Stay Out Of The Kitchen: IRS Denies Pickleball Club Tax Exemption
When a nonprofit organization seeks tax-exempt status, understanding the differences between various IRS classifications is essential. This is especially true for clubs and associations focused on recreational or social activities. Take, for example, a pickleball club that recently stepped into the kitchen and was served a denial when it applied for 501(c)(3) status. While the club's mission to provide recreational and social spaces for pickleball enthusiasts might sound ace, it didn’t meet the criteria for 501(c)(3). Instead, it seems more appropriately classified as a 501(c)(7) social club. Let’s rally around the reasons why that is, and what it means for organizations in a similar position.
The Pickleball Club’s Denied 501(c)(3) Status
The pickleball club’s application for 501(c)(3) status was served a rejection when the IRS determined that its activities were not organized and operated for 501(c)(3) purposes (educational, religious, or charitable). The club’s mission—focused on providing a recreational space for pickleball enthusiasts—was substantially designed for the recreational and social purposes of the club members.
Under 501(c)(3), organizations must demonstrate that they are organized and operated for exclusively charitable purposes, such as education, religious advancement, or scientific research. While the club’s goals were certainly valuable to its members, they were seen as primarily social and recreational in nature. The IRS maintains that for 501(c)(3) status, the activities must benefit the general public or a specific, broad charitable class—not just a closed group of individuals with shared recreational interests. Looks like the club was out of bounds for 501(c)(3) status—but don’t worry, there’s another way to serve its mission.
501(c)(7) Organizations: The Social Club Option
The IRS recognizes social clubs and recreational organizations under Section 501(c)(7). These organizations exist primarily for the pleasure and social enjoyment of their members, as opposed to serving the broader public. The 501(c)(7) designation is specifically for organizations that are not focused on charitable, educational, or other public-serving missions, but rather on providing social and recreational benefits to a defined membership. It’s important to note that there is no tax deduction for contributions to a 501(c)(7), but that’s no reason to not seek exemption as a 501(c)(7) since an organization operating as a (c)(7) does not necessarily need tax-deductible contributions to operate, as explained below.
The central purpose of these clubs is to provide tangible benefits to their members, such as access to clubhouses, golf courses, swimming pools, or shared activities like sports or hobbies. When these benefits are funded by the members themselves, the IRS grants tax-exempt status to avoid double taxation—a recognition that members are essentially paying for the benefits directly, just pooled through a shared organization. The goal isn’t to promote specific activities over others but to give people the opportunity to pool their resources and make the shared experience more rewarding. Beyond the financial and legal framework, 501(c)(7) organizations are about community and fun!
A 501(c)(7) organization is allowed to operate as a nonprofit but is distinct in its focus on the social and recreational needs of its members. For the pickleball club, this would mean that its mission of fostering a community for pickleball enthusiasts would fit perfectly within the 501(c)(7) framework. It’s a perfect match.
It’s also important to note that 501(c)(7) organizations are not businesses. While they may charge dues or host events, their purpose is entirely focused on enriching the social and recreational lives of their members—not generating profits.
Key Requirements for 501(c)(7) Status
To qualify as a 501(c)(7) social club, an organization must meet these requirements, outlined by the IRS:
Membership: The organization must be a club composed of individuals who come together for shared interests and purposes. As outlined in IRS guidance, a “club” is characterized by key elements such as membership of individuals, the presence of personal contact, mixing and mingling among members, fellowship, shared active interests, and common goals that justify the existence of the organization. These traits emphasize the organization’s focus on fostering a collective and interactive member experience rather than serving the general public.
Primary Purpose: The club must be organized for pleasure, recreation, and other nonprofit purposes. These activities should serve the personal interests and enjoyment of its members.
Substantial Activities: Substantially all of the organization’s activities must directly support its exempt purposes of pleasure, recreation, and other nonprofit goals. For instance, a pickleball club offering a paid tournament for the general public might be considered an unrelated business activity, while an in-house members-only tournament would be considered part of the club’s exempt purpose. The IRS measures “substantially all” by evaluating the source of the organization’s gross receipts. Specifically, no more than 35% of gross receipts (including investment income) may come from sources outside the membership. Additionally, within this 35%, no more than 15% of gross receipts may be derived from the use of club facilities by nonmembers. These limits ensure that the organization’s primary focus and financial support remain centered on its members and their shared purposes.
Prohibition on Private Benefit: No part of the organization’s net earnings may inure to the benefit of any private shareholder or individual. Consider a pickleball club that has already received 501(c)(7) status. The members enjoy playing pickleball together and socializing. As the club becomes well-known, families in the surrounding community express interest in involving their children in the sport. A group of entrepreneurial parents who are already members of the pickleball club propose allowing children from the community to participate in the club for a fee, with the profits from those fees distributed among the club’s members. Such an arrangement would constitute an impermissible private benefit to the members. If the club proceeds with this plan, it would likely jeopardize its 501(c)(7) status, as the distribution of revenue violates the prohibition against private inurement.
Non-discrimination: The organization must not discriminate on the basis of race, color, or religion. This ensures inclusivity and compliance with IRS requirements for tax-exempt status.
Other Key Considerations for 501(c)(7) Clubs
● Public Use of Facilities: Social clubs operating under Section 501(c)(7) are generally not at risk of losing their tax-exempt status when they allow limited public use of their facilities. The IRS recognizes that these limited uses do not substantially deviate from the club's primary social or recreational mission. Social clubs should be cautious when opening their doors to the public, however. The core mission of the club must remain focused on its members' social or recreational purposes, and any public use should be incidental and limited in nature. If a club begins to offer its services or facilities too broadly to the general public, it may begin generating unrelated business income and risk losing its tax-exempt status.
● Unrelated Business Income Tax (UBIT): Clubs are also taxed on unrelated business income. It’s important to note, however, there are numerous exceptions to UBIT rules. Generally, a Section 501(c)(7) organization generates UBIT when it earns net income from an activity that meets all three of these elements:
o a trade or business that is
o regularly carried on, and
o not substantially related to the organization's exempt purpose.
In determining whether income qualifies as UBI, the IRS considers:
Trade or Business: This includes any activity aimed at producing income from the sale of goods or the performance of services. This is a relatively low threshold to satisfy.
Regularly Carried On: Whether an activity is regularly carried on depends on its frequency, continuity, and manner of operation, particularly if it resembles the way a for-profit business operates.
Not Substantially Related: If an activity is substantially related to the organization’s exempt purpose, it does not generate UBIT. This means that the activity must directly contribute to the organization's core mission. For example, if a pickleball club is a nonprofit organization focused on promoting health and wellness, offering pickleball lessons or leagues to its members would be considered substantially related to the organization's exempt purpose because it directly supports its mission to encourage physical fitness and community engagement. As a result, income from these activities would not generate UBIT.
In contrast, renting out the facility for private events unrelated to the club's mission, such as corporate parties or for-profit tournaments, could generate UBIT because it does not further the club’s exempt purpose of promoting the wellness and fitness of the members.
If the club earns $1,000 or more in UBI during a year, it must file Form 990-T with the IRS to report this income and pay any applicable taxes. Additionally, recent IRS regulations require clubs to track income and expenses by activity, prohibiting the offsetting of profitable and unprofitable activities, which could result in a tax obligation.
Don’t forget that nonmember income cannot exceed 35% of gross receipts. Nonmember income is one of the most common types of income that triggers UBIT because nonmember income is more likely to be unrelated to the club’s exempt purpose.
Recordkeeping: The IRS requires that social clubs keep detailed records to track nonmember income, ensuring that they can distinguish between different types of income (e.g., food sales, gambling income, facility rentals).
In conclusion, the IRS denial of the pickleball club's application for 501(c)(3) status highlights the importance of understanding the specific requirements for tax-exempt classification. While 501(c)(3) status may be a fault for clubs focused on recreational or social activities, 501(c)(7) offers a court for organizations that exist primarily for the pleasure and enjoyment of their members.
For clubs seeking to maintain their tax-exempt status under 501(c)(7), it's crucial to stay aligned with the core mission of providing social and recreational benefits. Activities and income generation must serve the club's membership and not unduly benefit the general public or private individuals. As long as clubs remain focused on their mission, manage their financial activities carefully, and comply with IRS requirements, they can continue to offer valuable community spaces for social engagement—just as the pickleball club can, by reapplying under the correct classification.