Key Takeaways
- Taxable clubs with member and nonmember activity may owe income tax despite a financial loss because Internal Revenue Code (IRC) Section 277 limits member-loss deductions.
- Section 277 bars member activity losses from offsetting nonmember or investment income. Excess member losses carry forward and apply only to future member income.
- Accurate member and nonmember income tracking supports Section 277 compliance, tax reporting and documentation for taxable private clubs.
Most taxable clubs incorrectly assume that if they produce a net loss in their overall operations, then they also have a tax loss and owe no income tax. This is not the case for taxable clubs with both member and nonmember activity. Under Internal Revenue Code (IRC) § 277, a taxable club may not use losses from member-related activities to offset nonmember income or investment income. As a result, a club can report a net loss on their financial statements but still owe income tax.
This tax rule is designed to prevent clubs from using the cost of providing member benefits as a shelter against outside or nonmember income. Additionally, it is important to note there are significant differences between the § 277 limitations and the more widely discussed tax-exempt club nonmember limitations.
Section 277: The Basic Rule
Section 277 applies to certain taxable membership organizations operated primarily to furnish goods, services or other benefits to members. The law states that deductions attributable to member activities are allowed only to the extent of income derived from member activities. Excess member-related deductions are not currently deductible against other sources of income. Instead, they can be carried forward and treated as deductions against member income in the following year.
Bottom line: a taxable club’s losses from member dining, golf operations, recreational facilities or other member services cannot be used to reduce tax on investment income, public event income or other nonmember receipts.
Why Does This Rule Exist?
The reasoning behind § 277 is that a taxable club exists primarily to provide benefits to its members and should not be used to reduce or eliminate income tax on other activities. If the club could freely deduct the excess costs of those member benefits against nonmember income, it could use member operations as a tax shelter.
To prevent this, Congress enacted § 277 to create a separate limitation for member activity. This rule prevents a club from turning the cost of member enjoyment into a deduction against outside earnings.
Backdrop: Revenue Ruling 2003-73
The IRS further explained § 277 in Revenue Ruling 2003-73. In that ruling, a taxable social club had income and losses from three categories: member activities, nonmember activities and investments. The IRS concluded that losses from member activities could not offset either nonmember income or investment income. The excess member loss had to be carried forward to the next year and could be used only against future member income.
The ruling also states that for § 277 purposes, investment income is generally treated as nonmember income, even if the funds being invested originated from members. This prevents a club from arguing that interest, dividends or similar earnings are simply a form of member activity and are therefore available to offset member losses.
Related Litigation: Concord Consumers Housing Cooperative v. Commissioner (1987)
A membership organization claimed that the interest it earned on reserve and escrow accounts should count as member income because the money in those accounts ultimately came from members. The Tax Court disagreed. It concluded that just because the money originally came from members does not mean the interest earned is member income. The interest was investment income, so it was treated as nonmember income for § 277 purposes. As a result, this income could not be reduced by losses from member activities.
Considerations Going Forward
For taxable clubs, § 277 effectively creates three separate baskets:
- Member income and related expenses,
- Nonmember income and related expenses,
- Investment income, which is treated as nonmember income for this purpose.
Remember, excess member losses can be carried forward until sufficient member income is earned to utilize them.
How PKF O’Connor Davies Can Help § 277 Clubs
We help taxable clubs understand how IRC § 277 applies to their operations, how to distinguish between member and nonmember activities, best practices for maintaining appropriate supporting records, and preparation or review of tax returns.
Contact Us
We welcome the opportunity to answer any questions you may have related to this topic or any other accounting, audit, tax or advisory matters for private and taxable clubs. Please reach out to your PKF O’Connor Davies client service team or email any of the private club services team members below:
Steve Noyes, CPA
Partner
snoyes@pkfod.com
Kerri Rawcliffe, CPA
Partner
krawcliffe@pkfod.com
Brooke Rossi, CPA
Partner
brossi@pkfod.com
Amber Stone, CPA
Director
astone@pkfod.com