Originally published on Forbes.com.
Groucho Marx is supposed to have sent a telegram to a club stating – “Please accept my resignation. I don’t want to belong to any club that will accept people like me as a member.” That sentiment is not exactly a tax principle, but it is very akin to one. The idea is that for an organization to be recognized as a social club exempt under 501(c)(7) belonging to it has to mean something, maybe not much, but something. That was the essence of Private Letter Ruling 201605021. Private letter rulings are redacted, so I’m going to call “the club” – How Dry I Am (HDIA).
A Club That Is Easy To Join – Very Easy
HDIA has some high sounding purposes in its Articles of Incorporation. It is intended to provide for the social, cultural and civic betterment of its member, support charitable endeavors, provide for recreation and the like and establish and maintain facilities where all this good stuff can go on. That’s the Articles of Incorporation. It advertises itself a little differently.
HDIA advertises itself as a family restaurant and bar and grill. The facility is leased from two of its members. It seems like a pretty convoluted way to run a restaurant, but there is a reason for it. HDIA is in a dry county where restaurants are not allowed to serve liquor. Private clubs are another matter. They can serve liquor to members. Thus the proliferation of private clubs in dry counties where liquor is served “by the wink”. Here is how it works at HDIA
Upon entering the front doors, a hostess is present to seat customers (non-members, members & guest) and members are asked to sign-in. Each customer is asked before seating if an order will be placed at the bar, if yes, then a membership card is asked to be presented. If the customer is not a member, the option to become a member is offered so alcohol may be purchased …
Does Not Qualify
The IRS broke HDIA the bad news that it did not qualify as an exempt organization.
You are not described under section 501(c)(7) of the Code because you are not organized for pleasure, recreation, or other nonprofitable purpose. You were formed to provide for the enjoyment, recreation, leisure, food, social activities and entertainment of your members as well as non-members. Your activity consists of operating a bar and restaurant. Your restaurant is open to anyone. Although you only sell alcohol to members, anyone over the age of 21 can obtain membership in order to purchase alcohol. Your sales of food and alcohol demonstrate that you are not operated for the purposes declared under section 501(c)(7) of the Code. Rather, you were formed primarily for commercial purposes.
That’s not all:
Per section 1.501(c)(7)-1(b) of the regulations you are not organized and operated for pleasure, recreation, and other nonprofitable purposes because you engage in the business of operating a bar and restaurant and you make your facilities available to the general public. You advertise yourself in print and on the radio as a family friendly restaurant and a bar and grill serving food. This advertising for public patronage is evidence that you are conducting a business. Since your primary purpose is to sell food to all members of the public and to sell alcohol to the general public through your issuance of unlimited memberships, you do not qualify for exemption under section 501(c)(7) of the Code.
Also damning is that there are no membership requirements – the Groucho Marx rule. Also there is no “commingling” among members.
Remember The IRS Scandal
This little comedy may seem far removed from the interminable IRS scandal now on Day 1043 by TaxProf Count. We privilege not for profit organizations in a variety of ways, not just through federal tax benefits but also by letting them sell liquor, where others cannot, run gambling, or make significant political expenditures without disclosing donors. There is even an entirely unmerited dose of credibility that organizations get for having achieved exempt status.
Yet we lay the regulation of entities seeking exemption from a variety of rules at the doorstep of our tax collection agency, even when the status has little or no tax significance as was the case with the 501(c)(4) organizations that made up the core scandal and this particular attempt at 501(c)(7) that just wants to serve liquor. Paul Streckfus of EO Tax Journal wrote me that the liquor cases have been haunting the IRS for a long time.
It’s been a long-standing problem. I remember these type cases coming through the EO Division in the mid-seventies. I guess it allows state legislators to have it both ways — we’re against liquor, but we can’t interfere with the rights of social clubs to sell liquor to their members, even if everyone knows the “membership” is a sham.
Let Them Just Collect Taxes
In a recent article in Tax Analysts- The IRS’s Multi-Mission Mismatch Problem – Kristin Hickman makes a strong argument for moving Exempt Organization regulation out of the IRS as part of a larger effort to focus it on its core competency.
IRS personnel have tremendous capacity to process and evaluate hundreds of millions of taxpayer filings and collect the taxes owed. But they are not typically social workers, environmental scientists, health policy experts, or First Amendment scholars. Consequently, however talented IRS employees may be at pursuing the IRS’s traditional revenue-raising mission, they may not be as good at addressing the needs of socioeconomically disadvantaged persons, promoting new sources of energy, remaking the healthcare system, or recognizing when administrative decisions implicate politically sensitive values like freedom of speech or religion.
Perhaps Congress could spin off exempt organization determinations and monitoring wholesale and have the responsible agency just provide the IRS with a list of approved entities. If the IRS suspects a problem with a particular entity, it could refer the matter back to the responsible agency.
I’ll drink to that and in Worcester County, I don’t need to belong to a club.
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