It’s a club treasurer’s worst nightmare…everything was going along swimmingly, the plane is paid for, all members pay their dues and usage fees on time, the engine and propeller reserve fund is inching upwards and is on target with the TBO…and then it all breaks (pick your choice):
Note that we’ve not included accidents, incidents or hangar-rash damages in the above list. This is why we carry insurance. If you decide to file a claim, your bylaws should be clear about who pays the deductible (and the increases in premiums for a few years)—more on this another time. If you decide not to file a claim, again the bylaws should clearly state who is on the hook for repairs, most likely the offender, just like they would if they owned the plane…which of course as a club member, they do.
Clubs sometimes get interested in trying to raise money outside of member income sources, such as fees, dues, and so on. Just like this really doesn’t make sense for a sole aircraft owner (why would other people help pay for your panel upgrade?), so it also doesn’t make much sense for a flying club, but that doesn’t stop some creative minds! As we will see, there are big traps here—not only with the receipt of income from nonmember sources, but also in what you may have promised or provided, in return. There are many factors to consider, and exactly what depends on how the club is structured and operated.
We’ll consider these:
Case 1: The club is established in the preferred way, as a non-profit corporation in the state of operations. Now, we know that many clubs are organized as LLCs and we have written widely about why this is probably not the best idea as it can really complicate the club’s (and members’) tax situation. If you are set-up as an LLC, it might be worth considering a one-time conversion to a non-profit corporation. Nevertheless, for this discussion it really doesn’t make much difference—income is earned, tax returns have to be filed, and possibly taxes have to be paid.
Case 2: The club holds tax exempt status with the IRS. This is where many clubs get confused, so let’s digress a little to straighten it out—we’ll talk much more on the topic of tax exemption in a later article.
By FAA
definition, flying clubs are non-profit social clubs. Clubs that are organized
as non-profit corporations in their state may decide to apply for tax exemption
under tax code 501.
Notice that these are quite separate processes—establish the “entity”
with the state and perhaps choose to apply for tax exemption with the IRS. Given that LLCs are considered entities with clear
profit motives, it is highly unlikely that the IRS will grant tax exemption to
a club organized as an LLC…not unheard of, just unlikely, which is another
reason not to organize as an LLC.
The next area of confusion is over the actual “type” of tax exemption. It turns out that tax code 501 has many options, the most well-known being 501(c)(3)—this is the familiar public-facing charitable organization such as National Public Radio and, as it happens, the AOPA Foundation, which funds AOPA’s You Can Fly and Air Safety Institute programs.
Nevertheless, this is not the choice for flying clubs! The only truly applicable path for flying clubs is 501(c)(7), Social and Hobby Clubs. If you wait to learn more about this, snuggle up to IRS Publication 557, Tax Exempt Status for your Organization.
By the way—clubs organized as non-profit corporations are not obliged to file for tax exemption. Why wouldn’t you, you may ask…? Well, the tax man giveth and the tax man taketh away.
Yes, being tax exempt is pretty valuable for an equity club that collects and keeps funds for life-limited parts such as engine and propellor reserves. Essentially, the IRS recognizes that an individual owner would not have to pay additional taxes on money earmarked for improvements, as they would have already paid taxes on the income that created the fund in the first place, and this recognition extends to non-profit social/hobby clubs with 501(c)(7) status. Very nice, indeed.
The taketh away part comes in the form of filing fees and strict rules about the sources of income. The filing application fee for 501(c)(7) tax exemption is $600, so you’d be wise to ensure that you’ll save at least that by being exempt from paying taxes, and the case where this is particularly relevant is that of a non-equity club. Recall that non-equity clubs are those where members do not have any equity stake in the assets of the club. This typically occurs when clubs lease aircraft. For more information on clubs leasing aircraft see the March 2018 Question of the Month. In such cases, and depending on the terms of the lease agreement, it is highly likely that lessor (the owner) will keep the major reserve funds, so the lessee (the club) generally operates much leaner and does not have to accumulate a large bank balance.
With this as background, we are now ready to tackle the actual question “How May Flying Clubs Raise Money?”, and you might have realized from the above that the devil is in the details— just how much depends on the tax status of the club.
Clubs that are not tax-exempt:
Even if a club is organized as a non-profit corporation in their state of operation, it will absolutely be obligated to pay federal (and likely state) taxes, unless it has explicitly received tax-exempt status from the IRS. So, if income exceeds deductions, as it should in a well-run (equity) club, it should expect to pay taxes.
In this general case, members are charged monthly dues to pay for the club’s fixed costs, and of course they pay per-hour rates that cover the variable costs of using the plane, things like fuel and oil consumed, contributions towards various time-based inspections, and so on. As we have dwelt on many times before, a wise club will ensure that monthly dues cover all of the predictable bills, even if the airplane doesn’t fly. Clubs get into all sorts of financial trouble if they try to “offset” monthly dues with slightly increased usage rates. This is fine and dandy when the plane is out flying, but if it is down for expended maintenance or there is a spate of bad weather, the fixed-cost bills will still pile up and cash flow may become an issue.
Let’s now consider some typical questions for non-tax-exempt clubs:
Q1: Can a club earn income from nonmember sources, that is, external to club fees, dues, assessments, etc.? (For example, selling hats, tee-shirts, and other merchandise.)
A1. Yes, but any income whether from members or elsewhere must be declared on the various annual reports and returns. (We’ll dig much deeper in a future article into to clubs’ obligations for annual reports and returns.)
Q2: Can clubs hold “raffles” or “drawings” for fund raising?
A2: You have to be really, really careful, here. Whether you call it a raffle, drawing, sweepstakes, fund-raiser, “opportunity” or whatever, a club can get into big trouble with this familiar and apparently mutually beneficial way to raise money. In the United States, all raffles and variants are considered to be games of chance. In other words, it is gambling, and so is tightly regulated in all states. Indeed, some states do not permit any sort of raffle, so if you live in Alabama, Hawaii or Utah, you can skip ahead to the next question!
Does this mean that you cannot hold a raffle (in the remaining 47 states)? No, but you’d better do some serious research as the rules are part of the criminal code in most states. Furthermore, even different counties may have different rules, so be sure to do your homework.
You will absolutely need to create formal rules and make copies available to participants, which must go into considerable detail about the prizes, winner selection process, and so on. Furthermore, winners may have to declare the prizes on their individual tax returns, and so the club may be required to inform the IRS of the winners’ tax credentials, requiring form W9 “Request for Taxpayer Identification Number and Certification”.
Our advice? Don’t go there without seeking guidance from a lawyer (and even then, don’t go there!)
Q3: Can a flying club charge for airplane rides, introductory flight, scenic flights, etc.?
A3: In a word “no”. In fact, in two words, categorically “no”!
This question is often part of the one above—that is, holding a raffle where the prize is a ride in the club airplane. It seems to make so much sense. A club has aircraft, even non-pilots like to take aircraft rides, so why not either raffle a ride, or just charge people for going up in the club plane? People have fun, the club gets some money and… probably gets into big trouble!
This, of course, completely “crosses the line” between operating as a non-profit social flying club, and a provider of commercial aviation services. As we have written about many times before in Club Connector, flying clubs are afforded many benefits that are not extended to commercial operators, and these benefits are firmly rooted on the definition of a flying club: “FAA defines a flying club as a nonprofit or not-for-profit entity… organized for the express purpose of providing its members with aircraft for their personal use and enjoyment only.”
Clubs
are essentially treated the same way as private individuals, rather than
commercial operators such as flight schools and FBOs, who, by providing
services to “the public”, are required to comply with more stringent rules, procedures,
and operating standards. Clubs on the
other hand, “…are organized for the express purpose of providing its members
with aircraft for their personal use and enjoyment only.” If you do cross
this line, you may get into trouble with the airport operator, and possibly
with the FAA, and will not make friends with legitimate flight schools and FBOs
who are heavily burdened by the costs of compliance to the additional
rules. By the way, you can also get into
trouble by just hinting that nonmembers can pay for rides (and instruction) in club
aircraft—click here for full story and the “holding out” limitations
imposed on clubs. Your club’s board of
directors should take this to heart and carefully review the bylaws and
especially the club’s website for statement such as “Lean to Fly” and
“Introductory Rides, $99”
If you need more reasons not to do this, here are a few:
1. The member acting as PiC for the rides would be well advised to review the regulations regarding the privileges and limitations of their specific certificate when it comes to “compensation or hire”: FAA issues new guidance on cost-sharing
2. Without doubt, if a club plane is being operated for the purpose of providing airplane rides in exchange for money (even in the form of the prize for a raffle that involved charges for tickets), then the flight will involve “compensation or hire”. This is also completely contrary to the expected behavior of flying clubs.
3. That being the case, you may well find that the club’s insurance policy would be invalid in the event of an accident or incident when conducting such nonmember operations.
4. Please don’t think that getting into trouble over this is a rare thing. The AOPA Flying Clubs team and our colleagues in the Advocacy group frequently work with clubs that are in dispute with airport operators due to their operational behaviors, mostly around primary flight instruction and paid introductory flights. If a club does not conform (to the FAA and airport rules and regulations), airport operators have the right to close it down until it changes its spots. On the other hand, airport operators cannot simply decide to not accommodate a compliant flying club just because it is getting pressure from, say, a flight school. The whole point is that there is an ecosystem. Think of this as “flight schools get them flying and flying clubs keeps keep them flying”.
Does
this mean that a club member cannot take a friend up for a ride in a club
aircraft? Absolutely not but beware the
rules for pro-rata cost sharing. Also,
remember that even charity flights come with rules and limitations. More on this, here: 14 CFR 91.146, Passenger-carrying
flights for the benefit of a charitable, nonprofit, or community event.
Q4: A related question regarding compensated flights: Can a club charge a prospective member for an introductory flight?
A4: Absolutely not, as by definition, the prospective
member is not a member, and from the above, the flight would be considered as
being for “compensation or hire”. The
way to handle this is for the club to eat the airplane usage as an expense on
the accounts. Of course, neither the
club nor the prospective member should pay the PiC for flight services, not
even if the PiC is a CFI. There are a
couple of other related “gotchas” here. You
can find articles on using club aircraft for flight training, and how particular
flight operations influence the need for 100-hour inspections, here.
Our advice? Leave sightseeing, introductory rides and the like to the people who do it for a living, are obeying the rules, and have processes and insurance in place for such operations—in other words, Flight Schools and FBOs.
Clubs that are tax-exempt:
Let’s now look at the case of a club, organized as a non-profit corporation in their state of operation, that also holds 510(c)(7) tax-exempt status. Such a club receives a truly amazing benefit from the IRS and so it is reasonable to expect that there are conditions and limitations in addition to those already mentioned above. This gets even sweeter if their state of operation also extends the exemption to state income tax. The point here is that such a club should never do anything that would jeopardize their exempt status. By the way, the most common cause of revocation is that the club “forgets” to file the appropriate annual reports to the IRS, likely in the case of a new treasurer taking over the books. It is possible to get back to exempt status, but it involves jumping through some seriously large hoops of fire.
Q5: What are some ways that a 501(c)(7) club can get into trouble by receiving nonmember income?
A5: Where to start…!
Firstly, here are some “must read” references to peruse on the wide topic of tax exemption:
IRS Publication 557: Tax Exempt Status for Your Organization.
Charities and Nonprofits: Tax Exemption
Tax Issues for Tax-Exempt Social Clubs: Really useful information in the context of this article.
Here are the requirements for 501(c)(7) tax exemption. This is from the IRS website Tax Issues for Tax-Exempt Social Clubs. The embedded links are also from that site:
We see that number 3 clearly tells us that the club must be supported by member income, but doesn’t say “fully supported”, so opening up the possibility of some income coming from nonmember sources. Number 4 above implies that every member must pay the same fees, dues and rates for the same access to the club’s benefits. This is one reason why “family memberships” and “student memberships” are such bad ideas—basically some members are being “inured to” by the others. Number 6 tells us that some minor amount of income may come from “nontraditional sources”. Looks like we need to dig a bit more!
On the same webpage, we learn about the effect of nonmember income on exempt status:
A social club may receive up to 35 percent of its gross receipts from nonmember sources, including investment income. Within the 35 percent amount, no more than 15 percent of gross receipts may be derived from nonmember use of club facilities and services. Where the permitted levels of nonmember income are exceeded, all facts and circumstances will be considered in determining whether the club continues to qualify for exemption.
Be careful here. Just because a club may earn up to 35 percent of its income from nonmember sources and not lose its status, if that income is from activities that are not part of the exempt purpose, it will not be exempt from tax. In other words, tax will be owed. This get us to the next piece in the puzzle—that of Unrelated Business Taxable Income (UBIT). The UBIT of exempt social clubs includes all gross income, less deductions directly connected with producing that income, but not including exempt function income. In general, exempt function income is gross income from dues, fees, charges, or similar items paid by members for the purposes for which exempt status was granted to the organization.
Alright then, a club may earn up to 35 percent of its total income from nonmember sources and not lose it exempt status, but all parts of that nonmember income (that is not part of the exempt purpose) will be taxable. Examples include:
· Accepting money for advertising in club newsletters or other publications.
· Proceeds from the public are not derived from members and so would not be considered exempt activities. For example, the sale of tee shirts, hats, food and beverage to nonmembers.
Our Advice: If your club holds tax exempt status, treat it like gold, and don’t jeopardize this benefit for a few dollars raised outside of member income. For more information regarding audits on 501(c)(7) organization, see this “Audit Guide”.
Summary:
Looking back at this article, it perhaps comes across as being negative and critical. Rest assured that the AOPA Flying Clubs team doesn’t judge poor operational behaviors. This is between you, the airport manager, the FAA, the IRS and your conscience—but we can, and do, provide guidance on best practices that will keep your club and the airport ecosystem healthy.
We hear of clubs, particularly larger ones, that blatantly advertise flight instruction, rides, etc. Most are horrified to hear that this is not only unethical, but also illegal. Some however, shrug and carry on. One such club went as far to say that if the airport management and/or FAA wanted to complain, then “bring it on, we’ll take our chances”.
We also hear of other clubs that just simply want to work the system. That a properly operating social flying club can receive exemption from federal income tax is truly a gift from the IRS, but some, of course, want more. We heard recently of a club that intentionally “holds-out” for instruction, rides, etc. but because if its size and importance to the overall airport business, just bullies the airport operator into letting them continue. This same club (already 501(c)(7) exempt) has apparently recently filed for 501(c)(3) status, by perpetuating the myth that flying clubs are somehow educational institutions. The reality is that a true flying club’s purpose is a member-facing social club, and no amount of training will ever change that purpose into one of public-facing education.
You might wonder why this club is so aggressively pursuing (c)(3) status. Well, their reasoning is that, in their state, such an organization would be exempted from sales tax, and they are about to purchase another club airplane. So, to save a few dollars in sales tax that would do good for the whole community, and the probably short-lived and hollow “stick it to the man” victory, they will probably lie on a federal form. Hazardous attitudes…? Yes indeed, and one wonders what other rules and regulations go by the wayside.
Bottom, bottom line. We strongly advise clubs to be fully self-funding, from members only. If you need more money, then assess the members. If a club cannot survive without external funds, it is time to fix the fundamental problems rather than being tempted to raise funds from outside of the club. Like everything else, flying clubs go through life cycles. What worked 30-years ago is probably not reality, today. Perhaps you will have to sell one of the club planes to keep the club viable or increase fees and dues. Some people will of course complain, but so be it… at least you’ll have a viable and sustainable flying club.
As always, fly lots and fly safely.
