Pennsylvania Club Made Millions From Natural Gas And Lost Its Tax Exemption

For 90 years, a Pennsylvania sportsmen’s club has offered its members a place to hunt, fish, shoot, and enjoy the outdoors. Then the club found itself sitting on something potentially more lucrative than a well-stocked trout stream: natural gas.

The club leased its mineral rights to a drilling company, collecting nearly $1 million upfront and millions more in royalties over the years. It reported the income to the IRS, including on returns used to report unrelated business income. But the money came with an unexpected consequence. The IRS revoked the club’s federal tax exemption, and the U.S. Tax Court has now upheld that decision.

The issue wasn’t whether the royalties were taxable. The question was whether collecting so much money from outside sources had changed the club’s nature for federal tax purposes.

A Sportsmen’s Club With Valuable Land

Consolidated Sportsmen of Lycoming County was incorporated in Pennsylvania in 1936. Located near Williamsport (the birthplace of Little League Baseball), the club owns approximately 230 acres of forest and meadow in the Marcellus Shale region. The club’s stated purposes include conserving forests, fields, and streams; promoting hunting and fishing; protecting water quality; and encouraging outdoor recreation.

The property features rifle ranges, trap and skeet shooting facilities, athletic fields, campsites, picnic areas, and playgrounds. Members also use the property for hunting, fishing, canoeing, kayaking, and other outdoor activities. Members have also used the property for Civil Air Patrol training and free safety training for police and environmental groups.

In November 1981, the IRS recognized it as exempt under section 501(c)(7)—that’s the section focused on social and recreational clubs.

In March 2011, the club’s board unanimously voted to lease its mineral rights to Rice Drilling B, LLC. The agreement included a signing bonus of approximately $921,800. Production began in December 2016, and between 2017 and 2023, the club received approximately $2.19 million in royalties.

Royalty payments varied significantly. In 2017, royalties accounted for 58.7% of total revenue, but by 2021, that figure had fallen to 19.6%. In 2022, royalties surged to more than $1.18 million, or 90.5% of annual revenue, before dropping to approximately $304,000, or 44.6%, in 2023. Although royalties alone didn’t exceed half of revenue every year, combined nonmember income, including investment income, exceeded 50% in every year from 2017 through 2023.

The IRS Takes a Closer Look

The club did not conceal its royalties from the IRS. It reported the income on its annual Forms 990 and filed Forms 990-T to report unrelated business taxable income. However, during an examination of its returns, the IRS became concerned about the amount of money the club received from nonmember sources.

In October 2021, the agency proposed revoking the club’s exemption retroactively to January 1, 2017. The club challenged the proposal, maintaining that its principal activities remained recreational and that the mineral lease required virtually no involvement from members. In September 2023, the IRS Office of Appeals concluded that the club no longer qualified under Section 501(c)(7) but made the revocation effective January 1, 2023, rather than 2017.

The club challenged the revocation in Tax Court under Section 7428, which allows certain organizations to dispute the loss of their tax-exempt status. In its answer, however, the IRS again asked that the revocation reach back to 2017. Only in August 2026, after both sides had briefed the issue, did the IRS concede that the revocation would apply prospectively, from January 1, 2023.

How Much Outside Income Is Too Much?

Section 501(c)(7) exempts clubs organized for pleasure, recreation, and other nonprofit purposes, provided substantially all their activities further those purposes. Before 1976, the statute required clubs to be organized and operated exclusively for those purposes. Congress relaxed that standard but didn’t specify how much nonexempt activity was permissible.

A Senate committee report suggested that clubs could receive up to 35% of gross receipts from outside sources, including investment income, without jeopardizing exemption. The IRS has used that figure as an administrative guideline for decades, even though it was never incorporated into the statute, Treasury regulations, or a revenue ruling. The legislative history also called for considering all the facts and circumstances when outside income exceeded 35%.

Consolidated Sportsmen argued that the IRS was focusing too much on revenue and too little on its members’ activities. Members continued hunting, fishing, shooting, and enjoying the outdoors, just as they had for decades. The gas lease, the club maintained, hadn’t changed that.

Does Collecting Royalties Count as an Activity?

The club argued that its members weren’t drilling for gas or managing extraction operations. Rice Drilling handled that work, while club officers spent very little time administering the lease. Because members devoted nearly all their time to recreational activities, the club maintained that it should continue to qualify for exemption under Section 501(c)(7).

Tax Court Judge David Gustafson disagreed. In an opinion issued October 29, 2026, he explained that the statute refers to the club’s activities, not merely those of its members. Activities conducted by contractors also count, and the club hadn’t provided evidence of the hours Rice Drilling spent extracting gas. As Gustafson put it, “minerals do not extract themselves.”

The court also rejected the argument that hours spent were the only appropriate measure of a club’s activities. Revenue could be considered, too, particularly when an organization earned substantial income without much direct involvement from its members. With nonmember income exceeding half of the club’s revenue for seven consecutive years, the court concluded that its non-recreational activities were too substantial to preserve its exemption.

The Court Leaves the 35% Question Open

The Tax Court didn’t decide whether the IRS’s longstanding 35% guideline correctly interprets Section 501(c)(7). It didn’t need to, since the club’s nonmember income consistently exceeded half its total revenue, and the court concluded that its nonexempt activities were substantial under any reasonable reading of the statute.

Judge Gustafson offered an example of a group that pools money to buy and maintain kayaks. The tax exemption allows them to share recreational costs without triggering additional income tax consequences. But if the group begins funding its activities through a substantial commercial business, investments, or mineral royalties, the analysis changes because the club is no longer simply pooling members’ resources for recreation. Instead, it engages in significant revenue-producing activities that may jeopardize its exemption, even if contractors handle the work and members continue spending their time kayaking.

The court upheld the revocation of Consolidated Sportsmen’s exemption effective January 1, 2023, but left open the question of how much outside income other clubs can earn without jeopardizing their tax-exempt status.

Why Reporting the Royalties Wasn’t Enough

The club had disclosed its royalties on its tax returns. Under section 512(a)(3), qualifying social clubs generally owe unrelated business income tax on investment income and certain other nonmember income, while member dues and other exempt-function income ordinarily remain outside that tax base. The court noted that the club’s mineral royalties were taxable regardless of whether it retained its exemption.

But reporting taxable income isn’t the same as qualifying for exempt status. Section 501(c)(7) allows clubs to earn some taxable outside income without automatically forfeiting exemption. It doesn’t permit nonexempt activities to become so substantial that the organization fails the statutory test. As Judge Gustafson explained, disclosing nonexempt activities on a tax return doesn’t, by itself, preserve an organization’s exemption.

Losing the exemption can have significant consequences. The club would generally become subject to federal corporate income tax rules, potentially bringing member-derived receipts, including dues, into the taxable-income calculation, subject to applicable deductions and limitations.

What Other Clubs Should Know

The decision has implications beyond organizations that own mineral rights. Social and recreational clubs often rely on income from real estate, investments, and other assets to support their activities. But they need to consider how those revenue sources affect their exempt status, not merely whether the income is properly reported and taxed. As this case illustrates, the amounts can fluctuate dramatically: the club’s royalties rose from 19.6% of revenue in 2021 to 90.5% in 2022.

Interestingly, the Tax Court had not previously addressed the application of the 35% guideline in a case involving years after the 1976 amendment. Even here, the court declined to decide whether the guideline was appropriate, leaving that question unresolved for other clubs.

For Consolidated Sportsmen, land that had supported decades of outdoor recreation also generated a valuable source of income. The question wasn’t whether the club could earn money from its mineral rights, but whether it could do so on this scale and retain its federal tax exemption. The Tax Court concluded that it could not.

The case is Consolidated Sportsmen of Lycoming County v. Commissioner, T.C. Memo. 2026-109 (Oct. 29, 2026) (Gustafson, J.).