Sometimes nonprofits raise money using gaming activities. Normally revenue generated from these activities is subject to taxation because it’s unrelated business income (UBI). However, the IRS may exclude these activities from UBI if they fit into certain narrow criteria.
For a more in-depth look into unrelated business income taxation, check out IRS Publication 598 or our previous article on Unrelated Business Income Taxation. For more information specifically into tax-exempt organizations and gaming, check out IRS Publication 3079.
What is Unrelated Business Income?
Firstly, exempt organizations have to pay taxes on revenue that fits into the definition of UBI. To qualify, the income needs to meet the following elements:
- From a trade or business;
- Regularly carried on; and
- Not substantially related to the charitable purpose.
Gaming Activities Generally
Ordinarily, games of chance do not further an exempt purpose. Therefore, revenue generated from these games of chance fall into the definition of UBI. Because of that, the revenue is taxable unless there is an exemption.
Bingo is specifically exempted from UBI if the following elements are met:
- The activity meets the legal definition of bingo.
- Bingo is legal in that location.
- For-profit companies do not regularly conduct bingo games in that jurisdiction.
Whether or not bingo is legal is a local decision. Before you opt to use bingo as a fundraiser, make sure it’s legal where you are and you get the necessary permits or licenses. For example, in North Carolina nonprofits can host bingo under very specific circumstances and with the proper permit.
You also have to make sure for-profit companies aren’t regularly conducting bingo games in your jurisdiction. Again, this is based on your location.
Other Gaming Activities
Other games of chance may avoid being treated as UBI if they are:
- Conducted with substantially all volunteer labor,
- Qualified public entertainment activities, and
- Games of chance conducted in North Dakota.
Substantially all Volunteer Labor
Even if your gaming activities don’t meet the definition of bingo, revenue from them should be exempted from UBI if at least 85% of the labor was done by volunteers. To meet this threshold, you need to keep very detailed records. Keep in mind you still need to meet the other two criteria: legal and not regularly conducted by for-profit companies.
Diving deeper into this, you need to count all hours related to the activity. Therefore, a paid executive director or staff member must limit their time spent on this. Your volunteers must also be true volunteers. You cannot give them free entries into a raffle or bingo cards. Otherwise, the IRS would classify them as paid workers under this definition.
Qualified Public Entertainment
The qualified public entertainment exemption is a fun one! These are “traditionally conducted at a fair or exposition promoting agriculture and education, including any activity whose purpose is designed to attract the public to fairs or expositions or to promote the breeding of animals or the development of products or equipment”. These are basically your state and county fairs. However, in order to qualify for this exemption, you have to be a qualifying organization.
A qualifying organization is basically any exempt organization that regularly participates in the fair as one of its substantially exempt purposes.
Beyond fitting these definitions, the activity must be in conjunction with one of these major fairs, in accordance with certain state laws that permit these types of activities, or according to a very specific formula. That formula allows the exemption if done according to state law that allows the activity for 20 days or less on payment to the state of a lower percentage of the revenue from the activity.
More likely than not, you’re going to fall into the first category. For example, the Raleigh Jaycees participate in the State Fair each year. They host a booth called the “Turkey Shoot” as a fundraiser. At this point, the Turkey Shoot is a staple of the North Carolina State Fair. The IRS likely exempts this revenue because it fits into this definition of Qualified Public Entertainment.
More often than not, this exemption applies to organizations like 4-H, FFA, and similar organizations.
Games of Chance Conducted in North Dakota
I don’t really care about this exemption. It’s the product of lobbying and unfair differences across state lines. However, you should know about it if you’re in North Dakota. However, this only applies if the gaming activity is in North Dakota. It doesn’t matter where your nonprofit is established. Be forewarned that a lot of people use laws like this to promote setting up your nonprofit in states like North Dakota.
Laws have exceptions to exceptions and UBI is no exception. Yes, I wrote it that way on purpose. Social clubs that are exempt under section 501c7 of the IRC cannot qualify for the gaming exemption to UBI.
If you want to use a gaming activity as a fundraiser, you need to know your local laws on gambling as well as these laws on unrelated business income. Once you have them figured out, it’s easy to keep conducting the same activity as regularly as your state laws allow.
Personally, I don’t think games of chance are the best fundraisers. They take a lot of up front work and stress trying to stay within the laws. However, if you’re going to do them, I hope this article has helped you understand the unrelated business income taxation portion of them.