The private club industry is changing with the times—embracing new members and new trends to help clubs stay relevant and competitive in the future. Unfortunately, some of these changes and new programs endanger one of the things that many private clubs value—their tax-exempt status.
In order to maintain their tax-exempt status, 501(c)(7) clubs need to be very careful not to engage in anything more than an insubstantial level of nontraditional business activities, even when seeking to adapt to member preferences and member needs. Though undeniably popular, two particular activities that can seriously endanger a club’s tax-exempt status are offering take-out or delivered food or off-site catering services for its members.
Some clubs may provide a take-out food and beverage service for their members, as an accommodation to those members on the run or who want to take a nice dinner home to their families, rather than getting everyone together to go to the club.
Occasionally, some clubs may also conduct outside catering activities. For example, some clubs may cater lunches in their members’ offices, so that they don’t have to bring the entire group to the club for a working lunch.
However, according to the IRS, consuming club food away from the actual club premises is deemed a nontraditional activity—of which the IRS highly disapproves. Both of these activities are considered “nontraditional” according to IRS standards, and, according to the IRS, tax-exempt status can be terminated if more than a “de minimis” amount of “nontraditional” business activity occurs. “De minimis” is a Latin word that can be generally defined as, “small, insignificant, and non-reoccurring.” Under this vague definition, almost any income from nontraditional activities jeopardizes a club’s tax-exempt status.
According to the IRS itself, when referring to a club’s tax-exempt status, “Nontraditional business activities continue to be prohibited (subject to an insubstantial, trivial, and nonrecurrent test) for businesses conducted with both members and nonmembers. Therefore, gross receipts from a nontraditional business activity would result in revocation.”
Unlike with IRS requirements regarding the 15 percent threshold for outside business income, the “de minimis” requirement does not have a safe harbor threshold. Clubs have had their tax-exempt status revoked for having as little as 5 percent of their qualified gross income come from nontraditional activities. The IRS has also stated that an amount in excess of $100,000 from nontraditional sources could not be considered de minimis, regardless of the percentage of the club’s gross income for which it accounts. The lack of a specific figure or percentage that can be called “de minimis” should make it exceedingly clear to clubs that such activity will jeopardize their tax-exempt status.
Furthermore, any income from nontraditional activities—even those conducted with and for members—is still considered nonmember income by the IRS, and is therefore subject to the Unrelated Business Income Test when computing the 15/35 percent limitations on outside business income.
Even though it may seem like it’s a good idea to provide services that club members would both value and use, the risks associated with actually doing so could substantially offset any profit that the club would generate from such activities and could result in millions of dollars of income tax liabilities. If a club would still like to consider providing take-out or off-site catering services to its members, it should carefully way the benefit of short-term profits with the long-term cost of forfeiting its tax-exempt status.
For more information on this topic, see NCA’s publication, The Legal Reference Guide for Private Clubs.
Jackie Abrams is NCA’s communications manager.