## Facts

- The Senate Committee on Finance issued a report accompanying legislation later enacted as Pub. L. 94-568 (1976), revising the tax treatment of I.R.C. § 501(c)(7) social clubs and related provisions.
- Before 1969, the IRS commonly applied an administrative audit practice under which a social club generally was not scrutinized if nonmember receipts did not exceed 5% of gross receipts.
- The Tax Reform Act of 1969 extended the unrelated business taxable income (UBTI) regime to most exempt organizations, including § 501(c)(7) social clubs, prompting Congress to reconsider the pre-1969 administrative practice.
- The report explains amendments to I.R.C. § 501(c)(7) (definition and exemption conditions), § 512(a)(3) (UBTI computation for social clubs and similar membership organizations), and § 277 (deduction limits for certain membership organizations).
- The report also addresses denial of exemption to social clubs with governing instruments or written policies providing for discrimination based on race, color, or religion.

## Issues

1. Under what quantitative limits may a § 501(c)(7) social club receive nonmember and investment income while retaining tax-exempt status?
2. How should UBTI be computed for social clubs and similar membership organizations, particularly with respect to investment income and corporate dividends-received deductions?
3. How should prior IRS administrative practice (the “5-percent” nonmember-receipts approach) be replaced within the post-1969 statutory UBTI framework?
4. What eligibility restriction should apply to social clubs that maintain discriminatory governing instruments or written policies?

## Decision

- The report supports replacing the IRS’s pre-1969 5% nonmember-receipts audit practice with a statutory framework addressing both exemption standards and taxation of specified income streams.
- The report explains a policy allowing a § 501(c)(7) social club to receive up to 35% of gross receipts, including investment income, from sources outside its membership without loss of exemption, subject to further limits described for public use of club facilities and services.
- The report endorses taxing certain nonmember and investment income as UBTI under § 512(a)(3) even when the club remains exempt under § 501(c)(7).
- The report explains amendments providing that corporate dividends-received deductions under §§ 243–245 are not treated as directly connected with producing gross income for § 512(a)(3) purposes and are correspondingly disallowed under § 277.
- The report supports denying exemption to a social club whose governing instruments or written policies provide for discrimination based on race, color, or religion.

## Legal Principles

- Exempt status for § 501(c)(7) depends on whether the club is organized for pleasure, recreation, and other nonprofitable purposes and whether substantially all activities are for those purposes, with no inurement to private individuals.
- Receipt of nonmember and investment income can be compatible with exemption within prescribed limits, but such income may still be taxable as UBTI.
- The pre-1969 IRS administrative “5-percent” approach was treated as inconsistent with the expanded UBTI regime and replaced by an explicit statutory and legislative-history framework.
- For § 512(a)(3) organizations, corporate dividends-received deductions are not “directly connected” deductions in computing UBTI, preventing reduction of tax on investment income through those corporate deduction rules.
- Tax exemption under § 501(c)(7) is unavailable to clubs with governing instruments or written policies that provide for discrimination on the basis of race, color, or religion.

## Conclusion

The report articulates Congress’s 1976 policy for § 501(c)(7) social clubs: exemption turns on member-oriented recreational purposes and “substantially all” activity for those purposes, while allowing limited outside receipts (commonly stated as up to 35% including investment income) and taxing specified nonmember and investment income as UBTI, denying certain dividend-related deductions in UBTI computations, and conditioning exemption on nondiscriminatory governing rules and policies.


S. Rep. No. 94-1318, 1976-2 C.B. 597 (1976)