Tax-exempt organizations and claiming the tip credit.

Can a social club exempt under Sec. 501(c)(7) claim the Sec. 45B credit for tips received by its employees, or is the credit limited to tips received in connection with its unrelated business activity? Further, once the credit amount is determined, is the use limited to the tax imposed on its

Restaurants and bars are allowed a nonrefundable credit for employer FICA taxes paid on employee cash tips (tip credit) under Sec. 45B. The tip credit was included in the Revenue Reconciliation Act of 1993 as part of a carrot-and-stick approach to collect payroll taxes on gratuities. The credit is equal to the employer's portion of the FICA obligation (currently, 7.65%) attributable to tips that, when added to regular wages paid, exceeds the minimum wage provisions of the Fair Labor Standards Act. No deduction is allowed for any amount included in determining the credit.

A question has arisen as to whether social clubs exempt under Sec. 501(c)(7) are limited to the extent to which they may use tip credits. An as yet unreleased TAM involves a country club with a private golf course and a clubhouse in which food and beverages are served to members and their guests. The club also allows its members to sponsor private parties. The income from these parties is reported as unrelated business income on Form 990-T, Exempt Organization Business Income Tax Return (and proxy tax under section 6033(e)).Waitresses, bartenders and busboys employed by the club are paid by the hour and also receive tips. The tips have been correctly reported on the club's payroll tax reports and appropriate Social Security and Medicare taxes have been paid.

The club also receives taxable investment income from its cash accounts. Like many social clubs, the club collects its dues annually and holds the funds in an interest-bearing account expended during the year. Sec. 501(c) (7)-exempt social clubs are taxed on this investment income and required to include it as unrelated investment income on Form 990-T.

Social clubs exempt under Sec. 501(c)(7) may not offset losses from nonmember activities against investment income, unless they conduct nonmember activities with an intent to make a profit. Based on the club's consistent lack of profit on its nonmember food and beverage activity, the club did not net its unrelated business activity losses against its taxable investment income. The losses on the unrelated business activity were carried forward and the club correctly computed the tax due only on its investment income. The club then claimed a tip credit based on all tips received by its employees. The tip credit was sufficient to pay the entire tax due on its investment income.