Santa Barbara Club v. Commissioner, 68 T. C. 200 (1977)

A social club’s tax-exempt status under IRC section 501(c)(7) can be revoked if it engages in substantial nonexempt activities, such as selling liquor to members for off-premises consumption.

Summary

The Santa Barbara Club, a social club, sold bottled liquor to its members for off-premises consumption, generating over 25% of its gross receipts from these sales. The court held that these sales constituted a substantial nonexempt activity, leading to the revocation of the club’s tax-exempt status under IRC section 501(c)(7). The decision was based on the absence of commingling among members in these transactions and the significant portion of the club’s income derived from this activity. This case highlights the importance of maintaining primarily exempt activities to retain tax-exempt status.

Facts

The Santa Barbara Club, organized in 1894, was a nonprofit social club providing facilities and services to its members in Santa Barbara, California. For the years 1969, 1970, and 1971, the club sold bottled liquor to members for consumption off its premises, a practice it had maintained for about 40 years. These sales exceeded 25% of the club’s total gross receipts for each year in question. The club also sold liquor for on-premises consumption and offered other services like food and tobacco sales, exclusively to members and their guests.

Procedural History

The Santa Barbara Club was initially granted tax-exempt status under IRC section 501(c)(7) in 1943. In 1972, the IRS revoked this status effective January 1, 1969, citing the club’s substantial income from off-premises liquor sales. The club contested this revocation, leading to the case being heard by the United States Tax Court.

Issue(s)

1. Whether the Santa Barbara Club’s sales of bottled liquor to its members for off-premises consumption constituted a substantial nonexempt activity under IRC section 501(c)(7).

Holding

1. Yes, because the sales of bottled liquor for off-premises consumption exceeded 25% of the club’s gross receipts and were recurring, indicating a substantial nonexempt activity that led to the loss of the club’s tax-exempt status.

Court’s Reasoning

The court reasoned that while the club’s primary purpose was social and recreational, the sales of bottled liquor for off-premises consumption did not involve member commingling and were not negligible in nature. The court applied the principle that a social club can engage in some nonexempt activities without losing its exemption, but these activities must be insubstantial. The court highlighted that the sales in question were ongoing and represented a significant portion of the club’s income. The court rejected the club’s argument that dealing only with members should preserve its exempt status, citing cases where activities not involving member commingling were deemed nonexempt. The court also considered the legislative history and IRS rulings, noting that while the IRS had previously allowed such activities, the substantial nature of the sales in this case warranted revocation of the exemption.

Practical Implications

This decision implies that social clubs must carefully monitor their activities to ensure they remain primarily focused on exempt purposes to retain their tax-exempt status. Clubs should be cautious about engaging in significant commercial activities, especially those not involving member interaction, as these can jeopardize their exemption. The ruling underscores the importance of the ‘substantial’ test in determining exempt status and has influenced subsequent cases and IRS guidance on the matter. Clubs may need to adjust their operations or face potential tax liabilities if they engage in similar off-premises sales. This case also highlights the IRS’s authority to change its interpretation of tax laws over time, which can impact long-standing practices of exempt organizations.