TLB regularly receives questions regarding the activities of social clubs, such as golf clubs, beach clubs, etc. There is a long history with regard to the IRS and its position on the various issues faced by these organizations. Three specific areas that receive IRS attention and scrutiny are discussed below.

Social clubs are organized for pleasure, recreation and other non-profit purposes for the benefit of their members and are afforded tax-exempt status under the Internal Revenue Code section 501(c)(7). The tax-exempt status of social clubs is designed to allow individuals to join together to provide themselves with recreational or social facilities on a mutual basis, without tax consequences. This tax treatment has been justified on the theory that, to the extent the club is funded by the members, each individual member will be in the same position as if they had paid for the benefits directly. Three rules that social clubs must understand potentially subsidize club members, and therefore threaten a clubs exempt status if not properly understood or followed.

Why do these rules matter? It is important to know the requirements and limitations of the three rules. A failure to do so will likely result in the IRS revoking a social clubs exempt status. There are various situation involving the three rules that would threaten a club’s exempt status. In general:

1. No more than 35% of a club’s gross receipts can come from non-member sources, including investment income.
2. Of the 35%, no more than 15% can come from non-members.
3. Gross receipts from non-traditional activities (from members or not) of more than 5% put the club’s exempt status at risk. Amounts below 5%, but increasing over a couple of years, may also put exempt status in jeopardy.
4. Not maintaining membership records and records of activities will result in revocation of exempt status and taxation of all revenue.

The rules are as follows:

1. Unrelated business taxable income rule

Social clubs have special rules regarding what is considered unrelated business income. Contrary to other exempt organizations, passive income of social clubs (dividends, interest, rent, etc.) is taxable, as is non-member income. IRC 512 defines UBTI for social clubs as “gross income (excluding exempt function income), less the deductions allowed by this chapter which are directly connected with the production of the gross income…”

IRC 512 further defines exempt function income as “gross income from dues, fees, charges, or similar amounts paid by members of the organization as consideration for providing such members or their dependents or guests goods, facilities, or services…”

To simplify all these technical definitions – social clubs income is all taxable, except for income received from members pursuant to exempt purposes. Gross receipts from UBTI cannot exceed 35% of the clubs gross receipts.

2. Traditional vs. non-traditional activities rule

Traditional activities of a social club may be conducted with members and non-members. An activity is considered traditional if it were engaged in with members, it would further the exempt-purpose of the club. Income from traditional activities conducted with members is not taxable. Income from traditional activities from non-members is taxable.

Some examples of traditional activities would be the operation of a golf course or the operation of a bar or restaurant that is used by club members, their guests, or non-members.

Non-traditional activities are defined by the IRS as an activity which, if conducted on a membership basis, would not further the club’s exempt purposes. An example of non-traditional business activity includes the sale of liquor or food to members for consumption off the club’s premises. This activity was considered “neither related to nor in furtherance of the social club’s exempt purposes.” Income derived from non-traditional activities is taxable, whether from members or not.

Anything other than an insubstantial amount of non-traditional activity is likely to result in revocation of exempt status, whether provided to members or not. There is no safe harbor, but the IRS and tax court has generally looked at amounts under 5% to be insubstantial.

3. Record keeping requirements (rule)

IRS regulations provide that every exempt organization must keep such permanent books of account or records as are sufficient to show specifically the items of gross income, receipts and disbursements. This burden falls to the social club to maintain adequate records to demonstrate member vs. non-member use. Failure to do so likely would result in a determination from the IRS that all receipts are from non-members, therefore subjecting income to taxation and putting the organizations exempt status at risk. This treatment was most recently applied in a private letter ruling issued by the IRS in 2006 (plr 200624069).

All social clubs should review IRS Rev. Proc. 71-17 concerning assumptions about non-member use. The Rev. Proc. outlines the record keeping requirements and it provides a set of assumptions that would allow non-member use to be classified as income from “guests” and treated as if from members.

These three areas will continue to be an area of IRS scrutiny. Please contact Rich Bienvenue at (508) 255-2240, or at rich@tlbcpa.net if you have any questions or if TLB can help your organization.

The Pension Protection Act of 2006 has been signed into law for over a year now - we take this opportunity to remind non-profit organizations of some of the provisions that continue to have an impact or became effective for years that started after 2006.

* New provisions require organizations that don’t meet the $25,000 filing requirement to electronically file an annual notice containing basic contact and financial information. (Effective for tax years beginning after 2006)
* Property (non-cash) given to a non-profit to further its exempt purpose is not a charitable deduction to the donor if the property is not actually used for the exempt purpose. Non-profits should provide their non-cash donors with an affirmation (could be added to acknowledgement letter) regarding the use of property for exempt purposes.
* Deductions for contributions of clothing and household items must be in at least “good used condition.” It has always been unclear how this would be enforced – speculation is that taxpayers should photograph the items donated in order to properly substantiate the deduction.
* Cash contributions under $250 used to be able to be documented by a contemporaneous written record. Now all contributions require a donor receipt or bank record to substantiate.
* 990-T is now part of the public disclosure requirements, along with form 990, 1023 and an organizations determination letter.
* A change in the definition of net investment income now includes capital gains from appreciation, annuities and exempt purpose assets for some private foundations. This may result in a substantial increase in these entities excise tax.
* Several provisions have tightened up the requirements, and imposed stiffer penalties for grants, loans and compensation between related parties.

We encourage non-profit organizations to become familiar with the various IRS rules and regulations that are ever increasingly effecting how they do business. Minimize your organizations risk, and your donors. Please contact TLB if we can help. Posted by Rich Bienvenue

Non-profit organizations are reminded that the same rules and regulations that applied with regard to solicitation, lobbying, advertising and unrelated business income before the internet and e-commerce age, still apply today.

Form 990 and various state filing forms for non-profits are now requiring non-profits to list their web site addresses. This allows the IRS and a states attorney general to easily monitor a non-profits web site for unrelated business income, tax and solicitation issues. Here are some of the issues that may be problem areas:

1.

Revenue sources – if the website for your organization references or has present indications of non charitable revenue sources, these may be scrutinized. Examples include rental of facilities (even if for a nominal charge), advertising, referral fees, sale of products, etc. Remember – the activity must contribute to the organizations accomplishment of its exempt purposes, based upon all of the facts and circumstances in order to be exempt income. The fact that income from an activity supports an organization’s exempt purpose is not enough to exempt the income from unrelated business income tax.

2.

Corporate sponsorship vs. advertising – several non-profits have corporate sponsors, be careful not to specifically endorse their products or services or otherwise fall into the “substantial benefits realm.”

3.

Links and banners – the IRS believes a static banner ad or a link to a sponsor retains its nature as an acknowledgment of a sponsor; however, a dynamic banner ad begins to take on the characteristics of an advertisement. Some non-profits have been successful in soliciting sponsorships in exchange for banner ads or links on the organizations website. Again, as long as the ad or link only identifies the sponsor, these will likely be considered acknowledgements – but be careful if there is any endorsement or testimonial regarding the sponsor (see number 2 above.)

4.

Affiliate programs – monetizing websites is becoming a big deal in the on-line community and may seem attractive to cash strapped non-profits. Companies such as Amazon.com and others provide for affiliate programs where the organization receives a percentage of sales generated from the website. In addition, Google and others pay host sites for “clicks” on advertisements placed on the website. Google adsense revenue would likely be considered non-exempt advertising revenue. Sales of products online would likely be considered along the same lines as sale of products through a museum shop or gift shop, etc. That is if the products sold is related to the organizations exempt purpose then it is exempt – if it isn’t related to the exempt purpose then it is unrelated business income.

5.

Solicitation issues – in general, a non-profit that solicits charitable contributions, by any means, within the borders of a state is subject to its laws, regulations and registration requirements. The terms “charitable” and “solicitation” are broadly defined and may be applicable to telephone calls, e-mails, advertising, direct mail or even a website posting directed to a states residents.

6.

Evidence of lobbying – there are strict rules and regulations concerning lobbying activities of non-profit organizations. Due to the ease of running and updating websites, it becomes easy to promote issues or causes for which your organization is passionate about. Be careful not to inadvertently put the organizations exempt status at risk.