Is IRS Targeting Drunkards?

This post was originally published on Forbes Apr 27, 2015

Private Letter Ruling 201515035 might not seem to have anything to do with the interminable IRS scandal (According to the TaxProf we are on Day 716 as I write this. And look who is featured on Day 716).  It's not as if there are people accusing the IRS of targeting drunkards, although the status of drunkards would probably rise in some circles if they were to start such a campaign, much as Churchill indicated that he would have a favorable remark about the devil, if Hitler ever invaded hell.  The connection to the scandal comes from its reflection of our overreliance on the IRS for determining matters that have nothing to do with federal taxation.

The nameless organization, let's call it Chug-A-Lug (CAL) was applying for exemption under 501(c)(7) (Clubs organized for pleasure, recreation, and other nonprofitable purposes) (There are 29 possible ways to be exempt under 501(c) alone, although there are not likely to be any applications under 501(c)(23), since only organization formed before 1880 are eligible).  CAL would be selling beer and wine in a restaurant called, in the ruling, N.  Maybe we are talking about No Name City

Liquor By The Wink

So you might ask - "Why is it that N does not just sell beer and wine?"  N is located in the state of P (Puitania?).  In Puritania, regular restaurants cannot sell beer and wine.  Private clubs are a different story.  Apparently the Alcoholic Beverage Commission of Puritania requires that the private clubs be recognized as such by the IRS.  Hence the application.

You explained that you formed as a nonprofit because the state of P required it in order to serve beer and wine at N's restaurant. 

And a pretty complicated business model.

Your President-Treasurer signed and agreed to the terms of the management contract on behalf of both you and N. Your President-Treasurer is also the owner of N. Your Secretary endorsed the management contract on behalf of N as a member-manager. This contract states you will pay N E% of gross receipts from the service of alcohol each month. 

The Club shall operate under the pool system and establish an alcoholic beverage replacement account. The initial replacement percentage shall be Q percent of service charges for alcoholic beverages.

The practice is sometimes referred to as "liquor by the wink" and is described in this article.

Route 66

I encountered something like this in 2010 on the return leg of my cross-country drive.  One of the best kicks that I got on Route 66.

was a steak dinner at a cowboy-themed restaurant called Boot Hill Saloon & Grill in the town of Vega, Texas (Population 900 +/-).  In order to have a beer with my steak, Bass Ale actually, if I remember rightly, I had to join the club.  I think I opted for the short term membership, which was a wise move.

Penny Wise?

I suspect that the owner of N was trying to save money on his application, because he was pretty blunt about what he was up to and it was clear that CAG simply did not qualify.

An organization cannot be recognized as exempt under section 501(c)(7) unless it shows that it is both organized and operated substantially for pleasure, recreation or other nonprofitable purpose. Your Articles of Incorporation state you are a private club that performs social, fraternal, and hospitality activities. Your facts indicate N operates a restaurant. Your primary activity consists of offering memberships where anyone paying your annual membership dues can purchase alcohol to be served with their food ordered at N restaurant. Currently, your annual membership is free. You are operated by the same people who own and operate N restaurant. Your sale of beer and wine demonstrates you are not operated for the purposes declared under section 501(c)(7). Rather, you were formed primarily to permit N to serve alcoholic beverages.

I suspect that someone who knows how to shepherd these things through would have dressed it up a little more.

Too Many Exempt Orgs?

There was also a recent ruling where somebody who wanted to run a bar tried to create a veterans organization (501(c)(19).  You may recall that an extra wrinkle of the IRS scandal was the IRS "targeting veterans".  This related to the IRS making at least some effort to enforce the rules about veterans organizations having  memberships that are mostly, you know, veterans, who are actually running the organizations.

The primary IRS scandal was about delays in processing applications for organizations that were applying for 501(c)(4) status, possibly to avoid donor disclosure requirements (i.e. dark money).

What all three of these scenarios have in common is applications for exempt status that have nothing to do with federal taxes.  And then there is the NFL with its 501(c)(6) status.  Don't get me started. You will even see organizations seeking exempt status for the, entirely undeserved, credibility that it gives them in some circles.

In my mind, if you are going to have a social club or a fraternal organization (501(c)(8)) or a trade organization (501(c)(6) that is not being run to make a profit, then run it to roughly break even and if there is a small profit, pay some taxes.  It won't kill you. Limit the exemption process to the 501(c)(3) organizations.

At any rate, the practical take away is that if you are applying for 501(c)(7) status to do "liquor by the wink", you need a better story than N had.

About Boot Hill

The steak dinner at Boot Hill is one of the most vivid memories of my cross-country trek. The steak was very tasty, so I thought I must be experiencing an authentic Texas cowboy steak or something like that.  Then I started chatting with this attractive young woman, who it turned out was the owner and chef of Boot Hill.

 Rory Schepisi is of Irish/Italian descent, which can happen anywhere I suppose, but is very common in New Jersey.  She in fact grew up in Fort Lee (a town made famous not too long ago by Christie's Bridgegate) a short bus ride or long walk from where I grew up (Fairview).

She ended up opening the Boot Hill in Vega, Texas as the result of a reality TV show called Popularity Contest in which ten hip urban professionals were put in a small town (i.e. Vega Texas) with the town then voting on who they wanted to stay there.  She came in second, but there was this one cowboy, who really wanted her to stay, so there she was.  The steak tasted so good because of the New Jersey Italian influence and I suspect the cowboy decor was inspired by Bonanza reruns.

Apparently Boot Hill is struggling right now, I hope it all works out in case I am ever passing through Vega Texas again.  I'll either renew my membership or maybe settle for a Mountain Dew.