By Justin Ash
Non-profit organizations, particularly churches and small 501(c)(3)s, typically use gaming activities as a way to solicit cash donations from the public. Whether it be bingo at the church or a 50/50 raffle for the local boosters club, these gaming activities have long been somewhat of a gray area when it comes to taxation. The IRS has recently issued some new guidance intended to clarify the rules regarding what type of gaming is subject to a special tax levied on some non-profits. This guidance should shed some light on what has historically been thought of as a “no man’s land.”
Firstly, non-profit organizations are granted an exemption from taxation only on activities that are substantially related to their exempt function, even if such an activity is considered a trade or business. Any other trade or business carried on that is not substantially related to its exempt purpose may be subject to tax. In other words, if you apply to be a 501(c)(3) for the purposes of running a little league for the local town your exemption from taxation does not automatically extend to the concession stand where you sell candy and popcorn. This is because the sale of concessions does not further your exempt purpose of running the local little league. It does not matter that the proceeds from the sale of the concessions are used for your exempt purpose. Furthermore, for certain types of non-profits, if unrelated business income grows too large in relation to donation income the non-profit could lose its status as a 501(c)(3).
In the above example the income generated from the sale of concessions is referred to as “Unrelated Business Income” commonly referred to as “UBI”. This income is subject to tax and is reported on the Form 990-T which is attached to the non-profit’s regular tax return. The newly issued IRS guidance clarifies the rules regarding what is and is not considered unrelated business income fornon-profits with regard to gaming and also clarifies some broad exceptions to this type of tax.
Before a non-profit’s activity is classified as unrelated, there are three requirements that must be met. First, the activity must be considered a trade or business (gaming is generally considered a trade or business if it generates revenue). Next, the activity must be regularly carried on (gaming conducted only annually at a fundraiser is not considered regularly carried on). Third, the activity must not be substantially related to the organization’s exempt purpose (simply using the proceeds from such an activity for the exempt purpose does not make them substantially related).
Even if the activity satisfies all of the above criteria, making it unrelated, there are still some broad exceptions that can get a non-profit out of paying tax on the income. If the organization conducts bingo as defined by the IRS, then that income is exempt as long as the activity does not violate local law and as long as for-profit entities cannot regularly carry on bingo in any part of the same jurisdiction. Also, gaming that is conducted with substantially all volunteer labor is exempt from paying tax on gaming income. There are additional exceptions, but the aforementioned are two of the most common.
For example, let’s assume that the non-profit that runs the little league mentioned above has an annual fundraiser dinner. At this dinner, volunteers conduct 50/50 raffles and sell tickets for drawings to win prizes, all of which are donated. Because these activities are conducted only once per year and they are conducted with an all-volunteer labor force, the non-profit does not have to calculate unrelated business income or pay tax on the gaming net income. Conversely, if the non-profit conducts 50/50 raffles weekly at every little league game throughout the season and the individuals conducting the gaming are paid for their services, then the non-profit would likely be required to file a schedule 990-T to report the gaming income and pay income tax on the net income from gaming.
If you are unsure if a non-profit you are involved with should be reporting unrelated business income please contact us. We can analyze the situation and advise you as to the best course of action.