By: Gary A. Porter, CPA


Portland Golf Club v. Commissioner (No. 89-530, 6/12/90, 1990 US Lexis 3297), a Supreme Court Decision, affirmed the Ninth Circuit's decision in "North Ridge Country Club" which effectively prevents the offset against interest income by losses from other activities.

Portland, a 501 (c)(7) exempt organization incurred losses on sales of food to nonmembers and used such losses to offset investment income. The Supreme Court held that because the food sales activity lacked a profit motive, it could not be aggregated against interest income. Unlike Northridge, which incurred losses based strictly on direct costs, Portland apparently realized profits based on its variable costs, but always incurred losses after allocating fixed costs. Portland had "improperly" used one allocation method to determine actual profit or loss for tax purposes, and another allocation method to support its profit motive. The court ruled that the same allocation method must be used in determining intent to profit as in computing its actual profit or loss.


In determining profit motive, Treas. Reg. Sec. 1.183-1 (c)(1)(ii) indicates that most activities are presumed to be engaged in for profit if gross income exceeds cost in any 2 of 5 consecutive years. The IRS has explained profit motivation as follows:

"Deductions are allowable under section 162 for expenses of carrying on activities which constitute a trade of business of the taxpayer and under section 212 for expenses incurred in connection with activities engaged in for the production or collection of income or for the management, conservation, or maintenance of property held for the production of income. Except as provided in section 183 and 1.183-1 [which authorize individuals and S-corporations to offset hobby losses], no deductions are allowable for expenses incurred in connection with activities which are not engaged in for profit.... The determination whether an activity is engaged in for profit is to be made by reference to objective standards, taking into account all of the facts and circumstances of each case. Although a reasonable expectation of profit is not required, the facts and circumstances must indicate that the taxpayer entered into the activity, or continued the activity, with the objective of making a profit."

To facilitate the application of this general standard, the IRS has supplied a list of nine factors, also based on a wide body of case law, for evaluating the taxpayer's profit motive. These factors include: (1) the manner in which the taxpayer carries on the activity; (2) the expertise of the taxpayer or his advisors; (3) the time and effort expended by the taxpayer in carrying on the activity; (4) the expectation that assets used in the activity may appreciate in value; (5) the success of the taxpayer in carrying on other similar or dissimilar activities; (6) the taxpayer's history of income or losses with respect to the activity; (7) the amount of occasional profits, if any, which are earned; (8) the financial status of the taxpayer; and (9) the elements of personal pleasure or recreation.

This obviously leaves the door open to aggregating losses against income of another activity where profit motive can be documented. Indeed, IRC Sec. 512 requires aggregation of activities, but this case refines that requirement to include only activities with profit motive.


This court explained that "taxes are levied on unrelated business income (UBI) only in order to prevent tax exempt organizations from gaining an unfair advantage over competing commercial enterprises". Taxable income was defined as gross income less deductions directly connected with the production of that gross income, but excluding exempt function income and deductions. Since Portland failed to support a profit motive, the offset of food sale activity losses should not offset investment income. Congressional intent was that investment income of social clubs should be subject to federal tax, and devised a definition of unrelated business taxable income (UBTI) with that purpose in mind. Further, "the statutory scheme for the taxation of social clubs was to achieve tax neutrality, not to provide these clubs a tax advantage."


 Those associations that elect IRC Sec. 528 using Form 1120-H, are exempt under IRC Sec. 501 (c)(22). The above criteria should also apply to organizations under this section.

 For those associations not electing under IRC. Sec. 528, they are held to be nonexempt membership organizations subject to the rules of the IRC Sec. 277. The courts have held, in the Concord Consumers Housing Cooperative v. Commissioner case (see Ledger Quarterly July 1989 Issue) that section 277 was intended to do for nonexempt organizations what Section 512 has done for exempt organizations. Basically, decisions for exempt organizations under IRC Sec. 511, 512 or 513 will generally apply to organizations subject to IRC Sec. 277.


 An interesting question arises as to the nature of a loss from an activity for which a profit motive cannot be documented.  The income and expense of this activity do not meet the definition of exempt income for an exempt organization, nor membership income for a nonexempt membership organization.

 Since IRC Sec. 528 does not allow a net operating loss to an association filing Form 1120-H, this loss is simply terminated for an electing association.

 For an association filing Form 1120, this loss would appear to constitute a net operating loss from a specific activity that may be carried forward. It would be dangerous to assume that you could combine this loss with membership activities, as an association might conclude that it had a Section 277 carryover, when in fact the loss might be masking a taxable net membership income. 

 As always, a detailed and careful analysis of an association's income and expenses is necessary. Proper characterization of income and expenses can avoid costly mistakes.

 In November, 1990, in announcement 90-138, IRS indicated that they will closely monitor social clubs for compliance with the Portland guidelines.


 Too often in the past, associations eager to avoid taxes have flocked to CPAs who have promised them that "their association clients never pay any tax". They achieved this by offsetting interest income with losses from other activities. CPAs who were more conservative, and who interpreted the tax law differently, watched their association clients leave to go to a CPA who would help them avoid paying any tax. The Portland case firmly establishes that all associations must pay tax on their investment income, and may not offset it with losses from other activities, unless they can prove a profit motive. No longer may associations indefinitely or indiscriminately offset interest income with losses from other activities.