Business networking organization denied tax-exempt status

In a recent letter ruling, the IRS determined that a networking organization operated and organized to provide members of the public the opportunity to connect and refer business to one another did not meet the definition of a club organized exclusively for “pleasure, recreation and other nonprofitable purposes” under Sec. 501(c)(7) and therefore denied it tax-exempt status.

Facts: A domestic networking organization was duly incorporated under state law as a nonprofit mutual benefit corporation. The purpose of the organization, which is open to the public, is to connect members with one another to receive business referrals. This is done through weekly meetings and networking events. Each member is charged a monthly membership fee, along with an initial one-time fee. Membership, which is nontransferable, is owned “by the individual or the company that paid the initial membership fee.” Each member represents a single business category, meaning that the member’s product or service “cannot be sold, promoted, or mentioned by another member in the chapter.” Members come from a variety of fields, such as “advertising, law, mechanic/auto body repair, accounting/bookkeeping, business consultancy, financial services, insurance, web development, virtual assistant services, among others.”

The organization is a chapter of a for-profit corporation that provides guidance regarding the rules and regulations governing the chapter. The for-profit corporation “sets the standard in the word-of-mouth referral industry and professional business networking groups.” The organization’s members have a “direct relationship” with the entity, including paying a membership fee to join and annual dues. Chapters meet weekly to exchange “qualified leads,” build solid business relationships, improve their presentation skills, and become better overall networkers.

The organization holds its meetings online or in a rented facility, such as a hotel, recreational center, or restaurant, with the main objective to facilitate business referrals among the group’s members. All the organization’s time is allocated to the weekly meetings, which are funded from the fees paid by its members. These meetings are organized to help members “improve their network and grow professionally.” All members are required to attend at least one formal lunch per month or engage in a one-on-one meeting with another member. Failure to do so results in a fine for any month missed. The chapter’s bylaws require each member to give a minimum number of referrals per month to another member. If a member fails to meet the referral requirement, they are warned by letter that their membership may be terminated.

Discussion: Sec. 501(c)(7) exempts from federal income tax clubs organized and operated exclusively for “pleasure, recreation, and other nonprofitable purposes.” Substantially all the activities of the club must be for one or more of these purposes, and no part of the net earnings can inure to the benefit of any private shareholder (Sec. 501(c)(7); Regs. Sec. 1.501(c)(7)-1(a)). The exemption generally extends to “social and recreational clubs” supported solely by “membership fees, dues and assessments” (id.). However, a club that engages in the business of opening its social and recreational facilities to the public is not organized and operated exclusively for pleasure, recreation, and other nonprofitable purposes (Regs. Sec. 1.501(c)(7)-1(b)).

The IRS found that the organization is not operated for pleasure, recreation, and other nonprofitable purposes. Its main objective is to organize events for its members to “connect and conduct business referrals.” According to the IRS, this activity is not incidental to Sec. 501(c)(7), since the events benefit the organization’s members’ private interests. Therefore, since the business referrals inure to the benefit of the members of the organization, the activities serve a private rather than public interest, disqualifying the organization from tax-exempt status under Sec. 501(c)(7).

Rev. Rul. 58-589 provides that a Sec. 501(c)(7) club may lose its tax-exempt status if it makes its facilities available to the general public. However, an organization will not be denied tax-exempt status if it receives income from the public, provided such participation is incidental and in furtherance of its general purpose. For an organization to retain exempt status, it must not enter activities “with the purpose of deriving profit,” unless they are incidental, trivial, or nonrecurrent.

In the IRS’s view, the organization resembled the social club that was the subject of Rev. Rul. 69-527, which did not qualify for tax-exempt status because its main endeavor was assisting members through “study and discussion of problems and other activities at weekly luncheon meetings.” Similarly, the organization in the letter ruling was created to aid its members’ business endeavors, with any social interactions being merely incidental to its business activities.

Conclusion: The IRS ruled that by facilitating business referrals and helping its members grow professionally, the networking organization described in the letter ruling is engaging in a business activity and not operated for pleasure, recreational, and other nonprofitable purposes. Since these private activities are not incidental to an exempt purpose, the IRS denied the organization tax-exempt status under Sec. 501(c)(7).

• IRS Letter Ruling 202505023

— John McKinley, CPA, CGMA, J.D., LL.M., is a professor of the practice in accounting and taxation in the SC Johnson College of Business, and Matthew Geiszler, Ph.D., is a lecturer in accounting in the Brooks School of Public Policy, both at Cornell University. To comment on this column, contact Paul.Bonner@aicpa-cima.com, the JofA‘s tax editor.