Consolidated Sportsmen of Lycoming County v. Commissioner, T.C. Memo. 2026-109, October 29, 2026

Tax-exempt social clubs operating under Internal Revenue Code (I.R.C.) § 501(c)(7) frequently generate revenues outside member dues, ranging from investment income to third-party facility leases and natural resource exploitation. A common misconception among tax advisors and exempt organization managers is that passive or third-party commercial activities—where club members spend virtually zero physical labor or administrative hours—do not count as non-exempt “activities” of the club for qualification purposes.

In Consolidated Sportsmen of Lycoming County v. Commissioner, T.C. Memo. 2026-109 (Oct. 29, 2026), the United States Tax Court unequivocally repudiated this “member-hours” insulation theory. In a fully stipulated declaratory judgment action under I.R.C. § 7428(a)(1)(E), Judge Gustafson sustained the Internal Revenue Service’s (IRS) revocation of a social club’s tax-exempt status because its gas and mineral royalty income regularly exceeded 50% of its total annual gross receipts. The court held that non-member commercial operations conducted on club property by third-party contractors constitute activities “of the club” under I.R.C. § 501(c)(7). Furthermore, monetary earnings serve as a primary metric for measuring the substantiality of non-exempt activities, overriding member-centric time allocations.

Factual Background and Operational History

The taxpayer, Consolidated Sportsmen of Lycoming County (CSLC), is a Pennsylvania domestic nonprofit corporation incorporated in June 1936. CSLC owns and maintains approximately 230 acres of forest and meadow land in Lycoming County, Pennsylvania, situated directly atop the Marcellus Shale natural gas formation.

CSLC was formed to promote forest, field, and stream conservation, foster better hunting and fishing, purify waterways, and encourage outdoor recreation. CSLC operates extensive facilities on its acreage, including rifle ranges, trap and skeet shooting areas, athletic fields, campsites, picnic areas, and playgrounds. Member activities encompass hunting, game raising, fishing, canoeing, kayaking, and hosting free safety training for local law enforcement, civil air patrol, and environmental protection groups.

In August 1981, CSLC submitted Form 1024, Application for Recognition of Exemption, under I.R.C. § 501(c)(7). On its application, CSLC stated that it engaged in no outside fundraising activities, though it reported minor historic timber revenue. On November 19, 1981, the IRS issued a favorable determination letter recognizing CSLC as a tax-exempt social club, explicitly conditioning exemption on CSLC operating as represented in its application and instructing the club to notify the IRS of any changes in its character, purposes, or method of operation.

Mineral Revenue Growth and Audit History

In March 2011, CSLC’s board of directors unanimously approved an oil and gas lease with Rice Drilling B, LLC (Rice), granting Rice exclusive rights to extract oil, gas, coalbed methane, and constituents on and under CSLC’s land for a primary term of five years. CSLC received a signing bonus of approximately $921,800 in 2011. Production and gas extraction commenced in December 2016, yielding substantial annual royalty payments to CSLC.

During tax years 2017 through 2023, CSLC’s mineral royalty revenues and total non-member income surged dramatically relative to total gross receipts:

In 2017, mineral royalties totaled $232,866, representing 58.7% of total revenue.
In 2018, mineral royalties totaled $186,099, representing 58.3% of total revenue.
In 2019, mineral royalties totaled $172,637, representing 57.3% of total revenue.
In 2020, mineral royalties totaled $78,027 (35.2% of total revenue), bringing total non-member revenue to 51.0%.
In 2021, mineral royalties totaled $34,085 (19.6% of total revenue), but combined with $66,788 in investment income, total non-member income reached $100,873, or 58.0% of total revenue.
In 2022, mineral royalties spiked to $1,180,656, accounting for 90.5% of total annual revenue.
In 2023, mineral royalties totaled $303,610 (44.6% of total revenue), bringing total non-member income to 54.0%.

Over this seven-year audit window, annual mineral royalties averaged well over $300,000, accumulating $2,187,980 in total gas royalties. In every single year from 2017 to 2023, CSLC’s aggregate non-member income exceeded 50% of gross revenue. Consequently, CSLC’s net assets expanded by over $1.06 million, growing from $1,874,563 in 2017 to $2,941,648 by year-end 2023. CSLC reported these royalty revenues on its annual Forms 990 (Return of Organization Exempt From Income Tax) and Forms 990-T (Exempt Organization Business Income Tax Return).

During these years, CSLC’s members spent virtually zero hours on mineral operations, and officers spent de minimis administrative time. All physical extraction and technical operations were executed exclusively by Rice personnel.

The IRS examined CSLC’s returns for 2016–2019 and issued a 30-day letter on October 27, 2021, proposing revocation of exempt status. Following administrative protest proceedings, the IRS Office of Appeals issued a Final Adverse Determination on September 27, 2023, revoking CSLC’s tax-exempt status under I.R.C. § 501(a) as a § 501(c)(7) social club effective January 1, 2023. The IRS reasoned that CSLC was not organized and operated substantially for exempt purposes because gas leasing constituted a substantial non-exempt activity.

Taxpayer Request for Relief and Core Legal Theories

CSLC filed a petition for declaratory judgment in the U.S. Tax Court pursuant to I.R.C. § 7428(a)(1)(E), asking the court to overturn the IRS determination and declare that CSLC maintained its qualification under I.R.C. § 501(c)(7).

CSLC’s primary argument rested on a strict “member-centric hours” interpretation of the statutory phrase “substantially all of the activities of which are for such purposes.” Specifically, CSLC contended that:

Member-Only Time Benchmark: The statutory word “activities” refers solely to human time expended by club members and officers. Because CSLC’s members devoted hundreds of hours exclusively to outdoor conservation and recreation, and spent zero hours extracting gas, substantially all member activities were exempt.
Rejection of Monetary Proxies: Gross receipts and revenue ratios are invalid statutory proxies for “activities.” Passive receipt of third-party royalties does not convert royalty income into an active “activity” of the club.
Facts and Circumstances Relief: Citing the legislative history of the 1976 amendments to I.R.C. § 501(c)(7) (S. Rep. No. 94-1318), CSLC argued that failing administrative non-member income guidelines requires the IRS to examine all facts and circumstances regarding member activities productive of revenue and compare them to member recreational hours.

Judicial Analysis of Statutory Framework and Precedent

Judge Gustafson began his legal analysis by outlining the scope of review and burden of proof. Under I.R.C. § 7428, Tax Court review of an exemption revocation is de novo. Pursuant to Tax Court Rule 142(a) and Rule 122(b), the IRS determination carries a presumption of correctness, placing the burden on the taxpayer to prove entitlement to tax-exempt status by a preponderance of the evidence (Partners in Charity, Inc. v. Commissioner, 141 T.C. 151, 162 (2013); Puritan Lawn Mem’l Park Cemetery v. United States, 15 Cl. Ct. 234, 240 (1988)).

The court contrasted the underlying policy of § 501(c)(3) charitable organizations with § 501(c)(7) social clubs. While charities receive tax exemption to serve public rather than private interests (Treas. Reg. § 1.501(c)(3)-1(d)(1)(ii)), social clubs are exempted under a completely different rationale. As the Supreme Court articulated in Portland Golf Club v. Commissioner, 497 U.S. 154, 162 (1990), social clubs are exempt not to confer commercial tax advantages, but to ensure members face no tax disadvantages from pooling personal after-tax funds for social and recreational services.

The court traced the statutory evolution of I.R.C. § 501(c)(7). Originally enacted in the Revenue Act of 1916 (ch. 463, § 11(a)(9), 39 Stat. 756) and retained in the 1939 Code (§ 101(9)) and 1954 Code (§ 501(c)(7)), the statute historically required clubs to be “organized and operated exclusively for pleasure, recreation, and other nonprofitable purposes.” In 1976, Congress amended I.R.C. § 501(c)(7) (Pub. L. No. 94-568, § 1(a), 90 Stat. 2697), substituting “substantially all of the activities of which are for such purposes” for the strict “exclusively” standard.

Simultaneously, under I.R.C. §§ 511 and 512(a)(3), social clubs are subject to Unrelated Business Income Tax (UBTI) on non-member income, including investment yields and third-party royalties. However, while paying UBTI resolves liability on specific revenue, it does not shield a club from total revocation if its non-exempt commercial activities become substantial.

Court Analysis: Defining “Activities of the Club”

Judge Gustafson systematically dismantled CSLC’s argument that “activities” must be evaluated exclusively through member labor hours. Addressing CSLC’s narrow perspective, the Tax Court observed:

“We think that perspective is too narrow. The word ‘members’ does not occur in section 501(c)(7). The statute does not provide tax exemption for ‘members’ but for ‘[c]lubs’. In the statutory phrase ‘activities of which’, the antecedent of ‘which’ is not ‘members’ (a word that does not occur in the statute) but ‘[c]lubs’.”

The court explained that a corporate entity acts not only through its members, but also through employees and independent contractors. When a social club engages an outside commercial entity to conduct business on club property, those commercial operations remain legal activities of the club:

“Likewise, if a club contracts with a third party (such as Rice) to conduct mineral extraction on the club’s property, then that mineral extraction is an activity of the club, though undertaken by a third-party contractor... A social club’s exploitation of its mineral interests does not cease to be an activity of the club merely because it is performed by a contractor.”

The court anchored this principle in prior precedent, citing Coastal Club, Inc. v. Commissioner, 43 T.C. 783, 810 (1965), aff’d, 368 F.2d 231 (5th Cir. 1966), where oil and gas leasing conducted by third parties was categorized as an unexempt activity of the club that overshadowed member operations. Furthermore, Judge Gustafson adopted the reasoning of Skillman Family Reunion Fund, Inc. v. United States, 196 F. Supp. 2d 543, 548 (N.D. Ohio 2002), which held that operations cannot hinge on trustee or member hours:

“[I]f the primary evaluatory criterion were to lie in an examination of the activities of an organization’s members, then an organization would be free to conduct whatever side ventures it desired, at whatever income levels of profit, so long as the individual members were pursuing the stated purposes of the club.”

Rejection of the Member-Hours Standard in Favor of Economic Metrics

The Tax Court flatly rejected CSLC’s assertion that hours are the sole valid metric for quantifying statutory activities and that dollars must be ignored. Judge Gustafson emphasized that CSLC presented its member recreational hours “in a virtual vacuum, with no comparison to mineral extraction hours, and with the insistence that the Court ignore the mineral extraction dollars.”

The court noted that investment and commercial management constitute recognized non-exempt activities under I.R.C. § 501(c)(7), citing Cleveland Athletic Club v. United States, 588 F. Supp. 1305, 1306 (N.D. Ohio 1984), rev’d on other grounds, 779 F.2d 1160 (6th Cir. 1985), and Bartels Tr. for Benefit of Cornell Univ. ex rel. Bartels v. United States, 617 F.3d 1357, 1359 (Fed. Cir. 2010).

Relying on United States v. Fort Worth Club of Fort Worth, 345 F.2d 52, 56 (5th Cir. 1965), the court reiterated that “the source of a club’s revenues, as well as their destination, is crucial in determining the purposes for which the club is ‘organized and operated’.” Judge Gustafson explicitly concluded:

“We conclude that investment can be a non-exempt ‘activity’ of a section 501(c)(7) social club and that the amount of the earnings of that activity can be an important metric of that activity.”

Statutory “Substantially All” Standard vs. Administrative 35 Percent Guideline

In administrative practice, the IRS frequently references a 35% non-member income ceiling derived from the 1976 Senate Finance Committee report (S. Rep. No. 94-1318, at 4, 1976-2 C.B. at 599). That committee report suggested that social clubs should be permitted to receive up to 35% of gross receipts (including up to 15% from non-member use of club facilities) from outside sources without losing exemption.

However, as Judge Gustafson highlighted, Congress never codified a 35% benchmark into I.R.C. § 501(c)(7), nor has the Treasury Department promulgated regulations embodying the 35% rule. The Tax Court noted that it was unnecessary to evaluate the administrative validity or deference owed to the non-enacted 35% guideline because CSLC’s commercial revenue stream failed under any statutory standard:

“Section 501(c)(7) requires not just that 65% of the activities of a club be for recreational purposes but rather that ‘substantially all of the activities’ be for recreational purposes... 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.”

“Because CSLC’s non-exempt investment activity is so substantial, deciding this case does not require us to consult the extra-statutory 35% standard of the legislative history and the IRS’s administrative position.”

To illustrate the economic reality, Judge Gustafson utilized an illuminating hypothetical of a ten-member kayaking club:

“The kayakers’ club could not avoid this disqualification by having not members but employees or contractors run a substantial business or by jointly funding an endowment that consists of passive investments that take zero of their hours but generate half of their income to supplement their dues. And they could not avoid this disqualification by purchasing property with mineral reserves, contracting with a third party to extract the minerals and pay them royalties, and using those royalties, rather than dues, to fund half of their budget.”

Evaluation of Facts and Circumstances

Under the committee report framework, an organization exceeding administrative gross receipt benchmarks might retain exemption based on all “facts and circumstances.”

CSLC argued that the IRS failed to evaluate facts and circumstances, demanding that the court compare member hours to revenue generated. Judge Gustafson dismissed this contention, stating:

“This ‘facts and circumstances’ allegation is nothing more than a re-casting of CSLC’s argument... that the mineral activity is relevant only insofar as members themselves are the ones who extract the minerals.”

The court noted that CSLC provided no mitigating operational facts regarding its recreational or mineral operations that would excuse generating over half its annual budget from commercial mineral extraction.

Conclusions and Key Takeaways for Tax Practitioners

The Tax Court held that CSLC failed to prove it was an organization described in I.R.C. § 501(c)(7). CSLC’s mineral leasing arrangement constituted a substantial non-exempt activity of the club, violating the statutory requirement that “substantially all” activities be for pleasure, recreation, and nonprofitable purposes. Accordingly, the court sustained the IRS’s revocation of CSLC’s tax-exempt status effective January 1, 2023.

For CPAs, EAs, and tax attorneys advising exempt social clubs, Consolidated Sportsmen of Lycoming County underscores several critical compliance rules:

Third-Party Operations Are Club Activities: Leasing club real estate or natural resources to commercial contractors (e.g., cell towers, solar farms, timber harvesting, mineral extraction) creates non-exempt club activities regardless of whether members participate in physical labor.
Gross Receipts Dominate Activity Metrics: Tax practitioners cannot shield clients from exemption revocation by proving that member volunteer hours outweigh contractor operational hours. Revenue generation remains a primary measure of substantiality.
50% Non-Member Revenue Is Fatal: While the 35% Senate report guideline remains unenacted, generating 50% or more of annual gross receipts from non-member sources will consistently trigger mandatory statutory revocation under the “substantially all” requirement.
UBTI Tax Payments Do Not Preserve Exemption: Paying I.R.C. § 511 tax on unrelated business taxable income under § 512(a)(3) satisfies annual tax obligations but provides zero defense against total revocation if the underlying activity is substantial.

Prepared with assistance from Gemini Notebook.