Definitions: private, non-profit, tax exempt.

(Originally published in the Private Club Advisor, June 2007)

Attempting to understand the relationship between privacy, not-for-profit status, and tax exemption can be quite a challenge. Why wouldn’t a club just abandon the complexities of exempt or not-for-profit status in favor of additional non-member business and a more robust financial statement? The answer centers on the importance and interdependence of the three factors— privacy, profit, and tax exemption.

Privacy:  Clubs generally exist for the social or civic purposes of a specific group. A club’s privacy (or lack thereof) is defined by who has access to its amenities and services. A club that fails to protect its private status can be deemed a place of public accommodation in the eyes of the law, subject to substantial regulations. Soliciting nonmember use of the club or drawing an excessive amount of income from non-member business jeopardizes the club’s privacy.

Tax exemption:  A 1990 statement by the Supreme Court noted “social clubs are exempted from tax not as a means of conferring tax advantages but as a means of ensuring that the members are not subject to tax disadvantages as a consequence of their decision to pool their resources for the purchase of social or recreational services.”

A club must be deemed private to qualify for tax exempt status and clubs that lose the tax exemption are rarely able to get it back. Tax exempt clubs are not exempt from taxes on investment income since that is unrelated to the club’s social or recreational purpose. The designation 501(c)7 refers to the specific section of Internal Revenue Service code governing such exemptions.

Not-for-profit: A club must be deemed private to operate as a not-for-profit entity. Not-for-profit or for-profit status is an operational model and does not, in and of itself, determine tax status. A club that is for-profit may still qualify for tax exemption based on the regulations for a 501(c)7. In that case, member income is not taxed even where significant profits are made.

Former IRS agent Mitchell Stump offers a checklist of the five best times for a club to be tax exempt in the club treasurer’s workbook section of his Club Tax Book (click here to see the checklist). You may also click here to see a concise history of club taxation from the club tax experts at Condon O’Meara McGinty & Donnelly.