Clubs organized for pleasure and recreation can qualify for federal exemption under section 501(c)(7) of the Internal Revenue Code. The exemption works very differently from charitable status.
What Qualifies
Section 501(c)(7) covers clubs organized for pleasure, recreation, and other nonprofitable purposes, substantially all of whose activities serve those purposes, with no part of the net earnings inuring to any private shareholder. The IRS also requires an opportunity for personal contact among members, limited membership, and support from membership fees, dues, and assessments.
The 35 and 15 Percent Guidelines
IRS guidance allows a club to receive up to 35 percent of its gross receipts from nonmember sources, including investment income. Within that 35 percent, no more than 15 percent of gross receipts may come from nonmember use of club facilities and services. These are safe harbors, not absolute limits. If a club exceeds them, the IRS considers all the facts and circumstances in deciding whether it still qualifies.
Exempt, but Taxed on Outside Income
A social club’s unrelated business taxable income is its gross income other than exempt function income, less directly connected deductions. Section 512(a)(3)(A). Exempt function income is essentially what members pay, in dues, fees, and charges, for goods, facilities, and services provided to them, their dependents, or their guests. Section 512(a)(3)(B). As a result, the IRS generally taxes a club’s investment income and its income from nonmembers who are not bona fide guests of members, even when the club spends that money on its facilities. A club with $1,000 or more of gross income from an unrelated business must file Form 990-T in addition to its annual return.
One rule helps clubs that relocate or rebuild. If a club sells property used directly in its exempt function and, within one year before or three years after the sale, buys other property that it uses the same way, gain is recognized only to the extent the sales price exceeds the cost of the replacement property. Section 512(a)(3)(D).
Keep the Records
A club that lets nonmembers use its facilities must record, for each event, the date, the size of the party, the number of nonmembers, the total charges, and the charges attributable to and paid by nonmembers. If a member pays for nonmembers, the record should include the member’s signed statement about any reimbursement. A club whose records do not separate income and expenses by type and source faces a presumption that all of its income is unrelated and taxable.
Discrimination Costs the Exemption
A club is not exempt for any year in which its charter, bylaws, other governing instrument, or written policy statement provides for discrimination against any person on the basis of race, color, or religion. Section 501(i). The statute makes narrow religious exceptions for certain fraternal society auxiliaries and for clubs that in good faith limit membership to members of a particular religion to further its teachings or principles.
Haft Law Group advises Florida clubs and other nonprofit organizations on exemption, governance, and compliance.