Losing Tax-Exempt Status as a Social Club: How Much Nonmember and Investment Income Is Too Much?

Under IRS guidance, a social club exempt under section 501(c)(7) can receive up to 35% of its gross receipts, including investment income, from sources outside its membership, and no more than 15% of gross receipts from the general public’s use of its facilities or services. Those percentages are guidelines, not statutory limits: above them the IRS weighs all the facts and circumstances, and the Tax Court has upheld a revocation where outside income ran above half of revenue.

That case, Consolidated Sportsmen of Lycoming County v. Commissioner, T.C. Memo. 2026-109 (Oct. 29, 2026), concerned a hunting club whose gas royalties often exceeded half its income.

Where the 35% and 15% figures come from

Section 501(c)(7) exempts clubs organized for pleasure, recreation and other nonprofitable purposes, “substantially all of the activities of which are for such purposes,” with no private inurement of net earnings. It sets no percentage.

Both figures appear in IRS Publication 557, chapter 4, with the 15% counted inside the 35%. The 35% figure traces to a 1976 Senate Finance Committee report; no regulation or revenue ruling adopts it, as the IRS acknowledged in Consolidated Sportsmen. The Tax Court assumed, without deciding, that the IRS may use 35% as a safe harbor, and did not decide whether 35% is itself too much. Because the club’s outside income ran above half, the case does not tell a club between 35% and 50% where it stands.

Count gross receipts the way the IRS does

Under Publication 557, gross receipts for this test are receipts from the club’s normal and usual activities: charges, admissions, membership fees, dues, assessments, investment income and normal recurring capital gains on investments. Initiation fees and capital contributions are left out, and so are unusual amounts, such as from the sale of a clubhouse.

Outside income includes investment income, receipts from corporate memberships (not individual memberships a company pays for), and income from nontraditional business with members, such as package liquor, take-out food or long-term room rental. Publication 557 adds that a club that will engage in business, such as selling real estate, timber or other products, generally will be denied exemption.

A simple example (ours): a club with $200,000 of member dues and charges and $90,000 of royalties and interest has outside income of about 31% of $290,000. If royalties rise so that outside income reaches $150,000, the share becomes about 43% of $350,000, above the guideline, and the club is in facts-and-circumstances territory.

Members’ hours alone are not the measure. In Consolidated Sportsmen, the Tax Court counted a drilling contractor’s work as the club’s own activity and treated investment earnings as an important measure of it. Facts that might help a club over the guideline are facts about the club, its exempt activities and its outside income, not the hardship of a retroactive revocation.

The income is taxed either way

Under section 512(a)(3), a social club’s unrelated business taxable income is its gross income other than exempt function income, less directly connected deductions. Exempt function income is, in general, dues, fees and charges paid by members for goods, facilities or services that further the club’s exempt purposes. The exclusions that protect a charity’s dividends, interest, royalties and rents from real property do not apply to a social club. Under the Form 990-T instructions, a club taxable as a corporation figures the tax at 21%.

If the IRS proposes revocation

If the IRS concludes that the exemption should be revoked, Publication 557 says it will explain the proposed action in writing and advise the club of its right to protest to the Independent Office of Appeals. Meet the deadline in the letter. Publication 557 lists what a protest must contain, including a statement of facts declared true under penalties of perjury and a statement of the law relied on.

Our practical advice: treat the protest as the place to build the club’s record. Prepare a year-by-year table of gross receipts split into member, public and investment sources, with the excluded items identified. Explain any one-time item that may count as unusual.

Also contest the effective date. Publication 557 says a revocation for a material change in operations ordinarily takes effect as of the date of that change, and may be retroactive if the organization operated in a manner materially different from what it originally represented. Section 7805(b) relief may be requested. In Consolidated Sportsmen, the IRS first proposed a 2017 date; the revocation ultimately took effect January 1, 2023.

This is a substantive revocation; automatic revocation for three years of missed annual returns follows different rules and cannot be challenged under section 7428.

Going to court under section 7428

Section 7428 lets the organization itself ask the Tax Court, the Court of Federal Claims or the federal district court for the District of Columbia for a declaratory judgment on its continuing qualification, which includes a revocation. Two conditions matter:

• Exhaust administrative remedies. The court will not issue a declaration unless the organization exhausted its remedies within the IRS, including the Appeals protest.
• File on time. If the IRS sends its final determination by certified or registered mail, the pleading must be filed before the 91st day after the mailing date.

In the Tax Court, the club bears the burden of proving it qualifies, as Consolidated Sportsmen shows.