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The IRS is honing in on club’s nontraditional activity revenue

In previous World's Smallest Newsletters from our Private Club Practice we have discussed the potential tax consequences associated with tax exempt 501 C7 Clubs that provide "nontraditional activities" to its members. These nontraditional activities may include, but are not limited to, meals to go (including holiday meals), on-site sale of bottles of wine from wine tastings or gas sales by yacht clubs.

Until very recently, the only guidance provided by the IRS on the allowable amount of nontraditional activities a Club could have without jeopardizing its 501 C7 status was a "de minimis" amount. Two recent audits of clubs in the Northwest region of the country have provided some insight as to what the IRS is considering "de minimis".

In two separate audits, the IRS agent determined that if the Club's nontraditional activity revenue was in excess of 5%, then the Club failed the "de minimis" test. When calculating the revenue base (or denominator) for the calculation, the agent EXCLUDED dues and investment income from the base, coming up with a number called "Modified Gross Receipts". Upon dividing the nontraditional activity revenue by this Modified Gross Receipts, both Clubs exceeded the 5% threshold. note that neither Club had any initiation fee revenue, but it may be a safe assumption if they had, the agent would have excluded that revenue as well.

Based upon the Clubs failing the 5% threshold under this calcuation, the IRS has issued letters revoking the Clubs' tax exempt status. We do not know if either Club will contest or appeal the IRS decision, which no doubt would be costly.

While many of us in the Club industry had heard the IRS, in its training manuals, was using a 5% threshold, no imagined that it would exclude membership dues revenue in the calculation. This modification is clearly the most troubling.

If you have any questions or would like to discuss this issue further, do not hesitate to contact us.

We would like to thank Mitchell Stump, our Club Tax Network partner, for sharing this very timely and valuable information.

Date: September 12, 2014