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May social club distribute assets to members on dissolution?

Your Legal Questions Answered

May social club distribute assets to members on dissolution?

The clubhouse owned by my 501(c)(7) social club most likely will be sold soon, and the club dissolved then or soon after. According to the bylaws, once all other debts are settled, the final distribution of club money and other assets will go to members who are vested, which means having been a member for 5 or more years or a "lifetime members." Does this violate the law and/or IRS rules on private inurement to members?

No.  A 501(c)(7) social club is distinctly different from a 501(c)(3) charity and the IRS contemplates that the remaining net assets will be distributed to the members on dissolution of a social club.  There is no federal requirement that club assets be used for charitable purposes, and giving the assets to charity without the permission of the members could actually be contrary to the recreational purposes set forth in the club’s articles of incorporation.

The no private inurement provision of the Tax Code applies to limit the revenue members may receive tax-free from outside the membership, such as investment income and other revenues from non-members, including from sales of property.  Congress has imposed taxes on these types of income, and set limits that can cost a club its exemption if exceeded. 

For most 501(c) exempt organizations there is no tax on the sale of capital assets, but for a 501(c)(7) social club, unrelated business income tax is imposed on the sale of assets used for club purposes, like your clubhouse, unless the proceeds are re-invested, within a year before the sale or three years after the sale, in other property used for club purposes.  Since the club plans to dissolve after the sale, it is likely to have to pay the tax on any gain obtained from the sale.

If you had not planned on paying this tax, you are likely to have less to distribute than you thought you would. In addition, you are likely to have more claims of membership than you expect.  A lot of “members” come out of the woodwork when there is money to divvy up.  But these are internal issues for the members, and don’t violate federal tax law.

Tuesday, September 1, 2020

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