subject to tax at the normal corporate tax rates. Exempt income is limited almost exclusively to income from fees, dues, and other amounts paid by members as consideration for the goods and services that the social club provides. For more information on unrelated business income, please see our June 6, 2016 blog post, “When are Nonprofit Revenues Taxable?: UBIT Basics.”
12. What happens when our club disbands?
Social clubs come and go. When they dissolve, the club will often have assets and liabilities that need to be handled appropriately. When social clubs sell their property in dissolution, they are generally assumed to have performed this action incidentally to the club’s tax-exempt purposes. In general, social clubs must distribute the net proceeds from the sale of their assets back to the members upon dissolution. Although it may be tempting for a social club to donate the proceeds from its assets (or the assets themselves) to a charity that advances purposes related to those of the social club, such an action likely does not further the social club’s pleasurable or recreational purposes and thus would be inappropriate. Of course, the members are free to donate any assets they receive from the dissolved social club to a charity.
13. What if we neglect to file Form 990s?
A social club’s tax-exempt status will auto-revoked due to its failure to file Form 990s for three years in a row, the club must apply to the IRS for recognition of its tax-exempt status. As discussed above, a social club operating without Section 501(c)(7) tax-exemption will be subject to taxation as a for-profit corporation or partnership (depending on its status under applicable state law).
Concluding Remarks: Stay in Your Lane
Exemption for 501(c)(7) social clubs makes it easier for people to pool their resources in pursuit of group recreational interests. As long as social clubs stay in their lane by operating to further their pleasurable and recreational purposes and by meeting their other IRS requirements, they can securely pursue their interests on a tax-exempt basis. However, if the organization deviates from its original purpose and tries to move into another lane, the social club runs the risk of losing its tax-exempt status.
[1] Hill & Mancino, Taxation of Exempt Organizations ¶16.02. Social Clubs, 2003 WL 1891186, 1.
[2] Rev. Rul. 70-32, 1970-1 C.B. 132
[3] Rev. Rul. 74-30, 1974-1 C.B. 137
[4] Priv. Ltr. Rul. 201414029
