Critical unrelated business income tax tips for social clubs

One of the most important considerations for section 501(c)(7) social clubs is best ensuring that they do not generate “too much” unrelated business income (UBI) that could jeopardize the tax-exempt status of the entity. Even if clubs are successful in this, the entity will most likely still be liable for the UBI tax on their income earned from conducting “unrelated” activities. 

When discussing the potential UBI liability of section 501(c)(7) social clubs, one first must determine whether an activity being conducted by the club is considered to be a member or a nonmember activity. Member income for a section 501(c)(7) social club is defined as those gross receipts derived from the normal, usual and typical activities of the social club, including member dues, member assessments, member initiation fees and sales revenue received from members. Please see section 512(a)(3)(B) of the Internal Revenue Code (IRC) related to this.

 It is debatable whether certain gross receipts of a club should be considered member income or not. For example, a club might have viable arguments that rental income generated from members should be considered member income. To wit, we successfully argued such with the Internal Revenue Service (IRS) for a social club client that was generating short-term rental income from its members. In another example, a  club generating parking revenue from members was held by the IRS to be generating member income when the member parking revenue was related to parking that facilitated access to club events, but generated nonmember income (subject to the UBI tax) when the parking revenue was related to parking for other than club events. Please note that Rev. Proc. 71-17 and GCM 39115 are both excellent resources addressing the normal and usual activities of a social club.

All of the nonmember income of a section 501(c)(7) social club is generally considered to be UBI (including investment income; see Rev. Rul. 81-69) and, hence, subject to taxation. In those situations when a club is recognizing nonmember UBI, it is permitted to deduct its direct unrelated expenses and allocate a portion of its indirect expenses to the club’s unrelated activities. Regarding the allocation of indirect expenses, it is essential that the social club contemporaneously document its “reasonable” indirect expense allocation methodology so it can withstand a challenge by the IRS. 

The determination of whether this type of club has generated “too much” UBI has changed over the years. Before 1976, in order for a social club to be considered tax-exempt pursuant to section 501(c)(7) of the IRC, it had to operate exclusively