A social club is a type of tax-exempt entity, defined under Internal Revenue Code 501(c)(7). It’s designed for organizations that are run for their members’ recreational and social benefit. As with every tax-exempt organization, there are pros and cons to this structure, and the only way to know if this is the right tax-exempt entity for your organization is to talk with an attorney in your state. The purpose of this article is to provide information about the benefits and limitations of a 501(c)(7) social club.

Side note: why do you need to talk to an attorney in your state? While it seems like tax-exemption is a purely federal law issue, rather than a state law issue, the formation of an entity is governed by state law. Thus, if you want to start a new organization, you need advice about how to form an entity under your state’s laws, as well as how to ensure that the entity you are forming will qualify for tax-exemption under federal law.

To qualify as a social club, an organization must:

Be organized for the pleasure or recreation of its members
Provide an opportunity for personal connection between members
Must limit who can be a member
Without discriminating against a person based on race, color, or religion (though religious clubs can do this so long as their purpose is to further the teachings or principles of that religion)
Be supported primarily by membership fees, dues, and assessments
Receive de minimis income from unrelated business, and
Not allow the net earnings of the organization to inure to any person having a personal and private interest in its activities.

Let’s use three hypothetical organizations to illustrate these requirements. The first is a golf/country club with a restaurant on site. The second is a recreational pickleball league for youth in Seattle. And the third is a makers club with a makerspace with equipment that can be reserved by members.

All three are organized for the pleasure or recreation of its members. The members enjoy golf/pickleball/making stuff, so we can check that first bullet.

However, in providing an opportunity for connection between members, we may have our first problem. If the makerspace is set up so that the members have economical access to expensive equipment, and the primary function of the organization is to own, operate, and maintain the equipment, rather than providing opportunities for comingling among members, then this organization will not qualify as a social club. This could be remedied, however, if the bylaws or articles require the club to organize regular “events” in order for members to get to know each other, share ideas, and learn from each other, and if the club’s purpose includes opportunities for social interaction and sharing ideas among members.

For the next two bullets, membership must be limited, but may not discriminate against anyone on the basis of race, color, or religion. For the golf club, anyone who has a passion for golf or the community of the country club is allowed to join. The requirements do not need to be particularly narrow, so long as there is some limitation. With the pickleball club, the limits are greater, and include the age of the player and where they live. However, if a youth outside of Seattle city limits applies for membership, the club can make an exception for a member beyond its usual criteria — but it affects the next requirement.

The IRS is always concerned about from where money comes into the organization, and what money can be spent on out of the organization. A social club must be supported primarily form membership fees, dues, and assessments.

At least 65% of the gross receipts must come from membership fees, dues, and assessments, and no more than 15% of the remaining 35% (or about 5%) can come from nonmember use/'participation. Let’s look at the pickleball club. Each member-player pays, for example, $100 to play for the season. The club uses that money to reserve courts, buy software to organize teams and game schedules, and advertise for more players. There are no “guest” players — only members play. Here, 100% of the gross receipts come from member dues. However, if there are players from outside Seattle, as discussed above, they would be excluded from “member fees” and treated as “nonmember income.” The club can admit these nontraditional members, so long as their income does not exceed 15% of the 35% of nonmember gross receipts for the year. If the pickleball club as 95 member-players, then they can have 5 nonmember-players. (An easier fix, however, would be to amend the bylaws to the “greater Seattle area” and slightly expand the geographic region).

For the golf club, as long as every golfer and every diner in the restaurant are members of the golf club, then 100% of gross receipts are from members and there is no issue with the 65%/35% income requirement. In most cases, however, people want to bring guests to both play golf and go to lunch. The IRS has clarified that income from bona-fine guests will be treated as member income. A bona-fine guest relationship will be assumed if the group consists of 8 people or less with at least one member, and the club receives payment directly from the member, or at least 75% of the group is members and the club is directly paid by one or more of the members.

The club must also avoid unrelated business income, or only accept it minimally. What is unrelated business income? It’s income received for activities that are not related to club’s exempt purpose, sometimes called income from “nontraditional” activity. Returning to the pickleball club hypothetical, let’s say that they decide to sell t-shirts with a funny pickleball cartoon on it. This is a nontraditional activity for a pickleball club, and the income from it must be de minimum in order to not affect the club’s tax-exempt status. Generally, the IRS views income that is 5% or more as “substantial,” and will jeopardize tax-exemption. So if the club has 100 members, each paying $100 in dues, the club could sell around $500 worth of t-shirts without risking their status. In this case, it doesn’t matter whether the t-shirts are bought exclusively by members or not, because the activity itself is nontraditional.

This is not the same as the 5% of nonmember income (though if only nonmembers buy the t-shirt, then that 5% will overlap completely). Unrelated business income also includes traditional activities that are paid for by nonmembers. So if a nonmember paid for their round of golf at the club, the club would owe taxes on that unrelated business income (if it’s more than 5% of receipts).

As you can see, this gets complicated quickly. It is of paramount importance that social clubs keep detailed records of activities involving nonmembers. If nonmembers are allowed to use the facilities, the clubs must collect and maintain the following information for each event:

Date
Total number in party
Number of nonmembers in the party
Total charges
Charges attributable to nonmembers
Charges paid by members
Where a members pays all or part of the charges attributable to nonmembers, a statement signed by the member indicating whether she or he has been or will be reimbursed for such nonmember use, and if so, the amount of the reimbursement.

Finally, private inurement is prohibited. No part of a club’s net earnings may inure to the benefit of any person having a personal and private interest in the organization’s activities. This is a requirement that often brings up conflicts of interest too, but look for that discussion in a future blog post. First, if the club has “profits” at the end of the year, they may NOT give it back to the members, or reduce the next year’s dues (unless services are also restricted), or provide additional benefits without increasing dues. Additionally, the founders or board may not receive any “bonus” for the year. Basically, none of the money or assets of the club should go to any one person or group of people.

If you think you can check all of the boxes, then it’s time to talk to an attorney.