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Gambling Your Nonprofit Away: Nonprofits, Gaming, and Unrelated Business Income

        



           Many nonprofits host game nights to fundraise. But if you’re not careful, you might have to pay taxes on this fundraising if the IRS considers it to be unrelated to your nonprofit’s purpose (called unrelated business income). In this blog post, first I summarize what is unrelated business income (UBI) and what happens if you have to recognize it on your taxes. Then, I go through a few ways you can structure your gaming nights to avoid unrelated business income.

 What is unrelated business income?

For tax-exempt entities, the IRS wants to make sure that nonprofits cannot use their tax-exempt status to avoid paying taxes on income that is not related to their tax-exempt purpose, this is referred to as UBI. If an activity meets three conditions it could qualify as UBI:[1]

  1. The activity must be considered a trade or business;
  2. the activity must be regularly carried on; and
  3. the activity must not be substantially related to the organization’s exempt purpose.

Here’s a video from the IRS with more information on UBI: Fundraising Guidelines for Charities (irsvideos.gov) 

Applying the three conditions to fundraising gaming specifically:

  1. Gaming is considered a trade or business activity if it generates revenue, which is true if you’re using it to fundraise.
  2. Whether the activity is considered regularly carried on depends on how often you are hosting the gaming nights.
  3. The fact that the activity generates income for the organization to spend on its charitable programs does not inherently make the activity related to the organization’s exempt purpose.

 So, when we apply the three factors to gaming specifically we see that there are ways to conduct gaming fundraising that avoid UBI.  

What happens if you have UBI?

The two big consequences of the IRS recognizing UBI as taxable income are:

  1. Paying taxes on the UBI; and
  2. losing status as a nonprofit.

Nonprofits can make up to $1,000 of unrelated income before they have to pay taxes on it.[2] Anything more will require nonprofits to pay both state and federal corporate income taxes, which will require filing a 990-T Form.[3]

The IRS uses the “reasonably commensurate” test to determine if a nonprofit’s unrelated activity is enough to disqualify a nonprofits tax-exempt status. .[4] The “reasonably commensurate” test allows a nonprofit organization to have some UBI as long as it carries out charitable programs that are reasonably commensurate with its financial resources.[5] So, the IRS looks at the nonprofit’s operations as a whole by evaluating how it holds itself out to the public, the impact of its exempt activities, and how much of  its resources, effort, and time is expended on business activities in comparison to that of its exempt purpose. Overall, there is no clear cut-off at how much UBI will cause the IRS to disqualify a nonprofit’s tax-exempt status. 

How can you avoid UBI?

There are a few ways to avoid UBI altogether:

1.     Avoid the “regularly carried on” condition

2.     Play bingo!

3.     Primarily use volunteers instead of paid staff 

  1. Avoiding the “regularly carried on” condition:

Gaming is only considered “regularly carried on” if it is conducted with a frequency and continuity similar to comparable activities of a non-exempt organization and if pursued in a manner similar to commercial gaming activities.[6] Gaming activities will not usually be treated as regularly carried on if they occur occasionally or sporadically. For example, gaming conducted only at an annual fundraising event is not regularly carried on but a weekly bingo night is considered to be regularly carried on. So, whether the gaming is considered UBI depends on how often you are hosting the gaming events. 

  1. Play bingo:

There is a specific carve out for bingo games in the Federal Regulations.[7] The game cannot violate any state law and it must be played in a jurisdiction where bingo games are not regularly carried on by for-profit organizations. Michigan only allows bingo games to be conducted by nonprofit organizations, and it requires the organization to obtain a license.

But as long as you obtain the appropriate license, it seems that bingo games will not be considered UBI. In Michigan, there are specific requirements and exemptions for different types of games and depending on the size and frequency of the events, you can find more information here.[8]

  1. Use volunteers instead of paid staff:

The IRS has a volunteer labor exception, which states that if the organization relies on at least 85 percent volunteer labor to conduct the event, then it is not considered UBI. For game nights that are not a substantial part of your nonprofits activities, relying on about 85 percent volunteer labor to host the event will likely permit funds raised in these events to be tax-exempt.[9] The IRS publication specifically states that: “If you rely on the volunteer labor exclusion to exclude gaming from unrelated trade or business, you should maintain accurate records reflecting the number of hours worked by compensated and volunteer workers.” Therefore, if your nonprofit chooses this approach you will need to keep appropriate records. This IRS guide contains more information on recordkeeping requirements that apply specifically to tax-exempt organizations.

 

 By Keerthana Nunna


[1] INTERNAL REVENUE SERVICE, PUBLICATION 3079: TAX-EXEMPT ORGANIZATIONS AND GAMING 6, https://www.irs.gov/pub/irs-pdf/p3079.pdf.

[2] The UBI can be offset by the amount under 26 U.S. Code § 512(a)(7), which includes “all deductions directly connected with such income.”

[3] INTERNAL REVENUE SERVICE, PUBLICATION 598: TAX ON UNRELATED BUSINESS INCOME OF EXEMPT ORGANIZATIONS 2–3, https://www.irs.gov/pub/irs-pdf/p598.pdf.

[4] Rev. Rul. 64-182, 1964-1 C.B. 187,

[5] INTERNAL REVENUE SERVICE, UPDATE ON FUNDRAISING 3–5, https://www.irs.gov/pub/irs-tege/eotopicg86.pdf.

[6] Id.

[7] 26 CFR § 1.513-5.

[8] MICH. COMP. LAWS § 432 (2020), https://www.michigan.gov/documents/BSL-CG-BingoAct_31723_7.PDF.

[9] INTERNAL REVENUE SERVICE, PUBLICATION 3079: TAX-EXEMPT ORGANIZATIONS AND GAMING 7, https://www.irs.gov/pub/irs-pdf/p3079.pdf.

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