CPA Poses Questions to IRS on Proposed UBTI Regs

June 23, 2020

Internal Revenue Service
CC:PA:LPD:PR (Reg-106864-18), Room 5203
P.O. Box 7604
Ben Franklin Station
Washington, DC 20044

Comments — Notice of Proposed Rulemaking Under Section 512(a)(6) (REG-106864-18)

I am a CPA, Consultant to the Private Club Industry, and Author of Club Tax Book “An Accumulation of Tax Issues Specific to Clubs.” I appreciate the opportunity to provide comments regarding how I believe the Proposed Regulations will affect 501(c)(7) Tax-Exempt Membership Organizations (Social Clubs).

NAICS

I believe I understand Treasury's and the IRS's position regarding the Multiple Nonmember Trades or Businesses theory of using the Sector categories. I am not sure; however, there was an intent for a 501(c)(7) Tax-Exempt Membership Organization to be required to separate their nonmember revenue into as many as eight (8) possible trades or businesses that do not fit into their natural business Departmental segments as used in the Uniform System of Financial Reporting for Clubs (7^th Edition). In its summary, Treasury and the IRS have made it clear that social clubs cannot use Sector 71 for its nonmember activities:

“A social club described in section 501(c)(7) would not be able to use the NAICS 2-digit code for arts, entertainment, and recreation (71), which includes golf courses and country clubs, to identify all its unrelated trades or businesses. As explained in the Background section, social clubs are subject to the definition of UBTI in section 512(a)(3), which defines UBTI, in part, as “gross income (excluding exempt function income)” and does not refer directly to “any unrelated trade or business.” However, as further explained in section 5 of this preamble, these proposed regulations apply regardless of whether an organization is subject to the definition of UBTI in section 512(a)(1) or section 512(a)(3). Accordingly, a social club must use the NAICS code that most accurately describes its unrelated trade or business activities. The social club may use the NAICS 2-digit code for arts, entertainment, and recreation (71) only to the extent such code describes its unrelated trades or businesses, such as rounds of golf played by nonmembers, the greens fees for which would result in UBTI.”

Below is my attempt to break down the eight (8) possible nonmember revenue sources by Sectors that do not fit the USFRC Departmental segments:

Sector 11: Agriculture, Forestry, Fishing and Hunting

• Nonmember hunting paid by nonmembers

  • operating commercial game preserves, such as game retreats and operating hunting preserves

• Nonmember equine boarding paid by nonmembers

  • establishments primarily engaged in equine boarding and equine owners entering horses in racing or other spectator sporting events

Sector 44-45: Retail Trade

• Nonmember Pro Shop sales paid by nonmembers

  • Athletic uniform; bicycle; golf, tennis; bowling; skiing, saddlery; sporting goods; exercise equipment; and sporting gun shops

• Nonmember Ship's Store sales paid by nonmembers

  • Fishing, boating and diving equipment shops

• Nonmember Grocery Store sales paid by nonmembers

  • Commissaries, primarily groceries including delicatessens, primarily retaining a range of grocery items and meats; beer, wine, and other spirits

Sector 53: Real Estate and Rental and Leasing

• Nonmember beach rentals paid by nonmembers

  • Beach chairs, umbrella rentals, cabanas

• Nonmember golf-related rentals paid by nonmembers

  • Golf carts; clubs; pull carts, range balls

• Nonmember long term real estate rentals paid by nonmembers

  • Residential apartments, residential cottages, commercial HOA/POA offices, real estate sales offices, dwelling houses

• Nonmember storage paid by nonmembers

  • Boat, RV, self-storage, trailer storage

• Nonmember snow ski-related rentals paid by nonmembers

  • Ski equipment, lift ticket

• Nonmember tournament site fees paid by nonmember

• Nonmember watercraft rentals paid by nonmembers

  • Boat, canoe, houseboat; personal watercraft; rowboat, sailboat; surfboard; water ski, yacht rentals

Sector 54: Professional, Scientific, and Technical Services

• Nonmember advertising revenue paid by nonmembers

  • Directory, naming rights, newsletter

Sector 61: Educational Services

• Day sport instruction camps paid by nonmembers

  • Camps, sports instruction

• Professional sports instructors paid by nonmembers

  • Basketball, bowling, fitness, golf, gymnastics, hockey, martial arts, racquet, riding, shooting, scuba, skiing, swimming, training

Sector 71: Arts, Entertainment and Recreation

• Nonmember guest fees paid by nonmembers

  • Boating, bowling, card playing, dance, day camps, fitness, golf, marina, pool, riding, shooting, skiing, tennis

• Nonmember reciprocal usage fees

Sector 72: Accommodation and Food Services

• Nonmember food and beverage paid by nonmembers

• Nontraditional food and beverage-to-go paid by Members

• Nonmember traveler overnight rentals paid by nonmembers

  • Club rooms, cottages, lodges, hotel type accommodations, bed-and-breakfast rooms

Sector 81: Other Services (except Public Administration)

• Nonmember personal care services, paid by nonmembers

  • Hair, nail and skin services, including barbershops, beauty salons, nail services, spas

• Nonmember parking lots and garages

As you will be able to see from the above list, the recording burden on 501(c)(7) Tax-Exempt Membership Organizations will be significant. If the intent was to place this type of extra burden upon 501(c)(7) organizations, the Multiple Sector Code requirement has accomplished its purpose.

Profit Motive

The Treasury Department and the IRS have indicated that they recognize that limitations exist in using NAICS as the method of identifying an exempt organization's separate unrelated trades or businesses.

“. . . adoption of NAICS 2-digit codes will not allow the offsetting of losses between the Sector of unrelated trades or businesses. Additionally, under existing precedent, an organization must determine whether an activity is an “unrelated trade or business” within the meaning of section 513 before it determines what NAICS 2-digit code describes that “separate” unrelated trade or business. An organization cannot use losses from an activity that consistently generates losses to offset income from a profitable trade or business unless the organization can show that the loss-producing activity is conducted with the requisite profit motive.” (highlight added)

How can an organization determine whether an activity is profit motivated and an “unrelated trade or business” before it determines what NAICS 2-digit code to use? Can clear guidance be provided as to how this is going to work? Will the IRS accept a 501(c)(7) Tax-Exempt Membership Organization's conclusion that it does not intend to claim a nonmember loss, as the nonmember activities are not profit motivated and ignore the NAICS 2-digit codes?

Existing Profit Motive Guidance

501(c)(7) Tax-Exempt Membership Organizations have been limiting nonmember loss tax deductions for a number of years, based on published guidance:

Revenue Ruling 81-69

“ISSUE

“May a social club described in section 501(c)(7) of the Internal Revenue Code, in determining its unrelated business taxable income under section 512(a)(3)(A), deduct from its net investment income its losses incurred on sales of food and beverage to nonmembers under the circumstances described below?

FACTS

The social club has unrelated business taxable income within the meaning of section 512(a)(3)(A) of the Code from investments made for profit. Also, it sells food and beverage to nonmembers at prices insufficient to recover the costs of such sales. The club's sales of food and beverages to nonmembers have consistently over a number of years resulted only in losses, and there is every indication that such sales to nonmembers will continue to result in losses for the club. The nonmembers are not guests of members under the guidelines of Rev. Proc. 71-17, 1971-1 C.B. 683.

. . .

HOLDING

Because the sales to nonmembers are not profit motivated, the social club may not, in determining its unrelated business taxable income under section 512 of the Code, deduct from its net investment income its losses from such sales to nonmembers.”

Conclusion

501(c)(7) Tax-Exempt Membership Organizations have already been separating nonmember losses from investment income and paying income tax on that segment (trade or business) of its revenue on Form 990-T. These Clubs will now be required to create numerous accounting silos or columns to demonstrate to the IRS that many, if not all, of its activities with nonmembers, are not necessarily entered into with a profit motive or marginally profitable at best.

I appreciate the opportunity to share my thoughts as you develop guidance in this area. Until the publication of a separate notice of proposed rulemaking regarding the reasonable allocation of expenses is issued, we will not know the full extent of the burden these multiple trades or businesses will have on 501(c)(7) Tax-Exempt Membership Organizations.

Sincerely,

Mitchell L. Stump, CPA
Palm Beach Gardens, FL