Tax Court upholds IRS revocation of a Pennsylvania sportsmen's club's exemption over natural gas royalties
In an Oct. 29 opinion, the court held that gas drilling by a contractor on the club's land was an activity of the club, and that royalties above half its revenue meant it no longer did substantially all of its work for recreation.
Gas royalties as a share of the club's total revenue, 2017 to 2023
Washington. The U.S. Tax Court has upheld the IRS's revocation of the tax exemption of Consolidated Sportsmen of Lycoming County, a Pennsylvania club whose natural gas royalties made up more than half of its revenue in most recent years. Judge David Gustafson issued the memorandum opinion Oct. 29.
The club, incorporated in 1936, owns about 230 acres of forest and meadow in Lycoming County, atop the Marcellus Shale, with rifle and trap ranges, fishing, hunting and campsites. The IRS recognized it in 1981 as a social club under section 501(c)(7), the exemption for clubs organized for pleasure and recreation.
In 2011 the club leased its oil and gas rights to Rice Drilling B, receiving a signing bonus of about $921,800. Royalties began after extraction started in December 2016 and totaled about $2.19 million from 2017 through 2023, from 19.6 percent of revenue in 2021 to 90.5 percent in 2022. In every one of those years, income from outside the membership was more than half of the club's revenue.
Whose activity counts
The statute requires that substantially all of a club's activities be for pleasure, recreation and other nonprofitable purposes. The club argued that only its members' activities count, and that its members spent virtually no time on the gas lease. The court disagreed: the exemption is for the club, so drilling a contractor does on the club's land under the club's lease is the club's activity, as fundraising by a hired firm is a charity's.
Nor are hours the only measure: investment can be a nonexempt activity of a social club, the court wrote, and the money it earns can measure it.
“When, as here, a social club receives, under a mineral extraction contract, royalties that often constitute more than 50% of its gross income, we think that under any reasonable standard it cannot be said that “substantially all” of its activities are recreational.”
What it means for social clubs
The IRS has long applied a guideline from a 1976 Senate report that lets a social club take up to 35 percent of its gross receipts from outside its membership. The opinion notes that Congress never enacted that test and that no regulation or revenue ruling sets it out; the court did not need to decide whether to defer to it, because the club's royalties were so far above it.
The royalties would have been taxed either way, since a social club owes tax on investment income; the question was only the club's exempt status. The IRS first sought revocation back to 2017, then conceded in August that it starts Jan. 1, 2023, as its 2023 letter said. An appeal would go to the U.S. Court of Appeals for the Third Circuit.
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