While the economy has improved, many clubs still struggle to bring in new members and to get existing members to spend what they did in the past. Because there are still too many clubs, many, other than the very exclusive, are just looking to survive. So many opportunities exist for our entertainment dollars that a club has to fight just to maintain its fair share. Costs, particularly wages and employee benefits, continue to rise. The vibrant economy makes it more difficult to find and keep good employees. In discussions with managers around the country, this clearly is the biggest problem they face.
Clubs compete in a marketplace that continues to change and not always to the benefit of clubs. The marginal clubs are looking to cut expenses and defer capital expenditures but you can only take this so far, particularly when the club down the street is making improvements. In reality, a club needs more members and more spending by existing members.
The board wants to fund operations without raising dues sufficiently. This is shortsighted. Clubs are in the dues business. However, boards see the increased use of the club by nonmembers or by providing nontraditional activities as a solution to all their problems. Unfortunately, the use of the club by nonmembers does not provide the needed revenue and may affect the usage of the club by members. Convincing boards of this reality is difficult and as a result, nonmember income approaches or exceeds the limits established for tax-exempt clubs.
Should a club give up its tax-exempt status?
At this point, a club may consider giving up its tax-exempt status. Adding to the debate are consultants that encourage the giving up of tax-exempt status because clubs do not make any money anyway or privacy and exclusivity are not important. It is critical that a club not make a decision that has a long-term impact, based on a short-term crisis. Before proceeding, consider alternatives! Do not change status on what you think might be the advantages. Investigate thoroughly. Taxable status is not a panacea. It has its own set of problems and limitations.
Benefits of Tax Exemption for Clubs:
- No tax on net member income – Dues, initiation fees, and special assessments all fall within this category.
- It is possible to defer the tax on the capital gains from the sale of some club property provided certain conditions exists.
- Net income from the sale of goods to nonmembers may be reduced through the allocation of certain overhead costs.
For a taxable club, initiation fees and special assessments are usually taxable. Dues and payments for services are always subject to tax. While a club may not have a profit from operations, most will have a profit when dues, initiation fees, and special assessments are added. If not, the club is headed into financial difficulty and potential bankruptcy. There may be a tax cost on conversion and it is unclear whether a club can make this change unilaterally since it had to apply to get the status in the first place.
Records must be kept on nonmember use of a club to ensure that permissible levels of use are not exceeded. Failure to keep adequate records could result in the income being treated as nonmember. A tax-exempt club is limited on the amount of income it may generate from nonmembers.
The Impact of Deductions, State Laws and Privacy Considerations
The paperwork burden does not disappear for clubs switching to taxable status. For a member-owned taxable club, records must substantiate which expenses relate to member and which to nonmember functions. The deductibility of certain expenses arising from furnishing services to members is limited to member income. Deductions that exceed member income may be carried forward to subsequent years. These limitations can result in higher income than expected.
Carefully review all state laws before changing taxable status. States reserve the right to tax entities engaged in business in the state in a variety of ways. Many states provide exemptions from taxes to organizations that qualify as federally exempt organizations. Exemptions often cover more than just state and local income taxes.
Privacy is very important and goes much further than just who you let into the club. It may impact operations, the application of certain federal laws and how the club is viewed in the community. Remember, many members prefer to maintain exclusivity, and by attracting too much nonmember business or by conducting too many nontraditional activities, the club may lose what makes it unique.
While there may be reasons for a club to change to taxable status (and survival may be one of them), the decision must have member support. In addition, check with tax and legal advisors prior to a final decision. Limitations and aggravations are present whether you operate as a taxable or tax-exempt organization.