Organizations may qualify as exempt from federal income tax under Internal Revenue Service (IRS) guidelines for a variety of reasons. Some organizations provide various forms of charity to the public. Others engage in fundraising activities, such as gaming, to raise money for charitable purposes. Some do both. Gaming in and of itself is not a charitable activity, but that does not mean it is banned for all tax-exempt entities. To help tax-exempt organizations better understand gaming rules, PYA has crafted this insight to break down IRS Publication 3079: Tax-Exempt Organizations and Gaming.
When Gaming Is Allowed and When It Is Disallowed
Even if a tax-exempt organization uses the proceeds from gaming activities to provide charity in accordance with its exempt purpose, the gaming itself is not a charitable activity. However, under certain circumstances, a tax-exempt entity may engage in gaming activities for a profit with no adverse effects.
First, individual or outside for-profit organizations may not inure to the proceeds of the gaming activity. This does not preclude payment for service to a bona fide business for services provided in relation to the gaming activity. For example, hiring and paying a cleaning crew to clean the facilities after the gaming event, when the cleaning fee is fair market value for the local area, is not private inurement to the business that provides the cleaning crew. However, inviting a personal friend of the organization’s CEO, and ensuring that the friend will be a winner of a cash prize if he attends the gaming event, is private inurement. A tax-exempt organization that violates the private inurement rule will jeopardize its tax-exempt status. As a result, the organization should take great efforts to ensure that the gaming is fair, and no individual or business has an unfair advantage.
Second, the proceeds from gaming are unrelated business income (UBI) for the tax-exempt organization and subject to income tax, unless the activity falls under one of the following specific exceptions:
- Gaming is not regularly carried on. There is no bright-line standard for what is considered “regular.” Once a week is considered regular; once a quarter is not. To be conservative, gaming activities should take place no more frequently than once a month, and preferably only once a quarter.
- The gaming activity is bingo, which is legal under the laws of the jurisdiction in which the gaming occurs. In addition, for-profit entities must be disallowed from conducting bingo gaming in the same jurisdiction. In other words, the local laws must state that non-profit entities are allowed to conduct bingo gaming and for-profit entities are not.
- The gaming activity is carried on by volunteers. This means that the volunteer helpers are not collecting any compensation, tips, or reduced-priced goods or services in exchange for helping at the gaming event. Those items are considered remuneration for their service, and therefore, the individual is not a volunteer. However, if at least 85% of the work is performed by true, uncompensated volunteers, then the gaming activity meets the UBI exception.
If any one of these exceptions apply, then the net proceeds from the gaming activity are not subject to UBI.
Tax Filings and Taxes on Gaming
Even if gaming qualifies for a UBI exclusion, the recipient of the gaming award is subject to individual income taxation on the net proceeds, defined as cash or noncash prizes received, less the amount of the wager on the specific individual game that resulted in a prize. For example, a person purchases 10 bingo cards at $5 each and wins $1,000 on one of the cards. The net proceeds are $995— winnings of $1,000 less the $5 purchase of the single winning bingo card.
Depending on the type of gaming activity and the amount won, the tax-exempt organization may be responsible for withholding income taxes on the payment and filing IRS Form W-2G: Certain Gambling Winnings to report the winnings to both the IRS and the individual winner. The threshold for reporting is as follows:
- Bingo or Slot Machines: Report winnings of $1,200 or more before deducting the amount of the wager.
- Poker Tournaments: Report winnings of $5,000 or more after deducting the wager/entry/buy-in fee.
- Keno: Report winnings of $1,500 or more after deducting the amount of the wager.
- All Other Games: Report winnings of $600 or more and at least 300 times the amount of the wager. (To determine if the $600 threshold is met, deduct the amount of the wager.)
The person who receives the winnings must sign Form W-2G to certify that he or she is entitled to the winnings. Common practice is to require a signature from the recipient before the winnings are paid to him or her. This ensures that the organization obtains the recipient’s signature, as required by the IRS.
Tax-exempt organizations that engage in gaming activities to raise funds must maintain adequate records to ensure compliance—both with the IRS and federal tax law and with state and local rules and regulations. The organization should document the reason for an exception from UBI, if the gaming qualifies for an exception. Alternatively, if the gaming proceeds are determined to be UBI, the organization must maintain records of the income received and the expenses that offset the income. Whether the gaming qualifies for an exception to UBI or not, the organization should have careful controls in place to account for and secure cash, as gaming frequently involves cash receipts and disbursements. If cash is not controlled and ends up diverted to private individuals or for private purposes, then the organization risks losing its tax-exempt status because funds are used for private inurement.
Running afoul of gaming rules can mean “game over” for a tax-exempt organization that does not take care to comply with federal, state, and local regulations. If you have questions about permissible gaming activities and their reporting and record-keeping, or would like assistance with any matter involving tax preparation and accounting, contact a PYA executive below at (800) 270-9629.