Of the more than 25 types of corporations and trusts given a free pass on federal income taxation, we, private clubs, enjoy that benefit, assuming we meet the criteria established by the Internal Revenue Code. But, it comes with a price and it seems that the price has just gotten a bit higher.
In return for being tax-exempt, the federal government requires private clubs to tell a little about who they are and what they do. This disclosure takes place on the Internal Revenue Service’s (IRS) Form 990, entitled the Return of Organization Exempt from Income Tax.
Under the old Form 990, clubs reported the income of their current officers, directors, trustees and key employees. Although an annoyance, this practice was mitigated by the fact that few, if any, club employees would be included in this disclosure. Usually, the club’s general manager was the only one who would have his/her privacy infringed on.
However, that has now changed.
To stop providing excessive salaries to staff members of entities that solicit funds from the general public and to prohibit public charitable or religious groups from purchasing a Bentley as their corporate car, a movement began in Congress to require more oversight of 501(c) organizations. Though this oversight action was really directed at traditional charitable organizations found under 501(c)(3), it also swept up the remaining 501(c)s, including 501(c)(7) social and recreational clubs.
To help manage this new oversight obligation, the IRS undertook the task of rewriting the Form 990. Last June, the IRS unveiled the first new iteration of the 990 since 1979. That rewrite has caused, and continues to cause, great consternation within the private club industry.
The New Form 990
After receiving the initial draft of the new 990, NCA took immediate issue with the enhanced compensation disclosure section. Along with the requirement to provide income information of the club’s officers, directors, trustees and key employees, the definition of “key employee” had been expanded to include far more than the traditional GM or CEO. Additionally, a new requirement forced clubs to disclose the names and salaries of their top five highest paid employees who were not key employees.
Needless to say, these significant new disclosure requirements caused many trade associations representing tax-exempt corporations to register complaints. Indeed, more than 650 organizations responded with less than flattering suggestions for the IRS. Surprisingly, the IRS actually took some of these comments to heart and agreed some modifications would be worthwhile.
In December 2007, the IRS released the new Form 990’s final draft, which incorporated some of the requested changes. But, still more was needed.
From December 2007 until April 2008, the IRS took a closer look at what it was requiring tax-exempt entities to do. A few 501(c)(3) entities may have paid outrageous salaries to their employees and have had questionable dealings, but that doesn’t require condemning all entities under the 501(c) subsection.
With that in mind, the IRS did something most federal government agencies never do: The IRS issued its draft instructions for the Form 990 and allowed public comments on them.
By allowing tax-exempt entities to express frustrations with the new 990 through public comments on the instructions, which include all of the definitions germane to our concerns, the IRS tacitly acknowledged more was needed to satisfy those who would use the form.
Improving Definitions
In response to this unique second chance, NCA, and most of the same 650 trade associations who worked on the 990’s first draft, submitted comments focusing on the new definitions. The most important was “key employee,” a definition that would force many private clubs to disclose income information from an array of staff members.
Without doubt, the new definition is overly broad and does not adequately indicate who is truly in charge of a private club. The 5 percent threshold is far too low for an accurate indication of what a staff member actually controls in a club. Furthermore, the IRS definition of key employee seems to indicate that “manage” equals “control” and that may not be the case in many private clubs. Key employees should be those who have significant control over a tax-exempt entity and function as a CEO, COO or CFO. These individuals should be disclosed and not most of the department heads.
When the initial draft of the 990 was issued, significant comments were made regarding the interpretation of “key employee.” Limiting the definition to an individual who serves as a CEO, COO or CFO seemed the most appropriate way to satisfy the IRS’ concerns. Ultimately, the IRS rejected this suggestion. But, by providing a second opportunity for specific comments on these definitions, the IRS may be more amenable to making the change now. We shall see.
The definition of “highest compensated employee” was the next area of concern. This new requirement necessitates the disclosure of the names and salaries of those top five individuals who are not key employees.
Again, the IRS has taken a very shortsighted view with this definition. The reality is that private club members are usually successful, well established individuals who demand top service wherever they go. As such, private clubs must pay top dollar to ensure their staffs can meet the needs of their discerning members.
The IRS wants to ensure a reason exists for such high compensation for employees of tax-exempt entities, but they are applying the wrong test to our clubs. In an industry like ours that does not take nor solicit public contributions but demands a significant investment from individuals to join, the payment of $100,000 to staff is hardly unreasonable. Disclosure of this information is simply unnecessary for 501(c)(7)s and by providing us a second chance to explain that through comments on the instructions may signal a change in the IRS’ perspective. Again, we shall have to wait and see.
Individual Privacy
Many private clubs are corporations that have been organized for pleasure, recreation, and other nonprofit purposes. NCA member clubs charge significant initiation fees, but those fees exist to provide exceptional service and an unparalleled facility. That takes financial commitment from individual club members and it takes the same kind of commitment from the staff, who expect to be paid well for their hard work.
To say the least, private clubs are a very different kind of 501(c) entity.
Throughout the 990 revision process, NCA has expressed concerns with the proposed changes, but we are mindful that some changes are inevitable. We do not mind that there is a compensation disclosure requirement, but we do mind how the IRS has defined what should be disclosed.
Amazingly, the IRS gave us another opportunity to revisit the definitions found in the draft instructions. And, with luck, our submitted comments, drawn from significant input from NCA members and non-members, will make a difference.
One thing is certain: In 2009 there will be a new set of disclosure requirements mandated by the new Form 990. All clubs must work with their accountants now to prepare for this, but when the dust has settled and when the IRS has digested all of the most recently submitted comments to these instructions, we may find the mandated disclosures will be less onerous than once thought.
As the voice of the private club industry, NCA has made clear the differences between 501(c)(7) clubs and traditional 501(c)(3) entities and how the new 990 fails to take those differences into consideration. By the end of July, the IRS will complete its review of the submitted comments and it will finalize its instructions. Then, we will see how well they heard us.
As they say, let’s hope for the best, but be prepared for the worst. After all, when dealing with the IRS that is the most prudent advice anyone can take.
Brad Steele, J.D., is NCA’s vice president of government relations.