rr-03-73.pdf

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Part I

Section 277 - Membership Organizations

Rev. Rul. 2003-73

ISSUE

(1) Whether a membership organization described in section 277(a) of the
Internal Revenue Code may offset losses generated from the provision of
goods and services to members during the current year against income
earned from the provision of goods and services to nonmembers during the
current year?

(2) Whether a membership organization described in section 277(a) of the
Internal Revenue Code may offset losses generated from the provision of
goods and services to nonmembers during the current year against income
earned from the provision of goods and services to members during the
current year?

FACTS

Club A
is a taxable social club that operates a golf course, tennis courts and a
clubhouse (including a restaurant) primarily for the benefit of its members. A
has
significant nonmember source income from use of the clubhouse by the general public
for wedding receptions, anniversary parties and special events. The nonmember use of
the clubhouse is a trade or business. A
also has investment income. Over a four-year
period, after deducting allowable expenses, A
has the following amounts of income (or
loss) derived from the provision of goods and services to members and nonmembers
and from investments:

In Year 1, A
has a loss of $2,000 from member transactions, income of $3,500
from nonmember transactions, and investment income of $500.

In Year 2, A
has income of $1,500 from member transactions, income of $3,000
from nonmember transactions, and investment income of $500.

In Year 3, A
has income of $2,250 from member transactions, income of $2,500
from nonmember transactions, and investment income of $500.

In Year 4, A
has income of $1,000 from member transactions, a loss of $2,000
from nonmember transactions, and investment income of $500.

LAW

Section 277(a) applies to taxable social clubs or other taxable membership
organizations operated primarily to provide goods or services to members.

Section 277(a) generally provides that deductions for the taxable year
attributable to furnishing services, insurance, goods, or other items of value to members
shall be allowed only to the extent of income derived during that year from members or
transactions with members. If for any taxable year such member-transaction
deductions exceed member income, the excess shall be treated as a deduction
attributable to furnishing services, insurance, goods, or other items of value to members
paid or incurred in the succeeding taxable year.

Section 277(a) only applies to transactions with members. As a result,
deductions for a taxable year attributable to furnishing services to members in excess of
member income earned during such taxable year are not permitted to offset income
derived from transactions with nonmembers (nonmember income) during such taxable
year. Instead, the excess deductions are permitted to reduce income derived from
furnishing services to members in the next succeeding taxable year. Moreover,
investment income generally constitutes nonmember income for purposes of section
277, and, therefore, investment income cannot be offset by expenses of providing
goods and services to members. See Concord Consumers Housing Cooperative v.

Commissioner
, 89 T.C. 105 (1987).

Section 172 generally provides for a deduction of net operating losses, and the
taxable years to which the net operating losses may be carried back or carried forward.

ANALYSIS

Section 277(a) applies to A
. Consistent with the analysis in Concord Consumers
Housing Cooperative, the fact that some or all of the principal generating A’s investment
income came from members does not cause the investment income to be treated as
member income. As A
’s investment income is not otherwise derived from transactions
with members, A
’s investment income is nonmember income for purposes of section
277.

Section 277(a) applies to A’s member and nonmember income and losses as
follows:

Year 1
Member Nonmember Taxable
Income
Income Income

Income/(loss)
before loss carryforward (2,000) 4,000
Minus loss carried forward N/A
N/A
Income/(loss) (2,000) 4,000 4,000
Loss carryforward (2,000) - 0 -

Year 2

Income/(loss)
before loss carryforward 1,500 3,500
Minus loss carried forward (2,000)
- 0 -
Income/(loss) (500) 3,500 3,500
Loss carryforward (500) - 0 -

Year 3

Income/(loss)
before loss carryforward 2,250 3,000
Minus loss carried forward (500)
- 0 -
Income/(loss) 1,750 3,000 4,750
Loss carryforward - 0 - - 0 -

Year 4

Income/(loss)
before loss carryforward 1,000 (1,500)
Minus loss carried forward - 0 -
- 0 -
Income/(loss) 1,000 (1,500) (500)
Loss available for
carryback or carryforward - 0 - (500)

In Year 1, A
has a loss of $2,000 from providing goods and services to members.
A
cannot deduct this loss against nonmember income. The loss is carried forward to
Year 2 as an expense of providing goods and services to members in the next
succeeding taxable year. Thus, A
has zero member income in Year 1. A has $4,000
in nonmember income in Year 1 ($3,500 + 500). A
’s taxable income in Year 1 is $4,000
($0 + $4,000).

In Year 2, A has income before any loss carryforward of $1,500 from providing
goods and services to members. A
deducts the $2,000 net loss carried forward from
Year 1 against its member income of $1,500, resulting in a member loss of ($500) in
Year 2 ($1,500 - $2,000). The $500 unused net loss carryforward from Year 1 is carried
to Year 3 as an expense of providing goods and services to members in the next
succeeding taxable year. A
has $3,500 in nonmember income in Year 2 ($3,000 +
$500). A
’s taxable income in Year 2 is $3,500 ($0 + $3,500).

In Year 3, A
has income of $2,250 from providing goods and services to
members. A
deducts the $500 net loss carried forward from Year 2 against its member
income of $2,250, resulting in member income of $1,750 in Year 3 ($2,250 - $500). A

has $3,000 in nonmember income ($2,500 + $500). A
’s taxable income in Year 3 is
$4,750 ($1,750 + $3,000).

In Year 4, A
has income of $1,000 from providing goods and services to
members and no loss carryforward deduction from Year 3. A
’s member income in Year
3 is $1,000. A
has a $1,500 nonmember loss (($2,000) + $500). A offsets its
nonmember loss against its member income, resulting in a taxable loss in Year 4 of
$500 ($1,000 - $1,500). If the $500 loss satisfies the requirements of section 172, A

has a net operating loss of $500 that, subject to the net operating loss rules of section
172, may be used in calculating taxable income for other taxable years.

HOLDINGS

(1) A taxable social club’s loss from transactions with members does not offset
nonmember income, but instead is carried forward to the next succeeding
taxable year as expenses incurred in providing goods and services to
members.

(2) A taxable social club’s loss from transactions with nonmembers is fully
deductible against both nonmember income and member income.

DRAFTING INFORMATION

The principal author of this revenue ruling is Ronald B. Weinstock of the Office of
Division Counsel/Associate Chief Counsel (Tax Exempt and Government Entities). For
further information regarding this revenue ruling contact Mr. Weinstock on (202) 622-
4290 (not a toll-free call).