The IRS released a number of rulings in 2014 affecting business leagues and social clubs. While these types of nonprofits play by a different set of rules from public charities, there are ample ways in which a business league or social club can lose its tax-exempt status or generate taxable income.
Business leagues are recognized as exempt from federal income tax under Section 501(c)(6) of the Code. Business leagues include chambers of commerce, boards of trade, and similar organizations. They are an association of persons having a common business interest, the purpose of which is to promote the common business interest and not to engage in a regular business of a kind ordinarily carried on for profit. They are membership organizations and their activities must be directed to the improvement of business conditions of one or more lines of business and not perform particular services for individual persons.
Common activities that may threaten business leagues’ exempt status are 1) the extent of involvement of members, and 2) commercial endeavors—whether the league directly competes with a for-profit line of business or otherwise provides particular services for the benefit of members.
A business league must have a meaningful extent of membership support. The IRS may look to the members’ voices in the operations, as it did in a recent application.i In that ruling, the IRS found that the organization was controlled by one individual and there was no indication that other members had a voice in the organization. In another ruling, the IRS stated that an organization failed to achieve exemption because its nonvoting membership was not involved at a “meaningful level.”ii
Support is generally in the form of dues from members, but there are exceptions. Nonmember support should be analyzed for both a focus on exempt status as well as potential unrelated business taxable income. As demonstrated in a recent ruling, support in the form of ticket sales to the general public may be related to an organization’s exempt purpose. A business league was organized to promote the enjoyment and involvement in a certain sport and to contribute to the sport’s growth by holding various tournaments throughout the year. The IRS compared the facts to an example in the Treasury Regulations,iii whereby income derived from admission charges to performances before audiences, when such performances contribute importantly to the accomplishment of the organization’s exempt purposes, does not constitute gross income from unrelated trade or business.
Providing services to members can be fatal to a business league’s exempt status. For example, the IRS recently found that an organization having real estate professionals as members did not qualify for exemption where the organization’s activities primarily consisted of contracting on its members’ behalf to provide unlimited access and use of the MLS, a national listing service.iv Services by a group of physicians to negotiate managed care contracts, facilitate group purchasing discounts, and conduct a centralized credentialing process were not activities directed to the improvement of business conditions of one or more lines of business, but rather the performance of particular services for individual persons.v
In another ruling, the IRS held an organization did qualify as exempt because it marketed branded products and performed particular services for its members. There, the organizers intended to create a globally competitive software platform. Irrespective of the industry benefit, the IRS stated that the organization engaged in a regular business ordinarily carried on for profit and was marketing a branded product.vi
Finally, two rulings were released in 2014, denying exemptions to professional clubs where members exchange referrals because they benefit the individual members rather than a line of business.vii
Social clubs, like business leagues, are membership organizations primarily supported by funds paid by their members for social, recreational, or other non-profitable purposes. They are recognized as exempt under Section 501(c)(7). Social clubs are an exempt classification, not necessarily as an intention of the federal government to promote a particular activity, but so as not to punish individuals who choose to pool their resources for social or recreational activities they may otherwise partake alone.
A social club must meet a gross receipts test in order to maintain its exemption. In order to meet the gross receipts test, an organization can receive up to thirty-five percent (35%) of its gross receipts, including investment income, from sources outside its membership without losing its tax-exempt status. Within this 35% amount, not more than fifteen percent (15%) of the gross receipts should be derived from the use of a social club’s facilities or services by non-members. In a recent case, the IRS found that an organization had exceeded the 15% gross receipts standard for non-member income on a continuous basis for at least three years, and there was no one single or unusual event that caused the club to exceed the 15% threshold.viii The same result occurred where a club received funding from the public via a swap meet and car show to finance activities for the pleasure and recreation of its members.ix The organization also advertised the swap meet to the public, which the IRS considered prima facie evidence of engaging in business and of not being operated exclusively for pleasure, recreational or social purposes.
The IRS regards commingling in person as a requirement for a social club to obtain exempt status. In a recent ruling, the IRS found that an internet-only organization with public access, e.g., unlimited membership, did not constitute a limited membership and did not provide for the requisite commingling to constitute a material part of its activities.x Furthermore, the “members” did not exercise control or have a voice in management of the club. The same reasoning was applied in the IRS’ denial of exemption to an on-line sorority.xi
If you have questions regarding your organization’s activities in connection with any of the topics discussed above, please contact Ryan Fischer at firstname.lastname@example.org or by phone at 844.4WINDES (844.494.6337).
iiiTreas. Reg. Sec. 2.513-1(d)(4)(i)
viiPLRs 201424023 and 201432026