Since 1916, Congress has exempted from income tax clubs formed to facilitate social interaction among their members. As a result, country clubs, hunting and fishing clubs, college sororities and fraternities, and tennis, swimming, and other sport clubs, among others, are generally exempt from taxation on income derived from their members. IRC § 501(c)(7). The exemption applies to clubs “organized for pleasure, recreation, and other nonprofitable purposes, substantially all of the activities of which are for such purposes and no part of the net earnings of which inures to the benefit of any private shareholder.”
Prohibited inurement under IRC § 501(c)(7) pertains to use of club assets or facilities to generate income from the public rather than club members. For example, use of a tennis club to generate income from the general public attending a national tennis tournament is private inurement by the social club. West Side Tennis Club v. Commissioner, 39 BTA 149 (BTA 1939). In 1976, Congress loosened the rules to allow social clubs to generate up to 35% of their annual revenue from non-member income, such as rents charged to the public and income from investments. S. Rep. No. 94-1318, 94th Cong., 2nd Sess. 4 (1976), 1976-2 C.B. 597, 599; see also H.R. Rep. No. 94-1353, 94th Cong., 2d Sess. 4 (1976). Thus, clubs may rent their facilities to non-members or generate investment income to a limited degree.
https://ncbarblogprod.wpengine.com/wp-content/uploads/2018/06/Blog-Header-1-1030x530.png00TAXhttps://ncbarblogprod.wpengine.com/wp-content/uploads/2018/06/Blog-Header-1-1030x530.pngTAX2025-08-21 10:11:012025-08-21 10:11:01Sale of Social Club Assets Upon Liquidation
The gain exclusion benefits for the sale of qualified small business stock (“QSBS”) have grown in popularity in recent years, in part due to the 2017 Tax Act’s reduction of the C corporation tax rate from a marginal rate of 35% to a flat 21%. Congress has now made QSBS even more appealing. Under the One Big Beautiful Bill Act (the “OBBB”), the gain exclusion from the sale of QSBS issued after July 4, 2025, has expanded from $10 million to $15 million per qualifying shareholder. In addition, the $15 million exclusion will be adjusted annually for inflation. For QSBS issued on or before July 4, 2025, the original $10 million gain exclusion still applies.
The OBBB also made changes to the QSBS holding period requirement, providing a phase-in of gain exclusion benefits rather than the previous cliff-vesting approach. For QSBS issued on or before July 4, 2025, no benefits are available for taxpayers who hold the QSBS for less than five years. For QSBS issued after July 4, 2025, 50% of the gain exclusion is available after a holding period of three years. 75% is available after four years. 100% is available after five years.
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The 2024 IRS Data Book released in April 2025 contains audit statistics for years 2014 through 2022, as of the fiscal year ended September 30, 2024 (FY 2024). For tax years 2020 and earlier, the statute of limitations for audits had generally expired as of September 30, 2024. However, for 2021 and later returns, the statute of limitations has yet to expire, so additional returns of those years may be audited.
For 2014 through 2022, audit rates dropped significantly. For example, individual tax returns had an audit rate of 0.6% for 2014 returns versus 0.2% for 2022 returns. For individuals with income between $1 million and $5 million, the audit rate dropped from 2.7% for 2014 returns to 1.1% for 2022 returns.
Limited Liability Companies (or LLCs) were invented in Wyoming in 1977. They have since spread to all states and become one of the most popular entities to use for businesses. From a tax perspective, LLCs are hybrid entities that can elect to be taxed in a number of different ways. Regulations that became effective in 1997 (commonly referred to as the “check-the-box regulations”) provide tax classification. Treas. Reg. § 301.7701-1, et. seq.
Treas. Reg. § 301.7701-3(b)(1) describes the default treatment of LLCs where no check-the-box election is made. The default treatment of an LLC with a single owner is as an entity disregarded as separate from its owner for income tax purposes. Treas. Reg. § 301.7701-3(b)(1)(ii). As a disregarded entity, the LLC has no federal income tax filing requirements. Its activities (including income and loss) are instead reported on the tax return of its sole owner. Where an LLC has more than one owner, the default treatment is as a partnership. It is required to file an annual Form 1065 to report the pass-through income and loss allocated to its partners.
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Section 269(a) applies where a “person or persons acquire, directly or indirectly, control of a corporation” and “the principal purpose for which such acquisition was made is evasion or avoidance of Federal income tax by securing the benefit of a deduction, credit, or other allowance which such person or corporation would not otherwise enjoy.” Section 269 allows the IRS to disallow the acquired deduction, credit, or other tax benefit and to “distribute, apportion, or allocate gross income . . . between or among the corporations, or properties, or parts thereof, involved.” Control means at least 50 percent of the total voting power of all classes of stock entitled to vote or at least 50 percent of the total value of shares of all classes of stock of the corporation.
Importantly, Section 269 does not apply to any acquisition for which tax benefits were a consideration, but only those where the principal purpose was tax benefits. Treas. Reg. § 1.269-3(a) defines principal purpose as where “the purpose to evade or avoid Federal income tax exceeds in importance any other purposes.” Thus, the tax benefit purpose must be the most important purpose for the acquisition, but it need not be the only purpose.
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I. Real Property Distributed from Testamentary Trust Meets the Section 1031 “Held for Investment” Requirement; PLR 202449007.
A testamentary trust terminated on the death of the decedent’s child. Real property held in the testamentary trust then passed to the decedent’s grandchildren. Prior to the trust termination, the trustees entered into a contract for the sale of the property and began to make arrangements for a deferred Section 1031 exchange of the property held in the trust. After the trust termination event, the trustees completed the sale of the property and sought a private letter ruling confirming the trust remainder beneficiaries (grandchildren of the decedent) would be permitted to complete like-kind exchanges as to their inherited real property.
The IRS ruled the trust’s previous purpose of holding the real property for investment purposes is imputed to the grandchildren notwithstanding the trustee’s planned sale at the time of the trust termination. The IRS emphasized, because the trust was a testamentary trust, the terminating event was fixed by the decedent and could not be modified or changed. The trust terminating event was an involuntary disposition of the trust’s real property. The transfer of the property to the grandchildren subject to the sales contract did not violate the held for investment requirement of Section 1031(a).
I. IRS Cannot Impose Tax on Withdrawals from an IRA It Seized; Hubbard v. Commissioner, 135 AFTR 2d 2025-484 (6th Cir).
Mr. Hubbard was a Kentucky pharmacist. He was convicted on drug and money laundering offenses for operating a pill mill. The court allowed the IRS to seize a number of Mr. Hubbard’s financial accounts, including his IRA. The IRS withdrew over $427,000 from the IRA. The IRS treated the IRA withdrawal as a taxable distribution to Mr. Hubbard and made an assessment against him of over $180,000 of tax, interest and penalties.
Courts have recognized two types of forfeitures. One is specific property forfeiture where the government becomes the new owner of specific assets at the time of conviction. The second type of forfeiture is a personal money judgment where the defendant is forced to pay a specific sum of money. With the second type of forfeiture, the court calculates the money that a defendant owes based on the value of forfeitable property involved in specific crimes.
Enacted in 2017, Section 1061 provides a minimum holding period of three years for long-term capital gains for carried interests issued to certain service providers. Section 1061 treats as short-term capital gain (generally taxed at ordinary rates) the portion of gain allocated to a service provider with respect to an applicable partnership interest that has not been held for more than three years. However, even if a service provider has held an applicable partnership interest for less than three years, capital gains allocated to the holder can qualify for long-term capital gains treatment if the asset sold by the partnership was held for more than three years. Also, Section 1061(a)(2) allows the service provider to take into account capital losses from assets held for more than three years.
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I hope this message finds you well. As we approach Memorial Day, I want to personally encourage you to attend the 24th Annual North Carolina Tax Section Workshop taking place Friday, May 23 to Sunday, May 25. This workshop is being held at the Kiawah Island Golf Resort and is an opportunity that promises not only high-quality continuing legal education but also meaningful connection with colleagues in our field.
Section 351(a) provides no gain or loss is recognized if property is transferred to a corporation by one or more persons solely in exchange for stock in such corporation, and immediately after the exchange such person or persons are in control (as defined in Section 368(c)) of the corporation. One of the requirements is the issuance of stock in connection with the transaction. However, the courts have found that in certain circumstances, the actual issuance of stock is not necessary.
By Steven B. Long and David P. Heeren
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