In Exchange: Reciprocal Arrangements With 501(c)(7) Clubs
By Mitchell L. Stump, CPA
Reciprocal arrangements between clubs are receiving a great deal of attention within the industry. With the increased use of the internet as a vehicle to speed up the billing and collection process of charges, more clubs will consider entering into these types of agreements. City clubs and yacht clubs have been promoting reciprocal use of their clubs for many years and believe that it is an added benefit to its members who are often out of town on business and pleasure.
There is an ongoing debate among professionals in the club industry as to whether this source of income is to be classified as "member related" or "nonmember related" income. This article will attempt to sort out fact from fiction and discuss the possible tax ramifications of these types of arrangements. It will also provide information the IRS may utilize when searching for additional tax dollars, if a club is examined.
Nonmember Income?
If income were to be received from reciprocal arrangements, clubs must make a decision as to whether to classify it as "member related" or "nonmember related" income in its accounting records. Though important to all clubs, the classification decision becomes extremely important to a club that has applied for and received tax-exempt under Section 501(c)(7) of the Internal Revenue Code. The question usually is not concerning that of reporting a significant profit from the activity, as many clubs will show a loss, given the available methods of allocating expenses. The issue is most important when a 501(c)(7) club makes the 15% / 35% limitation computation of Revenue Procedure 71-17.
As mentioned previously, there is not a consensus among professionals as to how income from reciprocal arrangements should be reported for tax purposes. Some believe that the IRS has improperly interpreted the law in the past and may be willing to reconsider its position in the future with its goal of being the kinder, gentler IRS. Others take a more conservative approach, wanting to wait for clear guidance from the IRS before taking the position of the income being "member related". No matter in which camp a club finds itself, reviewing the IRS's published positions of the past is necessary to identify a club's risks.
Published Rulings
Although Private Letter Rulings and General Counsel Memorandums are not documents that carry a great deal of weight for taxpayers other than to those to whom they are addressed, they give guidance to the reader of the thinking of the IRS. Thus, a review of two such documents is necessary in understanding what may be the position of an IRS agent upon examining reciprocal arrangements in the future.
In 1979, the IRS published Private Letter Ruling 7950015 dealing with reciprocal arrangements. One of the questions raised by the requesting "Club" was as follows:
Does the use of a Section 501(c)(7) social club by members of a club, which has a reciprocal agreement or working arrangements with the host club produce unrelated business income to the host club?
The general facts of this ruling found the "Club" had been recognized as an organization exempt from taxation as described in Section 501(d)(7) of the Internal Revenue Code. Its purpose was noted to provide a means of entertainment, amusement and athletic recreation and instruction for its members, stockholders and others.
The "Club" had reciprocal agreements with approximately 40 similar clubs across the United States and two in Canada. These agreements permitted the "Club" members to use the facilities of reciprocating clubs and allow their members to use the "Club" facilities. This use permitted the "Club" to bill the visiting reciprocal members' clubs and permitted those clubs to bill the "Club" for charges incurred by its members.
In addition to the reciprocal agreements, the "Club" had working arrangements with most of the country clubs in the area. The working arrangements did not render the participating club liable for its members' bills. These two types of agreements were the generating sources of the "Club's" business with non-members.
In discussing the rational of its decision and conclusion in this ruling request, the IRS representative stated:
"Regarding reciprocal agreements or working arrangements between clubs and the production of unrelated business income to the host club, it is the Service's position that under section 512 of the Code, amounts paid to a social club by visiting members of another social club are amounts paid by non-members even though both clubs are similar in nature, and the amounts paid are for goods, facilities, or services provided by such social club under a reciprocal agreement or arrangement with such other social club."
Thus, for this particular "Club", the IRS concluded that the use of a section 501(c)(7) social club's facilities by members of another club under a reciprocal agreement or working arrangement with the host club produced unrelated business income to the host club. The accounting department needed to record the income as "nonmember income."
In 1984 the IRS issued General Council Memorandum 39343 responding to a similar question as to whether income derived by a social club pursuant to a reciprocal agreement with a social club of like nature is to be treated as income from nonmembers. In the conclusion, this document notes:
"Amounts paid to a social club by visiting members of another social club are amounts paid by nonmembers even if both clubs are similar in nature and the amounts paid are pursuant to a reciprocal arrangement agreed to by both entities."
The analysis of law and regulation found in this General Council Memorandum guidance reveals some of the ammunition that may be ultimately used against the IRS in its stated position. Leaving the door open to arguments, the document states "It seems clear that the Service's current position is to treat income derived by a social club pursuant to a reciprocal agreement with a social club of like nature as income from nonmembers. Absent any formal modification, the Service must, of course, continue to follow the rule of Rev. Rul. 79-145". To date, formal modification of an interpretation of law different from that discussed in the rulings has not been forthcoming.
Arguments Against The IRS Will Continue
As noted in GCM 39343, proposed regulations to Section 512 do not specifically address whether fees paid pursuant to a reciprocal arrangement by visiting members of another social club should be considered exempt function income. These regulations, however, contain the broad statement that gross income from members does not include any amount paid to an organization by any person who is not a member, even though paid as consideration for providing goods, facilities, or services.
Privacy
Another issue facing clubs, and the topic of discussion in club related magazines and newsletters of late, is that of private status and the public accommodations laws. Because these are not federal income tax issues, no legal opinions are being provided by this author on how reciprocal arrangements effect these local laws. It would be wise for clubs to review their reciprocal agreements with their attorney to determine whether openly inviting "nonmembers" into the club by way of reciprocals has an effect on either or both private status and the public accommodations laws.
Conclusion
From the tax literature, it appears clear that the Internal Revenue Service may take the position to treat income derived by a social club pursuant to a reciprocal agreement with a social club of like nature as income from nonmembers. It is suggested that clubs review their nonmember income limitations before embarking upon new reciprocal arrangements. Know that with full disclosure of reciprocal arrangements found on your clubs web pages or that of reciprocal clubs, the world, along with the IRS, will have a road map to this source of income.
Mitchell Stump is the author of Club Tax Book, a regularly updated manual, available on an annual subscription basis. Clubs subscribing to Club Tax Book have access to the full text of each of the rulings cited. To order or renew subscriptions, contact Mitch at 561.776-0452.
