Soaring costs! Members wanting additional services! Finance committees trying to maintain the current dues structure! Tax-exempt clubs are exploring various avenues to increase revenue. In examining these new opportunities, clubs are asking common questions:
- What is unrelated business income?
- How much unrelated business income can the club earn and still retain its tax-exempt status?
- What records should the club maintain concerning the use of the club’s facilities?
- What are the unrelated business income tax consequences?
The Internal Revenue Code exempts from federal income tax non-profit clubs that are organized and substantially all its activities are for the pleasure, recreation, and similar purposes of its members. Net earnings must not inure to the benefit of private shareholders. Additionally, clubs may not have a policy written in any governing instrument which provides for discrimination based on race, color, or religion (but not sex).
Unrelated Business Income Tax (UBIT)
While a club may be tax-exempt, it may be subject to tax on its unrelated business activities. A club’s unrelated business income includes all gross income except:
- dues, fees, charges, or similar amounts paid by members for services provided them, their dependents or their guests;
- investment income set aside for charitable purposes; and,
- gain on the sale of property used by the club for exempt purposes to the extent that the proceeds are reinvested in similar property within a period beginning one year before and ending three years after the date of sale. The gain may also be used for capital improvements to other club property used for exempt purposes.
Expenses “directly connected” with the production of the unrelated business income are deductible. However, the dividends received deduction normally available to corporations is not available to tax-exempt clubs. A $1,000 specific deduction is allowed against unrelated business income.
Gross income from members includes: dues, fees, charges, or similar amounts paid by members of the club as consideration for the club providing goods, facilities, or services to the members, their dependents or their guests in furtherance of the exempt purposes of the club. Member income is specifically excluded from the definition of unrelated business income. A member’s spouse is treated as a member.
Generally, membership income does not include any amount paid to the club by nonmembers. However, certain payments made by nonmembers directly to the club or reimbursements paid to a member may be considered to have been paid by the member. Generally, this is limited to situations where the payment was made gratuitously to, or on behalf of, a member, or under certain circumstances, by the member’s employer either directly to the club or to the member as reimbursement for payments he made directly to the club.
Employer payments or reimbursements are considered member income if the guests are present due to some personal or social purpose of the employee-member or to some direct business objective or relationship of the employee-member in his work for the employer. If the purpose or objective of the employer is primarily unrelated to the activities of the particular employee-member, it will not be considered member income.
15/35 Percent Test
For clubs to retain tax-exempt status, the club must not receive investment and nonmember income exceeding 35 percent of the gross receipts. Gross receipts are defined for this purpose as receipts from normal and usual activities of the club including charges, admissions, membership fees, dues, assessments, investment income (dividends, rents, etc.), and normal recurring capital gains on investments, but excluding initiation fees and capital contributions.
A further restriction applies; no more than 15 percent of the club’s gross receipts may be from the use of its facilities or services by nonmembers. If exceeded, a facts and circumstances test is applied to determine if the club’s tax-exempt status should be revoked. Receipts of unusual amounts from the sale of a clubhouse or similar facility are not included in calculating the 15 or 35 percent limitations. Income received from members of other clubs using your club under a reciprocal agreement is nonmember income and is subject to the 15 percent limit as well as UBI tax.
Clubs may not engage in a nontraditional activity. This can, in and of itself, jeopardize the tax-exempt status. However, the IRS has provided an unofficial five percent safe harbor for nontraditional activities. This five percent is part of the 15 percent mentioned above. For an example, the sale of alcoholic beverages by a club for off-premises consumption is nontraditional.
The IRS requires clubs to keep detailed records on the extent of nonmember use and has set forth certain situations where, for audit purposes, a host-guest relationship will be assumed.
Two safe harbors are provided. If payment is made directly to the club by a member or the member’s employer, a host-guest relationship will be assumed:
- Where a group of eight or fewer individuals, at least one of which is a member, uses the club’s facilities.
- Where 75 percent or more of a group using club facilities are members.
In all other situations, a host-guest relationship must be substantiated by the club. The classic example of this is where a controller of a corporation hosts a meeting of his accounting staff at his club and his employer pays the cost of the meeting. In this situation, the staff are guests of the member because their presence is related to a direct business objective of the employee-member. Alternatively, if the controller sponsors a meeting of his corporation’s board of directors at the club, the persons invited are not guests of the member since the directors’ presence is not related to a direct business objective of the particular employee-member.
Adequate records must be maintained to substantiate that there was, in fact, a member in a group of eight or fewer or that 75 percent of a larger group were members and that payment was made directly by members or their employers. The club need not inquire about reimbursement where payment is made directly by the member.
The information that must be obtained in all situations involving groups of more than eight (even if a member pays the club directly) includes the date; total number and number of nonmembers in the party; total charges; charges attributable to and paid by nonmembers; as well as a statement signed by the member indicating:
- whether the member has been or will be reimbursed for such nonmember use and, if so, the amount of the reimbursement;
- the name of his employer; amount of the payment attributable to the nonmember use; the nonmember’s name and business or other relationship to the member; and, the business, personal, or social purpose of the member served by the nonmember use where the member’s employer reimburses the member or makes direct payments to the club. If a large number of nonmembers are involved and they are readily identifiable as a particular class of individuals, the class rather than the individual names of the nonmembers may be recorded; and,
- the donor’s name and relationship with sufficient information to substantiate the gratuitous nature of the payment or reimbursement where a nonmember, other than the employer of the member, makes payment to the club or reimburses the member and a claim is made that the amount is paid gratuitously for the benefit of a member.
The questionnaire gathers the information required by the Internal Revenue Service. Remember, this document is directed only to the federal income tax aspects. Discrimination on the basis of sex, having nonmember business, or allowing corporate checks may cause severe problems in dealing with any local public accommodation legislation.
If you have any questions regarding this or any other tax matter, please contact Kevin Reilly or Edward Yoder.
This article also ran in the National Club Association’s “Club Industry Brief” newsletter.