4.76.50  Examinations Of Organizations Conducting Gaming Activities

4.76.50.1  (09-15-2010)
Overview

  1. For many years , exempt organizations have operated Bingo, Pull-Tabs, Poker, many other types of games as a part of their activities. Why do organizations "game" ? Probably the number one reason is to raise funds – either to help cover the cost of running their organizations or to support worthy causes. For some organizations, gaming also permits its members to socialize with each other and fosters fellowship.

  2. The principal focus of these guidelines is on "bingo" and "pull-tab" games. While the guidelines may provide tools for analyzing other games, other games are generally not addressed directly.

  3. Additional assistance on gaming issues, particularly with regard to games other than bingo and pull-tabs, may be available through the Industry Specialist for Gaming.

4.76.50.1.1  (01-01-2004)
Definitions

  1. Definitions of terms used in these guidelines are based on definitions created by the North American Gaming Regulators Association (NAGRA), an association of commissioners of state lotteries, racing board directors, state and local law enforcement agencies, officials from departments of commerce and revenue, and attorneys from state attorney general offices.

    1. "Bingo" means a game of chance played for prizes with cards containing five rows of five squares bearing numbers, except for the center square which is a free space. Traditional bingo also requires the letters "B-I-N-G-O" appear in order over each column and no more than 75 numbers be used. The holder of a card, the" player," covers such numbers when objects similarly numbered are randomly drawn. The game is won by the first person covering a previously designated arrangement of numbers on such cards. A game of bingo begins with the first number called and ends when a player covers the previously designated arrangement, declares bingo, and the winning card is verified.

      Note:

      Beano, as it is played in Massachusetts, is the same as bingo.

      Note:

      The game known as "U-PICK-UM " meets the definition of bingo as per IRC 1.513-5(d).

    2. "pull-tab" means gaming pieces used in a game of chance which are made completely of paper or paper products with concealed numbers or symbols which must be exposed by the player to determine wins or losses.

      Note:

      Pull-tabs are known in various jurisdictions as charitable gaming tickets, break-opens, hard cards, banded tickets, jar tickets, pickle cards, Lucky Seven cards, Nevada Club tickets, instant bingo tickets, and other such names, and include the tickets used with tip boards, seal cards, and club special games.

    3. "Deal" means each separate game or series of pull-tab tickets with the same serial number.

    4. "Occasion" means a gathering at which a series of bingo games or a variety of other games are held and which is subject to time, prize, or game limitations established by each jurisdiction.

    5. "Prize" means cash or merchandise awarded to game winners. Merchandise prizes, including prizes donated, should be valued at fair market value.

    6. "Gross income" means gross receipts less prize payouts.

    7. "Gross receipts" means the amount received from the sale of any right to participate in a bingo game, including card sales and entry fees. Gross receipts also means the total amount received from the conduct of all gaming activities.

    8. "Net income" means gross receipts less prizes, taxes, and other allowable expenses.

4.76.50.2  (01-01-2004)
Pre-examination Analysis

  1. Determine the state agency in charge of enforcement over gaming activities conducted in the state.

    1. If possible, establish a personal contact within such agency.

  2. Obtain a copy of the state's gaming laws and regulations.

    1. Because state gaming laws are revised frequently, make certain the laws obtained were in effect for the years under examination.

  3. Learn the parameters of the state's gaming laws. Ascertain what types of organizations are allowed to conduct the gaming activities at issue and the conditions under which such organizations may conduct the games. Such conditions may include:

    1. A limit on the number of nights per week a single exempt organization can hold a gaming activity.

    2. A requirement the game be conducted by volunteers or employees of the exempt organization.

    3. Maximum pay out limitations; and other restrictions and requirements.

  4. Determine the state's reporting requirements.

  5. Review financial information reported periodically on the application for a gaming license, or required financial reports, filed with the state attorney general or other state gaming regulators.

    1. Amounts reported from the game under examination should be compared with games of similar size within the same jurisdiction.

    2. If the game under examination reports significantly less revenue and a smaller profit margin when compared to similar operations in its locality, that could indicate "skimming" or private purposes being served. In such cases, expand the scope of the examination.

  6. Other state regulators may also audit the organization. Review audit reports and/or investigators' memoranda of other regulators.

    1. For example, the State of Ohio Attorney General, Charitable Foundations Section, prepares detailed audit reports for bingo games.

    2. Investigative memoranda may also provide a summary description of complaints by the public regarding the organization's operation.

    3. Public records (e.g., applications for license) will generally be available to examiners; non-public records, such as audit reports, may be available only through a State/Federal Exchange Program. Contact the Area Disclosure Officer to determine if an Exchange Program exists.

4.76.50.3  (01-01-2004)
Initial Contact Overview

  1. Conduct a detailed interview with officers of the organization to determine its organizational structure and history. Also discuss whether the board monitors the game to ensure all funds are collected from the operator and workers.

4.76.50.3.1  (01-01-2004)
Facts to be Determined

  1. What types of gaming activities are conducted by the organization?

  2. Who conducts the activity?

  3. Who owns the hall where the activities are conducted?

  4. How are the games advertised?

  5. Who are the suppliers of the gaming equipment and/or supplies?

  6. What are the relationships between all parties involved in the conduct of gaming activities including, but not limited to, the exempt organization, the suppliers of the game pieces, the equipment suppliers, the operators of the games, the owner of the hall, and the workers?

  7. How long the gaming activity has been conducted?

  8. Is the gaming activity a departure from previous activities?

    Note:

    The factors in (6), (7) and (8) may provide evidence of private benefit or inurement.

  9. Review board minutes of the organization's decision to conduct gaming.

  10. What is the size and extent of gaming activities on an income, expense, and time basis?

  11. Has the manner in which the games have been conducted changed over time?

    Note:

    Significant changes in the operation may indicate the presence of private benefit or inurement.

  12. Talk to current and, if possible, former employees. If the organization will not divulge the names of former employees, consideration should be given to issuing a summons for such information IRM 4.76.50.9.3 and the Summons Multifunctional Handbook.

  13. Secure copies of all contracts.

4.76.50.4  (01-01-2004)
Analysis of Bingo Activity

  1. A typical bingo operation receives cash from various sources including the following:

    1. The sale of regular bingo games for the session;

    2. The sale of instant bingo cards (pull-tabs). The sale of pull-tabs is not only common at bingo operations, but often represents the bulk of a bingo operation's gross receipts;

    3. In addition to regular pull-tabs, some bingo operators sell" progressive" instant bingo jackpots, which can build up over time;

    4. Workers at booths or who roam throughout the crowd during the session sell pull tabs before, during, and after regular bingo games;

    5. The sale of food and beverages;

    6. The sale of dabbers and markers to incoming players.

  2. Substantial amounts of cash pass through many hands at the typical bingo operation, leaving the operation subject to numerous abuses. An important consideration is whether internal controls used by the organization demonstrate income and expenses are being properly reported.

  3. Determine if the bingo operation has a system of internal controls to safeguard adequately the revenue generated from the game. The internal control system should be structured so different people, each of whom serves as a check on the others, handle various parts of the gaming activity.

  4. The following is an example of various positions and responsibilities when an internal control system for a bingo operation is functioning properly. This example is not a mandatory internal control system; it is merely illustrative.

    1. The bingo operator controls execution of the game and records transactions of the game on the daily sheet.

    2. The cash controller independently counts the cash receipts and compares the cash on-hand to the inventory/paid out reports.

    3. The inventory controller reviews the daily sheets received from the operator to determine the inventory usage and profit achieved

    4. The check writer is responsible for making all payments related to the bingo game and for ensuring all deposits stated on the daily sheet appear on the bank statement.

    5. The Board of Trustees reviews and compares bingo reports or daily sheets with previous reports and bank deposits for consistency. The board should monitor the bingo game to ensure the internal controls, as described above, are functioning properly.

  5. Monitor the gaming activity while it is in operation. Determine the type of packages and/or specials purchased by bingo players at the beginning of a bingo occasion. Compare cash received at the door from bingo players (based, e.g., on a "head" count and estimates of average per player purchases) to door receipts reported previously by the bingo operation. While on site observation does not establish or disprove the accuracy of reported receipts, it may help the examiner determine the appropriate scope of the audit.

  6. Consider interviewing workers to determine if they are compensated for their services. IRM 4.76.50.8.3.for a general discussion of compensation. Where the exempt organization asserts its workers are uncompensated, request signed affidavits from all bingo workers listed on the charitable bingo license applications stating no cash payments or compensation was received from the organization.

  7. Determine whether other organizations conduct bingo at the same location. This information may be secured through interviews, licenses displayed at the site, or reports filed with state/local agencies. Problems identified with respect to one organization operating at a site may also exist with respect to other organizations operating at the same site. If so, consider whether an examination of other organizations is warranted.

4.76.50.5  (01-01-2004)
Analysis of Pull-tabs

  1. Consider reviewing the inventory of pull-tab supplies. Compare the boxes of pull-tabs to supplier invoices. In some instances, the bingo operator purchases pull-tabs for cash and the supply company does not provide an invoice to the charity. This creates a situation conducive to diverting funds from the charity.

  2. Where an organization's records do not reflect all pull-tab purchases, consider securing information from pull-tab manufacturers and/or suppliers to aid in reconstructing purchases.

    1. State laws generally require manufacturers and suppliers to have internal control procedures which enable them to track pull-tab deals by serial number.

    2. For those pull-tab deals not reflected in the organization's supplier invoices, contact the manufacturer to identify the supplier of the pull-tabs purchased for cash by describing the serial number and form number of the applicable deals. This information is printed on both the tickets and boxes of each pull-tab deal.

    3. Once the supplier is identified, consider interviewing the supplier's salesperson to determine the frequency of cash purchases by the organization. This will help in verifying the supplier provided copies of all the organization's pull-tab purchases when requested by the Service. IRM 4.76.50.6.3. for a discussion of pull-tab gross receipt analysis.

  3. Monitor the pull-tab sales. If the bingo operation uses floor workers to sell pull-tabs continuously before, after, and during the games, instant sales would be much higher when compared to games which sell pull-tabs solely from a booth. It is strongly recommended the examiner make an unannounced visit to view the gaming activities IRM 4.76.50.11..Pull-tab sales are not limited to bingo occasions. Often, pull-tabs are sold through arrangements with local bars and restaurants where in return for a cash payment by the organization, employees of the bar or restaurant sell the pull-tabs. To determine the tax consequences of such sales, the nature of the relationship between the exempt organization and the bar or restaurant must first be determined.

4.76.50.6  (01-01-2004)
Income Analysis

  1. An income analysis of bingo and pull-tab gross receipts is discussed in detail in IRM 4.76.50.6.2 and IRM 4.76.50.6.3.

4.76.50.6.1  (09-15-2010)
Gross Receipts Definition

  1. Gross receipts are the gross amount an organization received from all sources without reduction for any costs or expenses (e.g., before prizes). . Pursuant to IRC §6033(a)(1) and Treas. Reg. §1.6033-2(a)(1), gross receipts must be reported on Form 990 without reduction for prizes or similar expenses. See Treas. Reg. §1.6033-2(g)(4) on the definition of" gross receipts."

4.76.50.6.2  (09-15-2010)
Bingo Gross Receipts Analysis

  1. Reconcile the bingo operation's gross receipts reported on Form 990 to gross receipts reported on the summary of the daily bingo sheets. Trace the gross income from the bingo occasions to the bank deposit slip for each occasion. The bingo operation should be closely scrutinized if currency deposits are not made soon after each bingo occasion.

  2. Analyze the gross receipts to determine the potential for unreported revenue. The daily sheet for each bingo occasion usually reflects the bingo gross receipts from package sales, prizes paid, and the number of players in attendance. The average amount spent per player is computed by dividing the bingo gross receipts by the number of players in attendance. Compare the average spent per player to the prices for bingo packages sold during the bingo occasion.

  3. Potential for unreported revenue may also be determined by an analysis similar to the following:

    1. Determine a reasonable basis for estimating the average number of packages purchased per player.

      Example:

      Examiners in one region worked with gaming regulators and industry representatives to determine approximately 40% of bingo players at games in the area purchased the initial package; approximately 30% of the players purchased a second package; and approximately 30% of the players purchased a third package.

    2. Determine the average spent per player as reported on the daily sheets, as described in IRM 4.76.50.7.2(1).

      Example:

      (a) Number of bingo occasions for year. 100
      (b) Average attendance 200
      (c) Average receipts from Bingo $348,000
      (d) Average spent per person $17.40
      Line (c) divided by Line (a) divided by Line (b)

    3. Compare the average spent per player as reported to the average spent per player using the average number of packages purchased (Step 1) x the cost of packages.

      Example:

      Number of Packages Sold Per Player Cost Percent of Players Purchasing Cost Multiplied by Percent
      1 $15 40% $6.00
      2 $18 30% $5.40
      3 $20 30% $6.00
      Average Spent Per Person $17.40

    4. In this example, the average spent per person determined under each method is consistent. Accordingly, it appears revenues are being reported properly.

4.76.50.6.3  (01-01-2004)
Pull-tab Gross Receipts Analysis

  1. At many bingo games, the majority of profits are generated through the sale of instant bingo or pull-tabs. Instant bingo consists of the sale of pull-tab tickets, which come packaged in boxes. Each deal of pull-tabs sold will generate a specified gross income (sometimes referred to as "net profit" ) as indicated by the manufacturer.

    Example:

    An organization may purchase a pull-tab game called" Form 860" or "C-Note" . Each box contains 2,400 tickets that sell for $1.00 each. The box's winning tickets pay out a total of $1,992. This results in gross income of $408 (2,400 tickets at $1.00 less $1,992) for each box of tickets sold.

  2. Analyze the pull-tab income to determine if there were any unreported profits. Gaming regulators have reconstructed pull-tab operations that sold pull-tab tickets to players for $1.00 each. They determined for every dollar spent on pull-tab supplies, between eight to ten dollars in pull-tab profits is generated. If the examiner determines the pull-tab operation sold pull-tab tickets to players for $1.00 each and consistently reports around six dollars or less of pull-tab profits for each dollar spent on pull-tab supplies, the gaming operation may be under-reporting profits from the pull-tab operation.

    Note:

    The above pull-tab supply cost to profit ratio varies depending on the players purchase price of the pull-tab ticket.

    Example:

    If the pull-tab operation sells tickets to players for twenty-five cents, the regulators determined for every dollar spent on pull-tab supplies between four to five dollars in pull-tab profits is generated.

  3. Where the examiner suspects the organization is under-reporting pull-tab profits, consider completing the following analysis:

    1. Construct a schedule of the type of pull-tabs and the guaranteed profit for each deal purchased by the organization. Catalogues listing pull-tab profits for various deals may be obtained from suppliers.

    2. Compare the amount of pull-tab profits for all deals purchased by the organization for the year to pull-tab profits described per the general ledger; and

    3. Reconcile and obtain detailed documentation for any differences.

  4. Care should be taken when a gaming operation reports a smaller cost of pull-tab supplies compared to other organizations in its locale. In such cases, consider interviewing the salespersons of the supply companies to determine if any pull-tabs were purchased for cash. Sometimes when pull-tabs are purchased for cash, the supply company does not provide an invoice to the charity, and the profits from these deals are " skimmed" by the bingo operator.

4.76.50.7  (01-01-2004)
Expense Analysis

  1. In the case of charitable organizations whose primary purpose is to raise funds from gaming operations and pay the proceeds to charities, review any large grants or contributions to other charities. The grantee may be required to make kickbacks to for-profit fund-raising companies owned and operated by persons related to officers of the grantor. Contributions may be linked to the grantee's participation in supply or service agreements with the grantor officer's for-profit companies.

  2. A transfer to charity is generally treated as a charitable contribution if the transfer is made without adequate consideration. See American Bar Endowment v. United States, 477 U.S. 105 (1986).. Under Rev. Rul. 67-246, 1967-2 C.B. 104, one must show a contribution is being made with the intention of making a gift. While proof of donative intent may not always be required and may sometimes be inferred from surrounding circumstances, the intention to make a gift is, nevertheless, highly relevant in overcoming doubt in cases where there is a question whether an amount was paid as a purchase price or as a contribution.

  3. "Contributions" may also be linked to the grantee's providing" volunteers" to conduct gaming activities. In some jurisdictions, organizations conducting gaming activities enter into agreements (verbal or written) with other exempt organizations. These agreements provide, in exchange for the "contribution " , the grantee will provide "volunteers" to the grantor to assist in operating the gaming activities. These grants are not charitable contributions because they are made with the expectation of a return benefit. IRM 4.76.50.8.3. for discussion of whether the service of such "volunteers " is provided" without compensation" for purposes of IRC §513(a).

4.76.50.8  (01-01-2004)
Unrelated Business Income Tax

  1. The rules applicable in determining whether an exempt organization is subject to unrelated business income tax as a result of gaming activities are generally discussed in Announcement 89-138, 1989-45 I.R.B. 41 (Nov. 6, 1989). It states, in part, income from regularly conducted gaming activities is treated as unrelated business income, unless a specific exception applies.

  2. As discussed in subsection 50.9.6, recreational gaming activities may directly further exempt purposes, and therefore be " substantially related" income and not subject to unrelated business income tax, where the basis for exemption under the particular sub-section includes providing social/recreational activities for members. gaming activities involving the general public, however, are generally not "substantially related."

4.76.50.8.1  (01-01-2004)
Unrelated Business Exception Under IRC 513(f) for Bingo Games

  1. Determine if the bingo operation meets the exception from the unrelated business income under IRC §513(f). Games other than bingo, such as "instant bingo" and other pull-tab games are not within the IRC §513(f) exception.

  2. IRC §513(f) provides the term" unrelated trade or business " does not include any trade or business, which consists of conducting bingo games. For purposes of IRC §513(f), the term "bingo game" means any game of bingo:

    1. Of a type in which usually, the wagers are placed, the winners are determined, and the distribution of prizes or other property is made in the presence of all persons placing wagers in such game;

    2. The conducting of which is not an activity ordinarily carried out on a commercial basis; and

    3. The conducting of which does not violate any State or local law.

  3. Treas. Reg. §1.513-5(c)(2) provides bingo games are "ordinarily carried out on a commercial basis" within a jurisdiction, for purposes of IRC §513(f)(2)(B), if they are regularly carried on, within the meaning of Treas. Reg. §1.513-1(c), by for-profit organizations in any part of the jurisdiction.

    1. Normally the entire state will be the appropriate jurisdiction for determining whether bingo games are ordinarily carried out on a commercial basis.

    2. However, if state law permits local jurisdictions to determine if bingo games may be conducted by for-profit organizations, or if state law limits or confines the conduct of bingo games by for-profit organizations to specific local jurisdictions, then the local jurisdiction will be the appropriate jurisdiction for determining if bingo games are ordinarily carried out on a commercial basis.

  4. In determining if the conduct of the bingo games violates any State or local law, for purposes of IRC §513(f)(2)(C), review in detail the state or local law which permits the operation of bingo.

    1. Consider securing a legal opinion from the state or local law enforcement agency if the bingo operation appears to violate State or local law.

    2. In any factual account provided to a state or local law enforcement agency, be certain to delete all identifying references to the organization under audit to protect against possible disclosure violations.

  5. If the state or local government has made a judicial or an administrative adjudication of illegality with respect to the bingo game, income from the game is not within the exception provided in IRC §513(f).

  6. If the state is not willing to provide an opinion, and no adjudication has been made, consider contacting Area Counsel or Rulings and Agreements for assistance.

  7. The U.S. Tax Court held in Julius M. Israel Lodge of B'Nai B'rith No. 2113 v. Commissioner, 70 CCH Tax Ct. Mem. 673 (1995) that "instant bingo " does not satisfy the requirements of IRC §513(f) and the proceeds from instant bingo activities are subject to the unrelated trade or business income tax under IRC §511(a).

4.76.50.8.2  (01-01-2004)
Political Organizations and IRC 513(f)(2) Bingo

  1. In determining the taxable income of political organizations under IRC §527, proceeds from the conduct of any bingo games (as defined in IRC §513(f)(2)) are not included to the extent such amount is segregated for use only for the exempt function of the political organization. See IRC §527(c)(3)(D).

4.76.50.8.3  (01-01-2004)
UBI Exception Under IRC 513(a) and Reg. 1.513-1(e)(1)

  1. IRC §513(a)(1) and Treas. Reg. §1.513-1(e)(1) except from the definition of" unrelated trade or business " any trade or business in which substantially all the work is performed for the organization without compensation. The regulations do not specify a particular percentage as satisfying the "substantially all " requirement for this exception; however, the term "substantially all " is found elsewhere in the Internal Revenue Code and has been interpreted to be 85% or more. See, e.g., Treas. Reg. §53.4942(b)-1(c) and Treas. Reg. §1.514(b)-1(b)(1)(ii).

  2. The term "compensation " has broad application. In Waco Lodge No. 166, Benevolent & Protective Order of Elks v. Commissioner, 42 CCH Tax Ct. Mem. 1202 (1981), aff'd in part and rev'd in part, 696 F.2d 372 (Ct. Cl. 1983) aff'd in part and rev'd in part, 696 F.2d 372 (Ct. Cl. 1983), the Tax Court stated even free drinks or food provided to workers may be considered compensation for purposes of IRC §513(a). On appeal, however, the Fifth Circuit reversed the Tax Court's determination that any monetary or non-monetary payment, no matter how small, is "compensation" under the Code. Instead, the Fifth Circuit held whether non-monetary "payment " is "compensation" must be decided based on the facts and circumstances of each case. Using this as a guide, the Court of Appeals concluded the drinks and food given to workers in the Waco Lodge case was not "compensation " within the meaning of IRC §513(a)(1) since the average worker received the equivalent of only $0.63 an hour. The court stated it did not believe the Code's definition of compensation was meant to include such a "trifling" inducement.

  3. To determine if providing free food and beverages is payment of compensation for purposes of IRC §513(a)(1), the facts and circumstances of each case must be examined to determine if the amounts in question are de minimus and qualification for the exception is warranted.

  4. If the organization conducting the gaming activities makes a contribution to another exempt organization in return for the grantee providing volunteer labor, the amount paid is considered compensation in applying the volunteer labor exception in IRC §513(a). Because the organization is paying another organization for workers, the activity is not being performed for the payer organization without compensation. It is irrelevant that the workers are not compensated directly by the organization sponsoring the gaming activities. IRM 4.76.50.8 for discussion of the expense analysis on this issue.

  5. Tips received by workers from patrons constitute compensation within the meaning of IRC §513(a)(1). See Executive Network Club, Inc. v. Commissioner, 69 CCH Tax Ct. Mem. 1680 (1995). Thus, if workers receive tips, their labor is not performed without compensation for purposes of this exception.

  6. Secure a description of the duties of employees, contractors, and volunteers associated with the gaming occasions for the year under examination.

  7. All workers involved in the operation of the gaming activities must be taken into account. This includes, but is not limited to, workers involved in advertising the activity, the set-up and the clean up of the facilities, the actual operation of the gaming activity, concessions, accounting and legal services, and security.

  8. In determining if substantially all of the work is performed without compensation, the percentage of hours performed by compensated workers compared to volunteers is a relevant factor, but not the sole determinative factor. Although the term substantially all is not defined in the Code, a frequently used standard is 85 percent.

    Note:

    Payments to bartenders, waitresses, snack bar staff, maintenance workers, security, and other workers may be considered compensation for this purpose.

  9. If an exempt organization sponsors pull-tab games at a for-profit establishment, where employees of the establishment sell tickets, the organization may not use the exception in IRC §513(a)(1). The employees of the establishment are being compensated, albeit by a third party, and, therefore, the exception does not apply.

4.76.50.8.4  (01-01-2004)
UBI and Gaming in North Dakota

  1. Section 311 of the Deficit Reduction Act (DEFRA), (as amended by IRC §1834 of the Tax Reform Act of 1986) provides that for purposes of IRC §513 of the Code, the term unrelated trade or business does not include games of chance conducted by nonprofit organizations if the conduct of such games does not violate any state or local law and, as of October 5, 1983 there was a state law (originally enacted on April 22, 1977) in affect which permitted only nonprofit organizations to conduct such games. This provision applies to taxable years ending after June 30,1981. The amendment contained in the Tax Reform Act of 1986 limits the exception to games of chance conducted in North Dakota. Only North Dakota enjoys the exception for non-bingo gaming conducted after October 22, 1986.

4.76.50.8.5  (01-01-2004)
Deduction of "Lawful Purpose Expenditures" and Similar Amounts

  1. In South End Italian Independent Club, Inc. v. Commissioner, 87 T.C. 168 (1986), acq. in result, 1987-2 C.B. 1, the Tax Court held a tax-exempt social club in Massachusetts could deduct "lawful purpose expenditures" under IRC §162. These expenditures are amounts required under state law to be committed to so-called" lawful" purposes in order for the organization to retain its state gaming license. According to the court, these payments were not charitable contributions subject to the "10 percent of-income limitation" under IRC §512(b)(10), because they were involuntary expenditures made to obtain a quid pro quo. Instead, they were deductible under IRC §162 as being in the nature of a license retention expense. Following the opinion, the Service acquiesced in the result of the case.

  2. The issue of deductibility of lawful purpose expenditures and similar amounts under IRC §162 should be resolved consistent with the Service's acquiescence in the South End case. For this purpose, no distinction should be made based on whether the organization is described in IRC §501(c)(7) or some other provision, or on whether the gaming proceeds were donated to other charitable organizations or spent in the organization's own charitable activities.

  3. Women of the Motion Picture Industry, et al. v. Commissioner. 74 CCH Tax Ct. Mem. 1217 (1997) holds that tax-exempt organizations, that conduct instant bingo games are not entitled to business deductions for amounts transferred from their instant bingo accounts to their general accounts until the amounts are actually spent for charitable purposes. The court concluded the" transfer of ‘instant bingo’ proceeds to an organization's general fund is no more deductible than would be a contribution to a reserve for future liabilities. "

  4. The court did rule in favor of one of the organizations, Waldorf School Association of Texas Inc. (WSA), which paid $1.2 million to its bookkeeper during 1989, and was entitled to deduct a percentage of the amount paid based on the ratio which WSA's instant bingo proceeds bear to its total gross proceeds.

  5. Finally, the court held WSA was entitled to deduct as an ordinary and necessary business expense under IRC §162(a) the entire amount of its charitable payments in excess of the minimum amount required by state law (35 percent of instant bingo proceeds). The court rejected the Service's attempt to distinguish South End Italian Independent Club Inc. v. Commissioner, 87 T.C. 168 (1986) and found WSA" risked losing its bingo license if it used any part of its net bingo proceeds for other than charitable purposes. " By making the excess contributions, WSA was assured its license would not be revoked.

4.76.50.8.6  (01-01-2004)
IRC 512 (a)(3)

  1. IRC §512(a)(3) provides special rules used in determining unrelated business taxable income for certain organizations, including those exempt under IRC §501(c)(7). For covered organizations, the term" unrelated business taxable income " means gross income (excluding "exempt function income " as defined in IRC §512(a)(3)(B) less allowable deductions and with certain modifications. In general, exempt function income means income from payments by members as consideration for the organization providing members, their dependents, or guests, goods, facilities, or services furthering exempt purposes. Exempt function income also includes all income (except income from unrelated trade or business computed under IRC §512(a)(1)) which is set aside for a purpose specified in IRC §170(c)(4).

  2. Income from bingo games as defined in IRC §513(f) is not exempt function income unless:

    1. It is received from members under circumstances indicating the bingo game furthers exempt purposes; or

    2. It is set aside for a purpose specified in IRC §170(c)(4).

  3. If income from bingo does not meet one of these exceptions, an IRC §501(c)(7) organization is subject to tax on the income pursuant to IRC §512(a)(3).

4.76.50.8.7  (01-01-2004)
Allocation of Expenses

  1. As stated in IRM 4.76.2, where facilities or personnel are used both to carry on exempt functions and to conduct an unrelated trade or business, determine whether expenses, depreciation, and similar items are allocated between the two uses on a reasonable basis.

  2. Where an exempt organization conducts income-producing gaming activities, expense allocation issues may arise in a number of contexts. If the income from any such activity is subject to tax under IRC §511, care should be taken to ensure expenses relating to non-taxable activities are not improperly allocated to taxable activities in determining unrelated business taxable income. IRM 4.76.50.8.1, For example, pull-tab sales frequently account for the bulk of receipts at a bingo occasion; where this is true, and income from the bingo activity is excepted from tax pursuant to IRC section 513(f) , deductible expenses include only those attributable to the taxable pull-tab activity.

  3. Exhibit 4.76.50-1which provides examples of appropriate allocations.

4.76.50.9  (01-01-2004)
Qualification for Exempt Status

  1. Gaming activities may affect exempt status:

    1. When gaming serves a substantial non-exempt purposes;

    2. When determining foundation status and substantial income is from gaming;

    3. When gaming activities are illegal;

    4. When there is inurement and private benefit;

4.76.50.9.1  (01-01-2004)
Effect on Exempt Status Where Gaming Serves a Substantial Non-exempt Purpose

  1. If the organization is exempt under IRC §501(c)(3), determine if the gaming activity serves a non-exempt purpose. If the organization's gaming activity serves a non-exempt purpose and the non-exempt purpose is substantial, the organization is not exempt. An organization which conducts a large pull-tab operation may be engaged in an unrelated trade or business. But, if it has a charitable program (such as making grants to other charities), the commercial or business aspects may be considered incidental to the organization's charitable purpose. See Treas. Regs. §§1.501(c)(3)-1(c)(1), and 1.501(c)(3)-1(e)(1).

  2. The following cases provide examples of organizations, which were denied exemption on the basis of substantial non-exempt purposes

    1. In P.L.L. Scholarship Fund v. Commissioner, 82 T.C. 196 (1984) , the Tax Court held bingo games conducted by a scholarship fund in a commercial establishment serving food and drink were not operated exclusively for exempt purposes. The court stated that the fund raising activities were designed to enhance the profitability of the commercial establishment and agreed with the Service that the organization was not exempt under IRC §501(c)(3).

    2. In Make A Joyful Noise v. Commissioner, 56 CCH Tax Ct. Mem. 1003 (1989), the Tax Court held that operating regularly scheduled bingo games on behalf of other exempt organizations was a trade or business unrelated to the organization's exempt purposes. In this case, an exempt organization had been conducting bingo games but lost its state permit due to a change in state law. The organization began to lease its premises to other organizations and participate in the operations of the bingo games, receiving a portion of the gross receipts. The court found the organization did not prove its participation in the games was an insubstantial part of its activities. Because the organization could not demonstrate it conducted any charitable activities, and had only unfulfilled charitable objectives, the court upheld the Service's revocation. IRM 4.76.50.9.5.

    3. In KJ's Fund Raisers Inc. v. Commissioner, 74 CCH Tax Ct. Mem. 669 (1997) 82 AFTR2d, the Second Circuit in a summary order affirmed a Tax Court decision holding a corporation organized to raise funds for distribution to charitable organizations was operated for the substantial private benefit of a related corporation and its owners. Kristine Hurd and James Gould, owners of KJ's Place, a Vermont lounge, founded KJ's Fund Raisers Inc. (KJ's) to raise funds for distribution to charitable causes. KJ's primary fund-raising activity is the sale of "break-open" tickets at KJ's Place. In 1991 KJ's paid Hurd and Gould $6,000 each for their services, paid $6,000 in rent to KJ's Place, and distributed $12,500 to charities. The Service issued a preliminary adverse determination letter to KJ's in mid-1994 after which the corporation ceased paying Hurd, Gould, and KJ's Place. The corporation petitioned the Tax Court for a declaratory judgment. The Tax Court agreed with the Service and held KJ's was not entitled to exemption under IRC section 501(c)(3). KJ's argued it was entitled to tax-exempt status because its operations were in compliance with Vermont's 1994 law governing the sale of break-open tickets. The appeals court stated KJ's argument was irrelevant to a determination of whether the corporation had satisfied the requirements of IRC section 501(c)(3).

4.76.50.9.2  (01-01-2004)
Treatment of Gaming Income In Public Support Determinations

  1. Receipt of substantial gaming income may affect the private foundation status of an IRC 501(c)(3) organization and may, in turn, have other consequences.

  2. In determining if an organization is described in IRC section 170(b)(1)(A)(vi), gross receipts from activities not considered an unrelated trade or business (including bingo receipts that are non-taxable under IRC section 513(f)) are generally excluded from public support computations.

  3. Exhibit 4.76.50-2for an example of computing foundation status under IRC sections 509(a)(1) and 170(b)(1)(A)(vi) for a charitable organization, that has substantial gross receipts from bingo and pull-tabs.

  4. In determining if an organization is described in IRC section 509(a)(2), gross receipts, if derived from an activity which is not an unrelated trade or business, are included in both the denominator and the numerator of the support fraction.

  5. Gross receipts from gaming activities, which are not unrelated trade or business, are counted as" public support" in determining if an organization qualifies as a publicly supported organization under IRC section 509(a)(2). Because unrelated business income IRM 4.76.50.9.4 is included in IRC section 509(a)(2) determinations on a net basis (in contrast to including income from not unrelated activities on a gross basis) IRC section 501(c)(3) organizations which receive a significant portion of their support from non-taxable gaming activities, such as bingo, will therefore generally be classified as other than private foundations pursuant to IRC section 509(a)(2).

  6. Exhibit 4.76.50-3 for an example of computing foundation status under IRC section 509(a)(2) for a charitable organization, that has substantial gross receipts from bingo and pull-tabs.

  7. An IRC section 501(c)(3) organization receiving all its support from gaming activities, which are unrelated trade or business, may face certain adverse consequences. If the organization's sole source of support is from an unrelated trade or business, it may not meet the requirements for classification as a publicly supported organization under either IRC section 509(a)(2) or 170(b)(1)(vi). Accordingly, it may be a private foundation. Classification as a private foundation has numerous consequences for the organization.

  8. Exhibit 4.76.50-4 for an example of the adverse consequences for a charitable organization, which has substantial gross receipts from bingo and pull-tabs determined to be an unrelated trade or business.

    1. In Education Athletic Association Inc. v. Commissioner, 77 CCH Tax Ct. Mem.1525 (1999), (EAA) the Tax Court held a section 501(c)(3) organization which promotes athletic education is a private foundation because its sole source of income was from the sale of pickle cards, which was an unrelated trade or business. The court concluded the sale of pickle cards did not contribute importantly to the organization's exempt purpose even though all sale proceeds were used in furtherance of those activities. The court stated the "mere production of income to fund an exempt organization's activities is insufficient to establish a substantial causal relationship between the trade or business and the exempt activity. "

    2. Under IRC section 4943, a foundation and disqualified persons with respect to it may not together hold more than 20% of the interest in a business enterprise. The term" business enterprise" generally includes the active conduct of a trade or business, including any activity regularly carried on for the production of income from the sale of goods or the performance of services which constitutes an unrelated trade or business under IRC section 513. See Treas. Reg. section 53.4943-10(a)(1).

    3. If an organization is classified as a private foundation because its sole source of support is from an unrelated trade or business, it may have excess business holdings in a business enterprise within the meaning of IRC section 4943(a)(1), and may have to divest itself of them. Generally, the organization must cease to operate its gaming activities (or at least substantially restructure its operations and sources of support).

4.76.50.9.3  (01-01-2004)
Effect of Illegal Gaming Activities

  1. Under common law, the term "charity " encompasses all the major categories identified separately under IRC section 501(c)(3). Thus, an organization described in IRC section 501(c)(3) as being organized and operated exclusively for exempt purposes must be a common law charity.

  2. As a matter of trust law (one of the main sources of the law of charity), no trust can be created for a purpose which is illegal. The purpose is illegal if the trust property is to be used for an objective, which violates criminal law, or if the trust tends to induce the commission of crime, or if the accomplishment of the purpose is otherwise against public policy. Scott on Trusts, section 377 (3d ed. 1967). Thus, all charitable trusts (and by implication all charitable organizations, regardless of form) are subject to the requirement their purposes may not be illegal or contrary to public policy. These concepts are set forth in Rev. Rul. 71-447, 1971-2 C.B. 230.

  3. Furthermore, IRC section 513(f)(2)(C) requires the Service to tax the proceeds of any game of bingo, which violates State or local law. Therefore, if conducting the game of bingo violates any state or local law; the unrelated business income tax may be imposed (provided no other exclusion from unrelated business income tax applies).

  4. The Service cannot make determinations about the illegality of activities under laws other than the Internal Revenue Code. If a state or locality has not taken action with respect to a purported illegal act, the Service cannot declare the act illegal and revoke exemption.

  5. However, If an IRC section 501(c)(3) organization engages in an activity which clearly violates state law (e.g., the state requires a gaming permit and the organization does not have one), the examiner should raise the illegality issue. The illegal activity may be used as one basis for proposing revocation of exempt status, but it should not be the sole basis. If the organization is engaged in an illegal activity, there is usually a concomitant private benefit, inurement, or substantial non-exempt purpose. Any proposed revocation should address all issues fairly presented by the facts of the particular case.

  6. If the examiner is not certain an activity violates state law, and the state gaming authority is willing to do so, the examiner may request an opinion from the state gaming authority as to whether the activity is in violation of the law. Be aware of the disclosure problems involved. IRM 4.76.50.8.1

  7. The illegality/public policy doctrine applies under IRC section 501(c)(4) in a manner similar to its applicability under IRC section 501(c)(3). See Rev. Rul. 75-384, 1975-2 C.B. 204.

  8. For organizations exempt under IRC sections 501(c)(7), (c)(8), (c)(10), or (c)(19), the illegality of gaming activities will not jeopardize exemption if the activities further the exempt purposes of the membership organization. See Rev. Rul. 69-68, 1969-1 C.B. 153. IRM 4.76.50.9.6

4.76.50.9.4  (01-01-2004)
Inurement and Private Benefit

  1. IRC section 501(c)(3) organizations may not engage in transactions which serve private interests more than insubstantially or which allow their earnings to inure to the benefit of private shareholders or individuals. The penalty for such violations is revocation of IRC section 501(c)(3) status. (Alternatively, the organization may be liable for taxes on alternative benefit transactions. For a discussion on IRC §4958 , please refer to IRM 7.25.3.16.)

  2. In addition to section IRC 501(c)(3), several other Code sections include prohibitions against inurement, including IRC section 501(c)(7), which provides for the exemption of non-profit social clubs. Because the prohibition against inurement is absolute, even a small amount of private inurement is fatal to exemption. In Spokane Motorcycle Club v. United States, 222 F. Supp. 151 (Ct. Cl. 1963), net profits were found to inure to private individuals where refreshments, goods, and services amounting to $825 (representing 8% of gross revenues) were furnished to members of an IRC 501(c)(7) club. (But see paragraph 2 of this subsection) regarding Public Law 94-568).

  3. Treas. Reg. section 1.501(c)(3)-1(d)(1)(ii) states the burden of proof is on the organization to establish it is not organized and operated for the benefit of private interests. Since inurement issues are highly fact dependent, the courts do not look with favor on failure to provide relevant facts and they do not hesitate to find an organization has failed to carry it, See e.g.,.Church of Gospel Ministry, Inc. v. United States, 58 A.F.T.R.2d 86-5232 (Ct. Cl. 1986); Universal Bible Church, Inc. v. Commissioner, 51 CCH Tax Ct. Mem. 936 (1986).; Schoger Foundation v. Commissioner, 76 T.C. 380 (1981).

  4. Abuses may exist in tightly controlled bingo operations. Sometimes, individuals with no apparent charitable history form an organization. The stated exempt purpose of such an organization is to conduct gaming operations and make grants to other organizations. The organization then employs the individuals who created it to operate the gaming activities. If the organization was created to provide employment for the founding individuals, the organization may have a substantial non-exempt purpose precluding exemption under IRC section 501(c)(3). IRM 4.76.50.9.5and See Text 50.9.5.

  5. See IRM 7.25 , for other examples of inurement.

  6. If it is determined an organization is conducting a charitable program and the inurement and/or private benefit issues can be corrected, consideration should be given to implementing the provisions of IRC section 4958 (Intermediate Sanctions).

4.76.50.9.5  (01-01-2004)
Other Factors for Determining "Private Benefit"

  1. Rev. Rul. 64-182, 1964-1 (Part 1) C.B. 186, concluded an organization qualified for exemption under IRC section 501(c)(3) where it used the proceeds from a business activity to conduct a charitable program, commensurate in scope with its financial resources, of making grants to other charitable organizations. Thus, an organization whose principal activity is operating games of chance may nevertheless qualify for exemption, provided it uses the proceeds of the business activity in a real and substantial charitable program (such as charitable grant making) commensurate in scope with its financial resources, and otherwise meets the requirements for exemption. If an organization conducts a charitable program as described in Rev. Rul. 64-182, it is not a "feeder" organization whose exemption is prohibited by IRC section 502, even though its primary activity is a business activity. See Treas. Reg. section 1.501(c)(3)-1(e)(1).

  2. An organization satisfying the commensurate test will generally be considered to be serving primarily charitable purposes. An organization which does not meet the commensurate test should be carefully analyzed to determine whether it serves a private rather than a public interest under Treas. Reg. section 1.501(c)(3)-1(d)(1)(ii). Generally, an organization, which does not have a significant charitable program, should be carefully examined to determine whether its purpose is to serve private interests.

  3. In many instances, a bingo or pull-tab operation is the principal activity for the charitable organization. Bingo and pull-tab operations generally do not further IRC section 501(c)(3) purposes directly. Unless there is a significant charitable program using the funds derived from the bingo or pull-tab operations, the organization may not be considered described in section 501(c)(3). Thus, to be considered as serving public rather than private interests, the organization must operate a real and substantial charitable program "commensurate" in scope with its financial resources.

  4. In Rev. Rul. 67-5, 1967-1 C.B. 123, the Service found a foundation controlled by its creator's family, was operated to enable the creator and his family to engage in financial activities which were beneficial to them, but detrimental to the foundation. This resulted in the foundation's owning non-income-producing assets, which prevented it from carrying on a charitable program commensurate in scope with its financial resources. The Service concluded the foundation was operated for a substantial non-exempt purpose and served the private interests of the creator and his family. Therefore, the foundation was not entitled to exemption from federal income tax under IRC section 501(c)(3).

  5. In Help the Children, Inc. v. Commissioner, 28 T.C. 1128 (1957), an organization operated bingo games. Its charitable function consisted of contributions to charitable institutions of amounts, which were insubstantial when compared to gross receipts from the bingo games. The court held the organization did not qualify for exemption under IRC section 501(c)(3) because it did not operate any charitable institutions and its principal activity was the profitable operation of bingo games on a business or commercial basis.

  6. In Pius XII Academy v. Commissioner, 43 CCH Tax Ct. Mem. 634 (1982), the court held an organization which claimed to be a school failed to supply information to enable a conclusion that when operational (if ever), it would conduct its activities in a manner which would accomplish IRC section 501(c)(3) purposes. The organization planned to conduct bingo games and eventually use the money to operate a school. The court agreed with the Service that the organization presented only vague ideas about the operation of the school and was more interested in obtaining a bingo license. Because the organization could not describe its exempt activities in sufficient detail, it failed the operational test for exemption under IRC section 501(c)(3).

  7. Whether an organization's charitable program is real and substantial and commensurate in scope with its financial resources is determined by considering all relevant facts and circumstances. An organization which raises funds ostensibly for charitable purposes but consistently uses virtually all its income for administrative and promotional activities is subject to challenge based on serving private rather than public interest under Treas. Reg. section 1.501(c)(3)-1(d)(1)(ii).

  8. If the examiner finds the amount expended by the exempt organization for its charitable program is commensurate in scope with its financial resources, it may continue to be recognized as exempt (absent evidence of inurement, substantial private benefit, or other substantial non-exempt purposes).

  9. The following factors may be relevant in determining whether an organization with a small charitable program compared to its resources is serving private interests:

    1. The reasons for the small charitable program, and whether the reasons are beyond the organization's control (e.g. high state taxes on gaming receipts, state-imposed pay out requirements) or are transitional in nature (e.g. start up costs).

    2. Whether the gaming activity is conducted using significant donated input (labor, space, etc.).

    3. Whether the organization accumulates substantial amounts, or whether the organization pays out virtually all its net income for charitable purposes within a reasonable period of time.

    4. Whether private benefit or inurement exists;

    5. Whether the organization's charitable program is comparable to similarly situated organizations in the area; and

    6. Any other relevant facts and circumstances.

4.76.50.9.6  (01-01-2004)
Qualification Issues - Other Than IRC Section 501(c)(3)

  1. IRC section 501(c) describes several categories of organizations whose exempt function includes providing social or recreational activities for members and their guests. These include social clubs under IRC section 501(c)(7); fraternal organizations under IRC section 501(c)(8) or 501(c)(10); and veterans' organizations under IRC section 501(c)(19). Such organizations generally may, consistent with exempt status, conduct recreational gaming activities in which members and guests participate IRM 4.76.50.9.3). gaming activities involving the general public, however, do not directly further exempt social/recreational purposes.

    Note:

    The impact of gaming on exempt status is discussed generally in Chapter 2 of Publication 3079, Gaming Publication for Tax-Exempt Organizations.

  2. Where social/recreational purposes are included under a particular exemption provision, it is important to analyze the meaning of "membership" . Membership status that permits the "member" to participate in a particular social/recreational activity may be insufficient to distinguish a member from the general public. For example, Rev. Rul. 58-588, 1958-2 C.B. 265, held an organization formed to operate a health, recreational, and social club did not qualify for exemption under IRC section 501(c)(7) where its predominant activity was selling services to an unlimited number of so-called "members" who had no right in the management of the club and whose only rights were to use the facilities upon the payment of specified fees. See also Rev. Rul. 66-225, 1966-2 C.B. 227, where the organization sold "temporary " memberships to guests at an adjoining motel; IRM 7.25.7, the club as a subterfuge for business with general public; and also see Rev. Rul. 64-194, 1964-2 C.B. 149, "social" memberships of IRC section 501(c)(8) organizations.

  3. As noted in paragraph (1), gaming activities involving guests of members may also further recreational/social purposes. The mere presence of non-members at a gaming activity does not in itself further exempt purposes. Rather, entertainment activities (such as gaming) provided to bona fide guests of members may further social/recreational purposes. A bona fide guest is one where the member pays the cost of the non-member's participation.

  4. gaming conducted off the premises of an exempt organization is rarely, if ever, "substantially related" to exempt social/recreational purposes, even if the organization can establish some portion of the income is derived from members.

  5. The extent to which an exempt organization may conduct non-exempt business activities, consistent with exempt status, is addressed elsewhere. See IRM 7.25.4 (non-exempt activities under IRC section 501(c)(4); IRM 7.25.6, (IRC section 501(c)(6) organization must be primarily engaged in activities or functions constituting the basis for its exemption); IRM 7.25.7 (dealings with public under IRC section 501(c)(7); IRM 7.25.8 (effect of business activity on exemption under IRC section 501(c)(8).

  6. IRC section 501(c)(4). In general, the conduct of gaming as a recreational activity does not bring about civic betterment and social improvement and thereby promote social welfare within the meaning of IRC section 501(c)(4). The impact of gaming on exempt status of IRC section 501(c)(4) organizations is discussed in Chapter 2 at Publication 3386, Tax Guide Veterans' Organizations.

  7. IRC section 501(c)(5). gaming activities are not related to the exempt purposes of a labor organization exempt under IRC section 501(c)(5). See Rev. Rul. 59-330, 1959-2 C.B. 153.

  8. IRC section 501(c)(6). Like providing luncheon and bar facilities (see Rev. Rul. 70-244, 1970-1 C.B. 132), gaming activities do not directly further business league purposes and therefore would generally not, standing alone, support exemption under IRC section 501(c)(6). Moreover, such activities may violate the prohibition in Treas. Reg. section 1.501(c)(6)-1 which holds the purpose of a business league may not be to engage in a regular business of a kind ordinarily carried on for profit.

  9. IRC section 501(c)(7). Recreational gaming activities involving members and their guests furthers the exempt purposes of a social club exempt under IRC section 501(c)(7). See Rev. Rul. 69-68, 1969-1 C.B. 153 and Rev. Rul. 74-425, 1974-2 C.B. 373.

    Note:

    The impact of gaming on exempt status of IRC section 501(c)(7) organizations is discussed in Chapter 3 of Publication 3386, Tax Guide Veterans' Organizations.

  10. IRC sections 501(c)(8)/501(c)(10). Recreational gaming activities of fraternal associations exempt under IRC section 501(c)(8) or 501(c)(10) are related to the exempt social and recreational (" fraternal" ) purposes of such organizations to the extent of members' participation in such activities. To the extent nonmembers participate in such activities, however, the activities are generally not related to the exempt purposes of fraternal organizations.

    Note:

    The effect of gaming on exempt status of IRC section 501(c)(8) organizations is discussed in Chapter 4 of Publication 3386, Tax Guide For Veterans' Organizations.

4.76.50.10  (01-01-2004)
Related Entities

  1. Identify related entities as early as possible in the examination. The gaming operation may have related management, real estate, supply, equipment, or concession companies.

  2. Determine that any management, real estate, supply, equipment, or concession companies receive only reasonable compensation as would ordinarily be paid for like services by like enterprises under like circumstances as described in Treas. Reg. section 1.162-7(b)(3).

  3. Review any management, supply, rental, or concession agreements. Closely scrutinize agreements in which an exempt organization pays for management, rental, supplies, or equipment based on gross receipts or gross or net income from the bingo or pull-tab operation.

  4. The following factors in a management or operating agreement may indicate private benefit or inurement:

    1. The contract is lengthy in duration.

    2. The contract provides penalties if the exempt organization terminates the agreement.

    3. The gaming operator was not selected through open bidding or the organization lacks documentation to support such a claim.

  5. A sub-lease is sometimes used to divert money from an exempt organization. In such an arrangement, a commercial operator leases property from the owner, and then becomes the landlord to the exempt organization, charging rent exceeding the amount paid to the primary lessor. Charging rents in excess of fair market value siphons off profits. This allows the operator-landlord to retain the bulk of the profits of the games and may give the operator-landlord a direct pecuniary interest in the profitability of the bingo games. Compare the rent paid by the commercial operator under the primary lease to the rent paid by the exempt organization under the sub-lease. If the rent paid by the exempt organization appears to be disproportionately high when compared to the rent charged under the primary lease, there could be private benefit/inurement issues.

4.76.50.11  (01-01-2004)
Determining Who Conducts the Activity

  1. To resolve certain exempt organization issues the relationship between the exempt organization and the professional operator and/or supplier must be determined.

4.76.50.11.1  (01-01-2004)
Types of Relationships

  1. Determine whether the relationship is an agency relationship, joint venture, sale/license agreement or a more complex arrangement.

4.76.50.11.1.1  (01-01-2004)
Agency

  1. An agency relationship exists if

    1. The agreement/relationship between the parties manifests an intent the contractor act on the exempt organization's behalf in conducting the business activity, and

    2. The exempt organization can control the contractor's activities performed on its behalf.

  2. If an agency relationship exists, the activities of the agent (operator/supplier) are attributable to the principal (the exempt organization) See National Collegiate Athletic Association v. Commissioner, 92 T.C. 456 (1989), rev'd on other grounds, 914 F.2d 1417 (Ct. Cl. 1990).

4.76.50.11.1.2  (01-01-2004)
Joint Ventures

  1. Where the contractual relationship is not one of agency, a joint venture (taxable as a partnership pursuant to IRC sections 761(a) and 7701(a)(2)) may be created. Then, the income taxable to each party will be determined under the partnership taxation principles in Subchapter K; and the exempt organization's treatment of the income, for unrelated business income tax purposes, will be governed by IRC section 512(c). Also, whether an activity is regularly carried on, would depend on the activities of the venture, and not be based solely on the exempt organization's activities. As a rule, the Service will not find a partnership where the parties did not intend to create one.

4.76.50.11.1.3  (01-01-2004)
Sale/License

  1. If the factors indicating agency are not present, the relationship between the parties may involve the sale of the right to conduct the gaming. The key factors to examine in determining if the exempt organization has sold or licensed the use of its exemption to obtain a state permit to conduct gaming are

    1. The intent of the parties;

    2. Who has the right to control the activity; and

    3. The fee arrangement.

4.76.50.11.1.4  (01-01-2004)
Complex Arrangements

  1. A particular arrangement may employ both elements of agency and licensing; an exempt organization may license its right to conduct gaming but hire a manager for concessions, for example. Each arrangement should therefore be examined carefully to determine how it should be characterized.

4.76.50.11.2  (01-01-2004)
Implications

  1. Ascertaining whether the exempt organization or a third party is conducting the gaming activity may affect determinations on the following issues:

    1. Illegality: The determination of who is conducting the activity may affect the determination of whether a gaming activity is legal under state law. Often, state laws concerning gaming require the licensed exempt organization to conduct the gaming activity directly and not to use professional managers or paid employees. Determining if an exempt organization is conducting the gaming activity may thus affect both exemption determinations as well as unrelated business income determinations (See Text 50.8.1).

    2. Exemption for IRC section 501(c)(3) Organizations: Where an IRC section 501(c)(3) organization sells or licenses the use of its exemption to a professional operator to conduct the exempt organization's gaming activities, it may be furthering the private interests of the gaming operator rather than the public interest and, if substantial, could result in loss of exemption. IRM 4.76.50.9.4and IRM 4.76.50.9.5for a further discussion of inurement and private benefit.

    3. Exemption for IRC section 501(c)(4) Organizations: Because IRC section 501(c)(4) organizations are precluded from carrying on a business with the general public in a manner similar to organizations operated for profit (Treas. Reg. section 1.501(c)(4)-1(a)(2)(ii)), the determination of who is conducting a gaming activity is significant in determining an organization's qualification for exemption under IRC section 501(c)(4). If the gaming activities are being conducted by the organization, exemption may be precluded if the organization's activities (including those of its agents) do not primarily further social welfare purposes . Regardless of whether conducted directly or through an agent, gaming as a primary activity would jeopardize 501(c)(4) exemption. In addition, issues dealing with inurement may preclude exemption in these circumstances.

      Example:

      If the gaming license is subsequently sold to another entity, an inurement issue may arise.

    4. Unrelated Business Income Tax Considerations: Whether an organization receives income from the conduct of gaming activities (and the proper unrelated business income tax treatment of these amounts) will depend in large measure on its role in conducting those activities. Rev. Rul. 77-121, 1977-1 C.B. 17, and Rev. Rul. 72-542, 1972-2 C.B. 37, together establish the following principle: If the exempt organization is the "promoter" of, and bears the risk of loss from the activity, receipts are included in its gross income, not the operator's. Where, on the other hand, the exempt organization's role is limited to having its name associated with the event and accepting payment of the net income, the operator must include the gross receipts in its income. Also of relevance is National Collegiate Athletic Association v. Commissioner, 92 T.C. 456 (1989), rev'd on other grounds, 914 F.2d 1417 (Ct. Cl. 1990), rev'd on other grounds, 914 F.2d 1417 (Ct. Cl. 1990), which held activities of an "agent" who conducts business activities on behalf of an exempt organization are attributed to its principal for purposes of the unrelated business income tax provisions.

4.76.50.12  (01-01-2004)
Books and Records

  1. Treas. Reg. section 1.6001-1(c) requires exempt organizations to keep such permanent books of account or records as are sufficient to show specifically items of gross income, receipts, and disbursements. In addition, organizations must keep such books and records as are required to substantiate the information required by IRC section 6033 and the regulations thereunder.

  2. With respect to liability for unrelated business income tax under section IRC 511, organizations must also maintain books and records, required by Treas. Reg. section 1.6001-1(a), sufficient to establish the amount of gross income, deductions, credits, or other matters required to be shown on Form 990-T.

  3. Specific record-keeping requirements are provided concerning non-member income of social clubs exempt under IRC section 501(c)(7). See Rev. Proc. 71-17, 1971-1 C.B. 683, discussed in IRM 7.25.7.

    Note:

    The record keeping responsibilities are discussed generally in Chapter 3 and Exhibit B of Publication 3079, Gaming Publication for Tax-Exempt Organizations.

4.76.50.13  (01-01-2004)
Package Audit Considerations

  1. Specific audit considerations concerning gaming operations may include:

    1. Coordination of examination of exempt organization returns and bingo operator returns;

    2. Federal taxes on wagering;

    3. Form W-2G (Wage and Tax Statement);

    4. Withholding for nonresident aliens; and

    5. Employment taxes and tip income.

4.76.50.13.1  (01-01-2004)
Coordination of Examination of Exempt Organization Returns and Bingo Operator Returns

  1. Attempt to identify questionable items relating to the bingo operators Form 1040, U.S. Individual Income Tax Return, or Form 1120, U.S. Corporation Income Tax Return.

    1. The examiner is responsible for determining if a potential adjustment to a related income tax return is subject to discrepancy adjustment procedures.

    2. If a potential adjustment is determined not to be subject to discrepancy procedures, the workpapers should briefly explain the reason.

    3. If the income tax return warrants examination, refer it to the appropriate LMSB or SBSE Function with a request to conduct a collateral examination.

    4. Coordination will consist of keeping each other informed as to the progress of the examinations.

    5. The disclosure officer should be consulted when the examiner intends to disclose information resulting from related examinations conducted by the LMSB or SBSE Functions.

    Example:

    The exempt organizations selected for examinations by the LMSB or SBSE Functions are those skimming the cash proceeds from the bingo operation. If LMSB or SBSE's audit of the bingo operator discloses a substantial understatement of income, this fact would benefit the development of the administrative record compiled for the examination of the charity.

4.76.50.13.2  (01-01-2004)
Federal Taxes on Wagering

  1. Determine if the exempt organization is liable for federal excise taxes, which apply to wagering activities. Federal wagering tax laws apply to both legal and illegal gaming activities conducted by the exempt organization. The facts and circumstances of the types of wagering conducted, as well as the benefits derived therefrom may have a bearing on whether the wagers are subject to the taxes. See Publication 3079, Gaming Publication for Tax-Exempt Organizations for guidance.

  2. Wagers are subject to the tax without regard to the outcome of individual bets. The tax applies to

    1. Wagers on sports events or contests placed with a person engaged in the business of accepting such wagers,

    2. Wagers placed in a wagering pool which involves a sports event or contest, if the pool is conducted for profit, and

    3. Wagers placed in a lottery conducted for profit.

  3. Most legal wagering conducted by non-profit organizations relates to lotteries. "Pull-tab" or "instant " games meet the definition of taxable wagers placed in a lottery. Bingo games are specifically excluded from the tax. The term "lottery" does not include any wagering conducted by an exempt organization if no part of the net proceeds derived from the activity inures to the benefit of any individual. See Rev. Rul. 57-241, 1957-1 C.B. 419.

    1. In Choctaw Nation of Oklahoma v. United States , 85 AFTR2d, 00-1382 the court held an Indian tribe is not exempt from the gaming excise and occupational taxes imposed by IRC sections 4401 and 4411 and "pull-tab" games are essentially like lotteries which are taxable games. While the Choctaw Nation argued pull-tabs were not a lottery, the court held it was a lottery because the winner, or winning card, has been predetermined outside the players' presence. The court made a comparison between pull-tabs and a blackjack game, which is excluded, from the definition of a lottery. The pull-tabs were preprinted with winning or losing combination of symbols. When a player purchases a pull-tab card, the card has already been determined to be a winning ticket or losing ticket outside the players' presence. However, in blackjack card game, the winner or loser is not predetermined. Therefore, a blackjack card game meets the exclusion from being a lottery because the wagers are placed, winners are determined and distribution of prizes is made in the presence of all persons placing wagers. The same is not true for pull-tabs.

    2. In Chickasaw Nation v. United States, 85 AFTR2d, 00-1301,affirmed by the Supreme Court in Chickasaw Nation v. United States, 122 S. CT. 528 , certiorari to United States court of appeals for the tenth circuit. No. 00–507, argued Oct. 2, 2001– decided Nov. 27, 2001, the court ruled in a similar manner holding Chickasaw Nation was subject to the occupational taxes imposed by IRC sections 4401 and 4411 since a pull-tab game is like a lottery because the winner, or winning card, has been determined at the time the series is manufactured, and thus, the winners are predetermined outside the presence of any persons placing wagers and is therefore a lottery.

  4. Whether inurement exists may depend on the section of the Code under which a particular organization is exempt. However, where participation in the revenue raising activity is limited to members of a social or fraternal organization, inurement is not established since the financial resources are merely shifted between members of the group. See Rochester Liederkranz v. United States, 450 F.2d 152 (Ct. Cl. 1972).

  5. There are two types of wagering taxes, and the rates vary depending on whether state law authorizes the wagers.

    1. IRC section 4401(a)(1) imposes a 0.25% tax on the amount of any taxable wager authorized under the law of the state in which accepted.

    2. IRC section 4401(a)(2) imposes a 2% tax on the amount of taxable wagers not described in IRC 4401(a)(2) (i.e., those not authorized by state law).

    3. IRC section 4411(a) imposes an occupational tax of $500 per year on each person liable for the tax under IRC section 4401 on wagers, or upon the person engaged in receiving wagers for or on behalf of any person so liable.

    4. IRC section 4411(b) reduces the occupational tax to $50 where liability for the tax under IRC section 4401 is determined under IRC section 4401(a)(1) (i.e., state authorized wagers) and for persons who are engaged in accepting wagers only for or on behalf of persons so liable.

  6. Other wagering tax considerations. Certain gaming activities which are "conducted by" organizations exempt under IRC section 501 are not subject to wagering excise and occupational taxes, pursuant to IRC section 4421(2)(B). Rev. Rul. 69-21, 1969-1 C.B. 290, provides a "drawing" which is "conducted by" an organization exempt under IRC section 501 must, in fact, be operated by such organization to be excluded from wagering taxes. This would also be true for IRC section 527 organizations. There is a basic distinction between mere sponsorship of a drawing and actual conduct thereof. In general, "conduct" denotes supervision and control, as distinguished from lending the name of an organization to the activity or endorsing it.

  7. Forms 730, Tax on Wagering and Form 11-C, Special Tax Return and Application for Registry - Wagering, are used for reporting wagering taxes to the Internal Revenue Service.

4.76.50.13.3  (09-15-2010)
Form W-2G (Certain gaming Winnings)

  1. For regular bingo game prizes, a single prize of $1,200 or more requires the completion of a Form W-2G by the payer of the prize. The winner of a single prize of $1,200 or more must furnish the payer with proper identification, along with his/her Social Security Number (SSN). If the winner provides this information, withholding is not required. If the prizewinner does not provide a taxpayer identification number the payer must withhold 30% federal income tax.

    Note:

    All taxpayers do not have, or cannot legally get an SSN; but, if the person files a return without an SSN, the Service will assign a TIN, (which looks like an SSN but begins with a "9."), See Temp. Treas. Reg. section 7.6041-1; Announcement 92-162, 1992-47 I.R.B. 110.

  2. Awarding a door prize is a separate and distinct activity from the bingo gaming activity. For example, in the situation where there is a single admission fee to play bingo and to register for the door prize, under the general rule of IRC section 6041(a), a Form 1099-MISC should be issued for door prizes with a fair market value of $600.00 or more. In this situation, winnings, which result from the bingo game itself, would be subject to the reporting requirements of Treas. Reg. section 7.6041-1. In the situation where there is a separate and distinct payment to register to win the door prize, the registration payment would be considered a wager and subject to the requirements of IRC section 3402(q) and the regulations thereunder.

  3. In the case of a single pull-tab prize of $599.99 or less, the payer is not required to complete a Form W-2G and is not required to withhold federal income tax.

    1. In the case of a single pull-tab prize of at least $600, but not more than $5,000, the payer must complete Form W-2G. The winner must furnish the payer with proper identification and his or her social security number. If the winner provides the required information, the payer is not required to withhold federal income tax. However, if the winner fails to provide his or her social security number, the payer must withhold 30% as federal income tax. (Note that rates vary by year.) This backup withholding applies to the amount of the winnings reduced, at the option of the payer by the amount wagered. In the case of a single pull-tab prize which exceeds $5,000 (reduced by the wager), the payer is required to complete Form W-2G. In this situation, the payer also is required to withhold 27% (rates vary by year), of the net earnings as federal income tax. See IRC sections 3402(q) and 6041; Treas. Reg. sections 31.3402(q)-1 and 7.6041-1; Rev. Rul. 85-46, 1985-1 C.B. 334; Announcement 93-1, 1993-3 I.R.B. 60; and Announcement 92-162, 1992-47 I.R.B. 110.

  4. Determine whether all bonuses for progressive pull-tab tickets are properly accounted for on Form W-2G when required. For example, the Form 792 "Win on Diamonds" game comes with an extended play progressive card. The sum of $50 is transferred for each deal of the Form 792 to a progressive treasure chest, which may build to thousands of dollars in bonuses to be paid out to players. Such winnings may be subject to reporting and withholding requirements, although individual game prizes may not be large enough to trigger those requirements.

    Note:

    As of the publication date of this IRM section, a formal ruling on the W-2G reporting requirements for progressive pull tabs is pending.

  5. Exhibit 4.76.50-2 which summarizes reporting and withholding thresholds for gaming transactions.

    Note:

    The Form W-2G responsibilities are discussed generally in Chapter 4 of Publication 3079, Gaming Publication for Tax-Exempt Organizations.

4.76.50.13.4  (01-01-2004)
Withholding for Nonresident Aliens

  1. IRC sections 871(a)(1)(A) and 881(a)(1) generally impose a tax of 30 % of the amount received from sources within the United States by non-resident alien individuals and foreign corporations as "fixed or determinable annual or periodical gains, profits, and income. " IRC sections 1441(a) and 1442(a) generally require any person having control over such payments to withhold and pay over the tax.

    1. The tax and withholding requirements apply to U.S. source gaming winnings of non-resident alien individuals and foreign corporations, unless the proceeds are exempt from the withholding tax under IRC section 871(j) or a tax treaty, or if the nonresident alien individual or foreign corporation is engaged in the business of gaming.

    2. If the foreign person is engaged in a U.S. gaming trade or business, the person should file Form 4224 with the withholding agent and the person is responsible for filing a 1040NR or an 1120F reporting the wagering gain. SeeBarba v. United States, 52 A.F.T.R2d 83-5272. Forms 1042 and 1042S are used to report the tax. (The withholding tax is discussed generally in Publication 515, Withholding of Tax on Nonresident Aliens and Foreign Corporations).

  2. IRC section 871(j) exempts the proceeds of wagers placed in certain table games from tax under IRC section 871(a)(1)(A). Thus, withholding is not required with respect to winnings on blackjack, baccarat, craps, roulette, and big-6 wheel.

  3. Withholding requirements for gaming winnings currently do not apply to nonresident aliens and foreign corporations of sixteen treaty partners. These countries are: the Czech Republic, Finland, France, Germany, Hungary, Italy, Malta, Netherlands, Portugal, the Russian Federation, the Slovak Republic, Spain, Sweden, Tunisia, Ukraine, and the United Kingdom. Patrons from these countries should complete Form 1001, which should be on file with the establishment, which allows the exemption.

  4. Exhibit 4.76.50-2which summarizes reporting and withholding thresholds for gaming transactions.

4.76.50.13.5  (01-01-2004)
Employment Taxes and Tip Income

  1. Frequently, gaming establishment workers receive substantial tips from patrons. Under IRC section 6053 (a), all tipped employees are required to furnish their employers no less frequently than on the 10th of each month a written statement of all cash tips received during the previous month while employed by the employer. Cash tips include charged tips, checks, and other monetary media of exchange. The statutory provisions applicable to tips are

    1. Pertaining to FICA, IRC sections 3102(c), 3121(a)(12) and (g),

    2. Pertaining to FUTA, IRC section 3306(s), and

    3. Pertaining to income tax withholding, IRC sections 3401(a)(16) and (f), 3402(h) and (k).

  2. Where a worker receives no direct compensation from the exempt organization, the organization may contend tips are not received in the course of employment of the worker by the organization. Whether an employer-employee relationship exists in a given case depends on application of the factors delineated in Rev. Rul. 87-41, 1987-1 C.B. 296. See IRM 4.23, Employment Tax Procedures, regarding employment taxes on tip income and determination of employer-employee relationship.

Exhibit 4.76.50-1 
Illustration of Expense Allocations Where Organization Has Taxable gaming Income

The examples assume there are no deductions for purpose " lawful purpose expenditures." IRM 4.76.50.8.5.

(1) Illustration of Expense Allocation

The organization has taxable gaming income and exempt function income. It is a veterans' organization exempt under IRC 501 (c)(19) has the following receipts and expenses:

Description Income and
Expenses
Pull-tab sales $2,000,000
Membership dues 50,000
Member sales-bar and restaurant 750,000
     
Prizes 1,500,000
State gaming taxes/licensing fees 15,000
Cost of pull-tabs 40,000
Occupancy costs  
  Utilities 10,000
  Depreciation 15,000
  Rent off-site pull-tab sales 7,500
Food & beverage (bar and restaurant) 500,000
Employee expenses  
  Bar and restaurant 175,000
  Bookkeeper 40,000
  Office Manager 35,000
Supplies and equipment  
  Bar and restaurant 25,000
  Office and Miscellaneous 10,000
  Professional fees 5,000
  Postage 500
  Printing and Publications 1,000

Prizes, state gaming taxes/licensing fees, cost of pull-tabs, and occupancy costs for off-site pull-tab sales location are attributable solely to pull-tab sales, and therefore fully deductible. See Reg. 1.512(a)-1(b). Food and beverage, bar and restaurant employee expenses, and bar and restaurant supplies relate solely to exempt function income and are therefore nondeductible. Similarly, postage and printing and publications relate solely to membership newsletters and are also nondeductible exempt function expenses. Professional fees represent payments to a C.P.A., who billed the organization $3,500 to prepare Form 990 and $1,500 to prepare Form 990-T. Only the $1,500 for the preparation of the Form 990-T is deductible.

Occupancy costs, administrative employee expenses, and office supplies and equipment relate both to unrelated and exempt function uses, and must be allocated on a reasonable basis. See Reg. 1.512(a)-1(c). Examples of reasonable methods for each are provided below:

Employee expenses:

Contemporaneous time records indicate that the bookkeeper devotes 75% of his time to pull-tab sales, and 25% to general bookkeeping responsibilities. The office manager devotes 10% of her time to pull-tab sales, and 90% to other responsibilities. Use of contemporaneous time records is generally a reasonable way to allocate employee expenses. Thus, these expenses may be allocated as follows:

Description % UBIT Allocation % Exempt Function Allocation
Bookkeeper ($40,000) 75.0 $30,000 25.0 $10,000
Office Manager ($35,000) 10.0 3,500 90.0 31,500
TOTAL 44.7 $33,500 55.3 $41,500

Occupancy costs

The organization owns a building in which its bar and restaurant and administrative offices are housed. The bar and restaurant takes up half the space in the building. Thus, as an initial matter, the total occupancy costs may be allocated based on use of the space-half, $12,500, to exempt function activities and half, $12,500, to administrative functions. The administrative function expenses must then be further allocated between unrelated and exempt function expenses. One way to allocate administrative occupancy expenses would be to use an allocation factor derived from direct labor costs; this would be a reasonable method of allocation, based on the assumption that the occupancy costs generally reflect the use made by employees of the space to which the occupancy costs relate. Thus, 44.7% of the $12,500, or $5,583, would be allowable as a deduction in computing unrelated business taxable income.

Office supplies and equipment

The direct labor cost factor would also provide a reasonable basis for allocating the cost of office supplies and equipment. Thus, 44.7% of this $10,000, or $4,467 would be allowable as a deduction in computing unrelated business taxable income.

Unrelated Business Taxable Income Calculation

The organization's unrelated business taxable income is calculated below:

Description Income and
Expenses
Gross income $500,000
Deductions:  
  Specific deduction allowed under IRC 512(b)(12) 1,000
  gaming taxes and licensing fees 15,000
  Cost of pull-tabs 40,000
  Utilities 4,467
  Depreciation 6,700
  Rent 7,500
  Bookkeeper 30,000
  Office manager 3,500
  Supplies and equipment 4,467
  Professional fees 1,500
Total Deductions $114,134
Unrelated Business Taxable Income $385,866

(2) Illustration of Expense Allocation

The organization has taxable gaming income and excepted gaming income. See IRC 513(f)(2). The organization is exempt under IRC 501(c)(3) and has the following receipts and expenses:

Description Income and
Expenses
Pull-tab sales $2,000,000
Bingo sales 1,000,000
Membership fees 25,000
Contributions-general public 10,000
   
Prizes-pull-tabs 1,500,000
Prizes-bingo 900,000
State gaming taxes/licensing fees 25,000
Cost of pull-tabs 40,000
Bingo supplies 25,000
Occupancy costs  
  Rent-bingo hall 15,000
  Rent-administrative offices 25,000
  Utilities-administrative offices 10,000
Labor expenses  
  gaming manager 50,000
  Pull-tab sellers 30,000
  Bingo employees 50,000
  Security 20,800
  Janitorial-bingo hall 10,000
  Office manager 35,000
  Secretary 25,000
Professional fees  
  Form 990 3,500
  Form 990-T 1,500
Postage 500
Printing & publications 1,000
Program expenditures 200,000

The expenses may be allocated as follows:

    UBTI Exempt Function
Prizes-pull-tabs 1,500,000  
Prizes-bingo   1,000,000
State gaming taxes and licensing fees 5 16,667 8,333
Cost of pull-tabs 40,000  
Bingo supplies   50,000
Occupancy costs    
  Rent-bingo hall2 6,345 8,655
  Rent-administrative offices4° 1,725 23,275
  Utilities-administrative offices4° 690 9,310
Labor expenses    
  gaming manager1 25,000 25,000
  Pull-tab sellers 30,000  
  Bingo employees   50,000
  Security1 8,798 12,002
  Janitorial-bingo hall2 4,230 5,760
  Office manager 1,480 33,520
  Secretary 2,644 22,356
Professional fees    
  Form 990   3,500
  Form 990-T 1,500  
Postage   500
Printing and publications   1,000
Program expenditures   200,000

1 Based on contemporaneous time records.

2 Based on factor derived from direct labor costs of pull-tab (.423) and bingo (.576) activities.

Employee expenses

3 Contemporaneous time records indicate that the bookkeeper devotes 75% of his time to pull-tab sales, and 25% to general bookkeeping responsibilities. The office manager devotes 10% of her time to pull-tab sales, and 90% to other responsibilities. Use of contemporaneous time records is generally a reasonable way to allocate employee expenses. Thus, these expenses may be allocated as follows:

Employee (Total Salary) % UBTI % Exempt Function Amount
Bookkeeper ($40,000) 75.0 $30,000 25.0 $10,000
Office manager ($35,000) 10.0 3,500 90.0 31,500
TOTAL 44.7 $33,500 55.0 $41,500

4 Based on factor (.069/.931) derived from labor costs of employees utilizing space (see #3).

5 Based on factor (.667/.334) derived from gross amount wagered (the basis for calculating the taxes and licensing fees under state law).

Unrelated Business Taxable Income Calculation

The organization's unrelated business taxable income is calculated below:

Description Income and
Expenses
Gross income $500,000
Deductions:  
  Specific deduction allowed under IRC 512(b)(12) 1,000
  gaming taxes and licensing fees 16,667
  Cost of pull-tabs 40,000
  Rent-bingo hall 6,345
  Rent-administrative offices 1,725
  Utilities-administrative offices 690
  gaming manager salary 25,000
  Pull-tab sellers salaries 30,000
  Security salaries 8,798
  Janitorial services - bingo hall 4,230
  Office manager salary 1,480
  Secretary salary 2,644
  Professional fees 1,500
Total Deductions $140,079
Unrelated Business Taxable Income $359,921

(3) Illustration of Expense Allocation

The organization has taxable gaming Income and excepted gaming income See IRC 513(0(2). It has the following receipts and expenses:

Description Income and
Expenses
Pull-tab sales $875,000
Bingo sales 430,000
Pull-tab prizes 695,000
Bingo prizes 290,000
Door prizes 10,500
Bingo supplies 24,500
Bingo license expense 1,000
Pull-tab supplies 19,000
Pull-tab license expense 2,600
Advertising 16,000
Wages 26,000
Hall rental 30,000

Unlike the previous examples, neither the method of operating nor the organization's books and records provide a basis for determining how much of the labor costs are attributable to the taxable and non-taxable activities. Accordingly, all expenses other than those directly attributable to one or the other activity are allocated based on gross receipts, as follows:

    UBTI Exempt Function
Prizes - pull-tabs $695,000  
Prizes-bingo   $290,000
Door prizes   10,500
Pull-tab supplies 19,000  
Bingo supplies   24,500
Pull-tab license expense 2,600  
Bingo license expense   1,000
Advertising 5,280 10,720
Wages 8,580 17,420
Half rental 9,900 20,100

1 Based on factor derived from gross receipts from pull-tab (.33) and bingo (.67) activity.

Unrelated Business Table Income Calculation

The organization's unrelated business taxable income is calculated below:

Description Income and
Expenses
Gross income (gross receipts - prizes) $180,000
     
Deductions  
  Specific deduction under IRC 512(b)(12) 1,000
  Supplies 19,000
  License expense 2,600
  Advertising 10,720
  Wages 17,420
  Hall rental 20,100
  Total deductions $69,840
     
Unrelated Business Taxable Income $110,160

Exhibit 4.76.50-2 
Foundation Status 509(a)(1) and 170(b)(1)(A)(vi)

An IRC §501(c)(3) organization derived the following sources of revenue for the indicated periods. Contributions, bingo (not classified as unrelated business income), and pull-tab sales (not classified as unrelated business income.) The return under examination is for the year ended December 31, 2003.

Year 2002 2001 2000 1999 Total
Contributions 95,000 96,000 97,000 98,000 386,000
Gross Bingo 396,000 397,000 398,000 399,000 1,590,000
Bingo Expenses (471,000) (472,000) (473,000) (474,000) (1,890,000)
Net Bingo (75,000) (75,000) (75,000) (75,000) (300,000)
Gross Pull-tabs 996,000 997,000 998,000 999,000 3,990,000
Pull-tab Expense (596,000) (597,000) (598,000) (599,000) (2,390,000)
Net Pull-tab 400,000 400,000 400,000 400,000 1,600,000

The computation of the foundation status under IRC 170(b)(1)(a)(vi) would exclude from the numerator and denominator the proceeds from bingo and pull-tabs because they are considered to be gross receipts from related activities. Public support for purposes of IRC 170(b)(1)(A)(vi) would be as follows:

Public Support = 368,000 = 100%
Total Support 368,000

Although this computation results in 100% public support, which seemingly would qualify the organization to be considered an organization described in IRC §170(b)(1)(A)(vi), Treas. Reg. §1.170A-9(e)(7)(ii) should be considered. This Treas. Reg. precludes qualification under IRC § 170(b)(1)(A)(vi) for organizations which receive "almost all" of their support from gross receipts from related activities and receive an "insignificant" amount of their support from qualifying public contributions. The example given in the Treas. Reg. held that where qualifying public contributions were 1% of total support and the remaining 99% of support was from related gross receipts, the amount of public contributions was considered to be "insignificant" and the related receipts were "almost all" of the total support. Therefore, the organization in that example did not qualify as an organization described in IRC §170(b)(1)(A)(vi).

In the above example, public support was 7% ($386,000 in contributions divided by $5,966,000 total support. Total support was computed by adding ($386,000 contributions, $1,590,000 gross bingo, and $3,990,000 gross pull-tabs). While there is no clear definition of insignificant or almost all, facts and circumstances must be applied. Notwithstanding this indefiniteness, the intent of the Code and regulations is to deny IRC §170(b)(1)(a)(vi) classification where classification under IRC §509(a)(2) may be more appropriate.

Exhibit 4.76.50-3 
Foundation Status 509(a)(2)

Using the same financial information used in the computation of foundation status under IRC §170(b)(1)(a)(vi), the following would be the computation of foundation status under IRC §509(a)(2).

Year 2002 2001 2000 1999 Total
Contributions 95,000 96,000 97,000 98,000 386,000
Gross Bingo 396,000 397,000 398,000 399,000 1,590,000
Bingo Expenses (471,000) (472,000) (473,000) (474,000) (1,890,000)
Net Bingo (75,000) (75,000) (75,000) (75,000) (300,000)
Gross Pull-tabs 996,000 997,000 998,000 999,000 3,990,000
Pull-tab Expense (596,000) (597,000) (598,000) (599,000) (2,390,000)
Net Pull-tab 400,000 400,000 400,000 400,000 1,600,000

Total Support and Total Public Support
Contributions 386,000
Gross Bingo Receipts 1,590,000
Gross Pull-tab Income 3,990,000
Total Support and Total Public Support 5,966,000

Public Support = 5,966,000 = 100%
Total Support 5,966,000

Under these circumstances, where neither the bingo income nor the pull-tab income is unrelated, the organization would qualify for foundation status under IRC § 509(a)(2).

Exhibit 4.76.50-4 
Private Foundation Status

An IRC §501(c)(3) organization derived the following sources of revenue for the indicated periods: Contributions, bingo (classified as unrelated business income), and pull-tab sales ( classified as unrelated business income). The state and local statutes governing the conduct of bingo and pull-tabs is silent on the required use of net proceeds derived from these activities. For this scenario, we will assume this organization is not entitled to any lawful purpose expenditures. The return under examination is for the year ended December 31, 2003.

Year 2002 2001 2000 1999 Total
Contributions 95,000 96,000 97,000 98,000 386,000
Gross Bingo 396,000 397,000 398,000 399,000 1,590,000
Bingo Expenses (471,000) (472,000) (473,000) (474,000) (1,890,000)
Net Bingo (75,000) (75,000) (75,000) (75,000) (300,000)
Gross Pull-tabs 996,000 997,000 998,000 999,000 3,990,000
Pull-tab Expense (596,000) (597,000) (598,000) (599,000) (2,390,000)
Net Pull-tab 400,000 400,000 400,000 400,000 1,600,000
Tax on Unrelated Business Income 85,000 85,000 85,000 85,000 340,000

The computation of public support under IRC §§509(a)(1) and 170(b)(1)(A)(vi) is as follows:

Total Public Support
Contributions 386,000
Total Public Support 386,000

Total Support
Contributions 386,000
Net Bingo Receipts (300,000)
Net Pull-tab Income 1,600,000
Taxes on Unrelated Business Income (340,000)
Total Support 1,346,000

Public Support = 386,000 = 28.7%
Total Support 1,686,000

Treas. Reg. § 1.512(a)-1(a) provides in the case of an organization which derives gross income from the regular conduct of two or more unrelated business activities, unrelated business taxable income is the aggregate of gross income from all such unrelated business activities less the aggregate of the deductions allowed with respect to all such unrelated business activities.

In this situation, Treas. Reg. §1.170A-9(e)(7)(ii) is not applicable because the organization is receiving no support from related activities, Accordingly, since it did not meet the more than 1/3 public support consideration will need to be given to whether they would meet the 10% facts and circumstances test.

Further consideration would need to be given to whether they meet the public support test under IRC §509(a)(2). That computation is as follows:

Total Public Support
Contributions 386,000
Gross Related Receipts 0
Total Public Support 386,000

Total Support
Contributions 386,000
Gross Related Receipts 0
Net Bingo Receipts (300,000)
Net Pull-tab Income 1,600,000
Taxes on Unrelated Business Income (340,000)
Total Public Support 1,346,000

Public Support
=
386,000 = 28.7%
Total Support 1,346,000

To calculate whether the organization satisfies the not more than 1/3 from gross investment income and unrelated business taxable income test.:

Total Support
Contributions 386,000
Gross Related Receipts 0
Net Bingo Receipts (300,000)
Net Pull-tab Income 1,600,000
Taxes on Unrelated Business Income (340,000)
Total Public Support 1,346,000

Total Investment Income plus Unrelated Business Taxable Income less Unrelated Business Income Tax
Investment Income 0
Net Bingo Receipts (300,000)
Net Pull-tab Income 1,600,000
Taxes on Unrelated Business Income (340,000)
Total Investment and Net Unrelated Business Income (NUBI) 960,000

Investment and NUBI = 960,000 = 71.3%
Total Support 1,346,000

Since the organization receives only 28.7% of its support from permitted sources and receives 71.3% of its support from unrelated business taxable income less the unrelated business income tax, it does not qualify as a public charity under IRC §509(a)(2).

Exhibit 4.76.50-5 
Reporting and Withholding Thresholds for Gaming Transactions

Specific games Form 1099 W-2G Proceeds not Reduced by Wager W-2G Proceeds Reduced by Wager (1) W-2G Withholding (2) 1042S Foreign Payouts Variable Payment Excise Tax (excise tax is based on the wager)
Slot Win   $1,200     Yes No
Bingo Win   $1,200     Yes No
Keno win (1-20 games)       $1,500 yes no
Keno win (over 20 games)           yes
Sweepstakes, Lotteries, Wagering Pool, (proceeds more than 300 times the amount wagered) Withholding required regardless of payout odds     $600 $5,000 yes yes (State conducted lotteries are exempt)
Tournament (no entry fee) Tournament (with entry fee) (4) $600       yes no
Pari-mutuel - including horse racing, dog racing and Jai Alai with proceeds more than 300 times amount wagered   $600   $5,000 yes yes
Prizes received with no wager (Door Prize) $600       yes no
Sports event or contest (only reportable if proceeds exceed 300 times the wager)     $600 $5,000 yes yes

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