If a social club wants to keep its tax exemption under section 501(c)(7), it needs to look at how much money it’s making from side hustles, including anything contractors are doing for it.
Holding
The Tax Court backed the IRS and pulled the plug on Consolidated Sportsmen of Lycoming County’s tax-exempt status starting January 1, 2023. Why? Because their mineral lease wasn’t just a side gig—it was a big, nonexempt business.
Why It Matters
Outsourcing income-producing work does not exclude that work from the club’s activities. When applying section 501(c)(7), the Court considers activities performed by members, employees, trustees, and contractors.
Member participation alone does not establish continued exemption. Revenue from outside activities can be an important measure of their significance even when members spend almost no time on them.
Reporting and paying tax on mineral royalties does not resolve the separate exemption question. A club can lose its exemption when nonexempt activities become substantial.
The decision does not establish a numerical cutoff or validate the IRS’s 35% nonmember-income guideline. The Court resolves this case under the statute without deciding the guideline’s legal force.
Key Facts
Consolidated Sportsmen is a Pennsylvania nonprofit corporation formed in 1936. It owns approximately 230 acres in Lycoming County above the Marcellus Shale formation. Members use the property for shooting, hunting, fishing, camping, and other outdoor activities. The IRS did not dispute that those activities qualified as recreational purposes under section 501(c)(7).
The IRS recognized the club’s exempt status in 1981. The determination relied on the activities described in its application and instructed the club to report changes in its purposes, character, or operations. Its application described recreational activities and stated that it had no outside fundraisers.
In March 2011, the club entered into an oil and gas lease with Rice Drilling B, LLC. The agreement granted extraction rights on and under the property, and the club received a signing bonus of approximately $921,800. Gas extraction began in December 2016.
Mineral royalties totaled $2,187,980 during 2017–2023. Annual royalties ranged from $34,085 in 2021 to $1,180,656 in 2022. They represented 90.5% of total revenue in 2022 and exceeded half of total revenue in several other years. Total nonmember income, including other investment income, exceeded half of gross revenue in every year from 2017 through 2023.
Members spent virtually no time on mineral activities, and officers spent only minimal time. The great majority of their club-related hours concerned recreation. However, the record did not establish the contractor’s extraction hours. Given that evidentiary gap and the club’s burden of proof, the Court assumed that the contractor devoted substantial time to extraction.
The IRS’s September 27, 2023 final adverse determination revoked exemption effective January 1, 2023. During litigation, the Commissioner initially sought to revoke the exemption with effect from 2017 but later conceded that issue. The Court therefore did not decide whether retroactive revocation to 2017 would have been proper.
The parties submitted the case without trial under Rule 122, using an agreed administrative record and additional stipulated facts. The Court reviewed entitlement to exemption de novo, with the club bearing the burden of proof.
Statutory Framework
Section 501(c)(7) covers clubs organized for pleasure, recreation, and other nonprofitable purposes, provided substantially all their activities serve those purposes, and no net earnings inure to a private shareholder. Section 501(a) supplies the exemption. Sections 511 and 512 separately tax a social club’s unrelated business taxable income, which includes investment and other nonmember income under the special rules for social clubs. Section 7428 permits a declaratory judgment concerning continued qualification.
Congress replaced the former requirement that a club operates exclusively for qualifying purposes with the current “substantially all” standard in 1976. A Senate committee report described an allowance for up to 35% of gross receipts from nonmember sources, including investment income, and contemplated a facts-and-circumstances inquiry above that level. Congress did not enact a 35% test in the statute. The Commissioner acknowledged that no regulation or revenue ruling embodies that guideline.
Taxpayer’s Arguments
The club argued that members’ activities should control the exemption analysis. Because members devoted almost all their time to recreation and virtually none to mineral extraction, it maintained that substantially all its activities qualified.
It also challenged the use of revenue as a substitute for measuring activities. It argued that the IRS had misapplied the 35% guideline and had failed to give adequate consideration to all the facts and circumstances. Its submissions also described the adverse consequences of retroactive revocation and its disclosure of royalty income on filed returns.
Government’s Arguments
The Commissioner argued that the mineral arrangement was a substantial activity unrelated to the club’s exempt purposes. He relied on the scale of nonmember revenue and the 35% guideline drawn from the 1976 legislative history and IRS administrative practice.
Although the adverse determination had mentioned possible inurement, the Commissioner expressly disclaimed that issue during litigation. He also conceded his request to extend revocation back to 2017.
Court’s Reasoning
The statute addresses the club’s activities. The relevant language refers to the club's activities, not merely those personally performed by its members. Contracting with another party to extract minerals does not remove extraction from the club’s activities. The Court drew support from decisions treating outsourced fundraising and mineral operations as activities of the exempt organization.
Member hours were an incomplete comparison. The club presented recreational hours without establishing the contractor’s extraction hours. It therefore did not provide the comparison necessary to support its proposed time-based analysis. It also did not propose a comparison of recreational and extraction costs.
Revenue can measure an activity's significance. The Court rejected the premise that investment income is disconnected from organizational activity. The amount earned can indicate how substantial the activity is. The club could not require the Court to disregard mineral revenue while relying exclusively on members’ recreational time.
The mineral arrangement met the statutory standard. Royalties often exceeded half the club’s gross income, and total nonmember income exceeded half in every relevant year. On these facts, the Court concluded that substantially all the club’s activities could not be characterized as recreational. It did not adopt 50% as a general statutory threshold.
The 35% guideline was unnecessary to the decision. The Court assumed without deciding that the IRS might have discretion to administer a safe harbor of that kind. It expressly declined to decide the extent to which legislative history or IRS practice should control because the nonexempt activity here was substantial without applying that guideline.
No additional facts changed the activity analysis. The club largely repeated its focus on member hours or described the consequences of retroactive revocation. Those points did not reduce the significance of mineral extraction. Disclosure on returns also did not preserve the exemption where the underlying activities failed to meet the statutory requirement.
Result
The Court sustained the revocation effective January 1, 2023, and stated that it will enter an appropriate order and decision.
The Takeaway
If you’re advising a social club, keep receipts on everything they do—including what contractors handle—and pay attention to the money, not just the hours. Filing taxes on outside income and keeping your exemption are two different games.
List of Citations
I.R.C. §§ 501(a), 501(c)(7), and 7428(a)(1)(E): exemption, the qualifying-activities requirement, and judicial review of continued qualification.
I.R.C. §§ 511 and 512(a)(3): taxation of unrelated business taxable income under the special social-club rules.
Portland Golf Club v. Commissioner, 497 U.S. 154, 162 (1990): the rationale for exempting members’ pooled recreational resources.
Skillman Family Reunion Fund, Inc. v. United States, 196 F. Supp. 2d 543, 547–48 (N.D. Ohio 2002): investment activity and the limits of evaluating exemption solely through members’ time.
Coastal Club, Inc. v. Commissioner, 43 T.C. 783, 806, 810 (1965), aff’d, 368 F.2d 231 (5th Cir. 1966): mineral operations as club activities; decided under the different, pre-1976 statutory standard.
S. Rep. No. 94-1318, at 4 (1976), reprinted in 1976-2 C.B. 597, 599: the nonmember-receipts guideline and facts-and-circumstances discussion that the Court distinguishes from enacted statutory text.
Tax Court Rules 122, 142(a), and 217; Partners in Charity, Inc. v. Commissioner, 141 T.C. 151, 162 (2013): stipulated submission, the burden of proof, and review of exemption determinations.