Deductibility of Contributions From Gaming Proceeds as Section 162 Business Expenses for Calculation of Unrelated Business Taxable Income by an Exempt Organization


An exempt organization may deduct from its unrelated business taxable income the contributions and expenditures made from gaming proceeds as ordinary and necessary business expenses under section 162, if the organization was required to donate those proceeds to charity in order to retain its gaming license.

IRC Section and Treas. Regulation:

IRC Section 162 allows a deduction for all ordinary and necessary expenses paid or incurred during the taxable year in carrying on a trade or business.

IRC Section 170 allows a deduction for any charitable contribution or gift paid in the taxable year.

IRC Section 511 imposes a tax on the unrelated business income of exempt  organizations.

IRC Section 512(a) defines the term “unrelated business taxable income” as the gross income derived by an organization from any unrelated trade or business regularly carried on by it, less the allowable deductions which are directly connected with the carrying on of such trade or business.

IRC Section 512(b)(10) permits organizations subject to the section 511 tax the deduction allowed by section 170 but not to exceed 10% of the unrelated business taxable income computed without the benefit of this paragraph.

Resources (Court Cases, Chief Counsel Advice, Revenue Rulings, Internal Resources):

South End Italian Independent Club, Inc. v. Commissioner, 87 T.C. 168 (1986)  The court held that a Section 501(c)(7) tax-exempt social club’s charitable donations from bingo proceeds were fully deductible as section 162 ordinary and necessary business expenses in determining UBTI. Because state law required that gaming profits be used for charitable, religious or educational purposes, and the organization’s gaming license could be revoked if it violated the donation requirement, the court concluded that the organization was under a legal obligation to make the donations. Therefore, the donations were not charitable contributions under section 170, because they were involuntary expenditures made to obtain a quid pro quo. Instead, they were properly characterized as ordinary and necessary business expenses under Section 162 that are fully deductible under section 512(a)(3)(A).

Women of the Motion Picture Industry, et al. v. Commissioner, T.C. Memo 1997-518 The court held that the transfer of funds from an exempt organization’s segregated bingo account to its general account is not an ordinary and necessary business expense described in Section 162 until the funds are disbursed by the organization for a charitable purpose.Referencing South End Italian Independent Club, the court also held that charitable payments in excess of the minimum amount required by state law were deductible business expenses within the meaning of Section 162, because state law also provided that the organization risked losing its license if any part of its net bingo proceeds was used for other than charitable purposes.

IRM provides guidance related to “Deduction of ‘Lawful Purpose Expenditures’ and Similar Amounts,” and refers to Section 162 expenditures as amounts required under state law to be committed to so-called lawful purposes in order for the organization to retain its state gaming license.


Charitable contribution deductions from UBI allowable under Section 170 are generally limited to 10% of unrelated business taxable income by Section 512(b)(10). However, if charitable expenditures qualify as an ordinary and necessary business expense under Section 162, the expenditures are fully deductible under Section 512(a).

For example, if a tax exempt organization would lose its gaming license by not making charitable donations or not using proceeds for expenditures required by state law, those charitable distributions are considered a cost of maintaining a license. Therefore, such donations are considered ordinary and necessary expenses in operating a trade or business and are  deductible in full under Section 162. See South End Italian Independent Club, Inc. Whether or not proceeds from gaming are used for exempt purpose expenditures, and therefore qualify as ordinary and necessary business expenses under Section 162, is determined by state law. Questions about the legal interpretation of a specific state statute should be referred to Counsel.

The mere transfer of funds from a gaming account to a general account does not constitute a “lawful purpose expenditure” that is fully deductible under Sections 162 and 512(a), until the funds are actually spent for exempt purposes. See Women of the Motion Picture Industry.

Issue Indicators or Audit Tips:

Issue Indicators

  1. Income from gaming reported on Form 990 or discovered during examination of the organization.
  2. Expenses reported on Form 990-T for gaming licenses and/or prizes.
  3. Charitable contributions reported on Form 990-T in excess of 10% of the reported Unrelated Business Income.
  4. Gaming advertised in publications or at facility.
  5. Evidence of gaming equipment found during tour of facility.
  6. Unrelated Business Income reported from gaming with minimal or no reported Unrelated Business Taxable Income.

Audit Tips

  1. Determine the state agency charged with enforcement over charitable gaming activities.
  2. Obtain a copy of the state’s (or local jurisdiction’s) laws and regulations related to charitable gaming activities and licensure.
  3. Obtain a copy of the organization’s charitable gaming license.
  4. Review the financial information reported on the organization’s application for a gaming license.