Tax considerations for social clubs

Social clubs organized under IRC section 501(c)(7) have faced unique challenges in tax compliance before, during, and after the COVID-19 pandemic. Management and board members who serve these types of tax-exempt organizations should be aware of several key areas that could impact the organization such as those identified below and should make sure these areas are monitored regularly.

The 15/35 Test

Arguably, one of the most important areas for a social club is maintaining its tax-exempt status. One of the key calculations that the Internal Revenue Service (IRS) uses to assess this for a club is what is commonly known as the “15/35 test.”

This 15/35 test refers to the percentage of gross revenue derived from nonmember revenue. More specifically, a social club that recognizes greater than 35% of its total income as nonmember income (including investment income), may be in jeopardy of losing its exempt status because in the eyes of the IRS, the club is not being operated where “substantially all” of its activities are for the members of the club.

Furthermore, within that 35% nonmember income bucket, if more than 15% of the club’s revenue is derived from the use of its facilities or services provided to the public, then the club may also be in jeopardy of losing its tax-exempt status.

If these thresholds are exceeded, the club should be prepared to support its position to remain a tax-exempt organization through the facts and circumstances of its situation.

Nontraditional activities

Years ago, the IRS indicated that gross revenue generated by a club from the sale of items to be consumed off-premises would be considered “nontraditional business activities” that do not actually further the tax-exempt purpose of the club to provide pleasure and recreation to its members and therefore, those sales would be treated as nonmember income. Common examples of these types of activities often include curbside pick-up for food, sales of bottles of wine or other beverages, and even catering services. The IRS indicated that clubs should not receive more than a “de minimis amount” (or 5%) of its gross revenue from these types of activities, otherwise the club could run the risk of losing its tax-exempt status.

Prior to the COVID-19 pandemic, social clubs may have had some of these nontraditional activities. However, as access to club activities continued to be restricted due to the pandemic, many clubs adapted by increasing these types of off-premises sales. Club management should document these types of sales during the governmental shutdowns in effect where the club operates to substantiate the amounts generated in the event the club is challenged by the IRS. As operations return to normalcy, club management should revisit the need for these nontraditional sales and monitor the amount of revenue generated from them accordingly.