When a Nonprofit Dividend is Not Private Inurement

When is a distribution with respect to stock in a 501(c)(7) social club a distribution of the organization’s profit prohibited by the private inurement prohibition in that section?  In Breitman v. Atlantis Yacht Club, a social club’s bylaws contained redemption rights allowing members to sell their membership interest back to the club in certain circumstances.  The redemption price was set at an amount equal to the cost of membership on the date of redemption, even if that amount was higher than the member’s cost of membership.  Breitman joined the club when the required deposit was only $7,000.  Years later, when Breitman redeemed his membership, the cost was $25,000.  The club agreed to pay Breitman $18,000 in redemption of his membership. 

The Club’s attorneys warned that paying Breitman $18,000 more than his cost would result in a distribution of income or profit, in violation of state rules against such distributions and, of course, the prohibition against private inurement in 501(c)(7).  Sure looks that way to me.  The club decided not to pay the higher amount, so the member sued for breach of contract.  The Club defended by the assertion that the contract to pay the higher amount was illegal because it violated state and federal law prohibiting private inurement. 

The Court could have ruled that the contract was not illegal and left the rest to be decided by the NJ Attorney General and the IRS.  The Court asked the AG for his opinion but the AG decided to stay out of it.  Breitman argued as much, asserting that even if the payment constituted private inurement, it was not illegal and the Club should just have to explain the matter to the Service.  Not my problem, Breitman said.  That would have been too easy.  Instead, the Superior Court clicked its heals and said payment of the higher price was neither a distribution of income nor profit. Done and done.  The rationale – that the memberships weren’t purchased as an investment to make money – is completely unconvincing. 

I sure hope the attorneys help the Club re-write the  bylaws.

darryll jones