Academic journal article Journal of Accountancy

Social Club Is Liable for Taxes on UBTI: The Tax Court Rejects the Taxpayer's Argued Profit Motive and Disallows Losses Related to Nonmember Services

Academic journal article Journal of Accountancy

Social Club Is Liable for Taxes on UBTI: The Tax Court Rejects the Taxpayer's Argued Profit Motive and Disallows Losses Related to Nonmember Services

Article excerpt

The Tax Court held that a Sec. 501(c) (7) social club could not deduct losses from nonmember sales to offset investment income because the club failed to establish a profit motive for its nonmember activity.

Facts: Losantiville Country Club is a Sec. 501(c)(7) social club that operated a golf course, a swimming pool, tennis courts, and other facilities for use by its members in Ohio. Members paid dues and fees to use the facilities. Nonmembers paid surcharges for the same use.

Losantiville had filed a Form 990-T, Exempt Organization Business Income Tax Return, annually since it was founded in 2002. On its Forms 990-T, Losanti-ville reported gross receipts as well as expenses related to its nonmember sales activity. For 2010 through 2012, the years at issue, Losantiville reported losses with respect to its nonmember sales. Losantiville calculated the losses using the gross-to-gross method, the ratio of nonmember sales to total sales, to determine the deductible indirect expenses taken against nonmember sales. On the returns, Losantiville claimed the losses against investment income earned in those years, resulting in no unrelated business taxable income (UBTI).

In a notice of deficiency, the IRS determined that nonmember sales were not entered into for profit, so the losses could not offset investment income and the investment income was UBTI. The Service determined deficiencies relating to 2010,2011, and 2012, and assessed accuracy-related penalties under Sec. 6662. Losantiville challenged the determinations in Tax Court.

Issues: Under Sec. 511(a)(1) and Sec. 512(a)(1), tax-exempt organizations must pay federal income tax on their UBTI, which generally consists of income derived from any trade or business not substantially related to the conduct of their exempt purpose. Sec. 512(b) generally excludes most forms of investment income from UBTI for certain charitable organizations. However, Sec. 512(a)(3)(B) limits the "exempt function income" of Sec. …

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