United States

Non-traditional activity in private clubs


Recently, there has been some discussion about how the Internal Revenue Service (IRS) defines nontraditional activities and calculates the permissible threshold in a club exempt under Internal Revenue Code 501(c)(7). While community clubs, commonly referred to as CIRAs or clubs that are not exempt may have nontraditional activities, excessive amounts would not jeopardize their tax filings or tax status. However, clubs that are exempt under IRC 501(c)(7), must take nontraditional activities into consideration as their exempt status may be revoked if the IRS determines the club's nontraditional activities are greater than the threshold. This article will analyze the case law and IRS rulings specific to this matter to give insight on how the IRS calculates and determines reasonable amounts of nontraditional activities.

A club's activities with both members and nonmembers can be broken down into two main categories: traditional and nontraditional. Traditional activity, as defined under IRC section 501(c)(7), is any activity "exclusively for pleasure, recreation and other nonprofitable purposes." This phrase is so important that it is generally written on the first page of the exempt club's Form 990 as the mission or most significant activity of the organization. Nontraditional activities are defined as activities which do not further the club's exempt purpose. Examples of nontraditional activities include food and beverage prepared for off-premise consumption, wine sales for off-premise consumption and any other activity that doesn't further the club's exempt purpose.

While the IRS does provide a safe harbor for nonmember income, a 15 percent limitation calculated by taking nonmember receipts and dividing them by total gross receipts, there is currently no safe harbor or published test for nontraditional activity receipts. There are revenue rulings, letter rulings and court cases to help clubs establish a reasonable limit for nontraditional activity. Revenue Ruling 58-589, 1958-2 C.B. 266, states that when "a club engages in income producing transactions which are not part of the club purposes, exemption will not be denied because of incidental, trivial or nonrecurrent activities."  In more recent letter rulings, the IRS uses the word "insubstantial” to define permissible amounts of nontraditional activity.

In published cases and rulings, the IRS and courts used gross receipts from nontraditional activity dividends by total gross receipts of the club to calculate if the activity was insubstantial. More quantitatively, in TAM 92-12-002, the club was selling food for off-premise consumption. Over a five-year period, the percentage of off-premise food sales increased from 4.28 percent of gross receipts to 6.07 percent of gross receipts. The IRS determined this activity was increasing from year to year, substantial and revoked the club's exempt status. This case, and other cases like it, is where the link between the word insubstantial and the nontraditional activity threshold of 5 percent comes from.

From the cases and rulings, it shows that it is possible for a club to have small amounts of nontraditional activity and still be in compliance with the IRS. In determining the nontraditional activity percentage in a club, the club would take the total receipts from nontraditional activity and divide it by the total gross receipts.Total gross receipts are defined in Senate Report 1318, 94th cong. 2d Sess. 4 as "those receipts from normal and usual activities of the club including charges, admissions, membership fees, dues, assessments, investment income and normal recurring capital gains on investments." Therefore, in determining if the nontraditional activity is insubstantial, a club would use all the receipts stated in the Senate report to determine the nontraditional percentage, excluding items such as initiation fees and capital contributions.

Based on the rulings and other current guidelines set forth by the IRS, any club which has receipts from activities that do not further the club's exempt purpose should evaluate those activities to determine if they are increasing from year to year; specifically if the activity is greater than 5 percent of total gross receipts. If the nontraditional activity revenue is under 5 percent, current support would treat revenue as insubstantial; thus not jeopardizing the club's exempt status. Until the IRS defines a safe harbor for nontraditional activities, exempt clubs that provide food to go, off-premise wine sales or any other nontraditional activity, should limit these activities to a minimum.