Any trade or business activity in which substantially all the work is performed for the organization without compensation is not an unrelated trade or business.
IRC Section and Treas. Regulation:
- IRC Section 513(a)(1) excludes from the definition of “unrelated trade or business" any trade or business in which substantially all the work in carrying on such trade or business is performed for the organization without compensation.
- Treas. Reg. Section 1.513-1(e) specifies that, under Section 513(a)(1), any trade or business in which substantially all the work in carrying on such trade or business is performed for the organization without compensation is not an unrelated trade or business.
Resources (Court Cases, Chief Counsel Advice, Revenue Rulings, Internal Resources):
- Exec. Network Club v. Commissioner, T.C. Memo 1995-21 Tips received by workers in lieu of salary were compensation for purposes of Section 513(a)(1) and, therefore, a casino operation did not meet the volunteer labor exception and was an unrelated trade or business.
- S. Cmty. Ass'n v. Comm'r, T.C. Memo 2005-285 Independently contracted security guards were integral to the taxpayer’s gaming activity. The fact that the security guards were compensated by a third-party entity was of no consequence. Therefore, the volunteer labor exception did not apply.
- Waco Lodge No. 166, Benevolent & Protective Order of Elks v. Commissioner, 696 F.2d 372 (5th Cir. 1983) Whether non-monetary “payment” equals “compensation” must be decided on the facts of each case. Although free drinks did not constitute compensation, the 23.1 percent of the work performed for cash compensation was substantial enough to prevent the bingo game from meeting the exception for volunteer labor.
- St. Joseph Farms of Ind. Bros. of Congregation of Holy Cross, Sw. Province, Inc. v. Commissioner, 85 T.C. 9 (1985), nonacq. 1986–2 C.B. 1. There must be a “but-for” connection between payment and services in order for the payment to be considered “compensation.” The Brothers took a vow of poverty and received no actual compensation. Though they did receive food, clothing, shelter and medical care, they would receive this even if they did not work on the farm. Ninety-one percent of the labor was performed by the Brothers without compensation and the volunteer labor exception applied.
Rev. Rul. 78-144, 1978-1 C.B. 168, holds that a Section 501(c)(3) organization's net leasing activity is not excepted from being an unrelated trade or business by reason of the volunteer labor exception under Section 513(a)(1). Although the work in connection with the leasing was performed without compensation, the volunteer labor exception applies only where the performance of services is a material income-producing factor in carrying on the business.
- IRM 18.104.22.168.1
Exclusions from Unrelated Business - Volunteer Labor
IRC Section 513(a) provides generally that trade or business activity of an organization subject to UBIT under Section 511 that is not substantially related to the exempt purposes of the organization is an unrelated trade or business. Under Section 513(a)(1), however, if substantially all of the work of the trade or business activity is performed without compensation, the activity is NOT considered an unrelated trade or business and does not result in unrelated business income. The following examples illustrate the application of this exception:
Example 1. A retail store operated by an exempt orphanage where substantially all the work in carrying on the business is performed by volunteers without compensation is not an unrelated trade or business. (Reg. Section 1.513-1(e))
Example 2. A volunteer fire company conducts weekly public dances. Holding public dances and charging admission on a regular basis may, given the facts and circumstances of a particular case, be considered an unrelated trade or business. However, if unpaid volunteers performed the work at the dances, the activity is not an unrelated trade or business. (Rev. Rul. 74-361)
- The term ”substantially all” is not defined in section 513 or regulations for purposes of this exception. When analyzing all the facts and circumstances it is helpful to identify and compare the number of hours worked by people who work without pay and the number of hours worked by people who are compensated to determine if substantially all the work is carried on by unpaid volunteers. However, the existing court cases do not apply a set percentage test and the “substantially all” test is to be applied in a general manner. See Waco Lodge and St. Joseph Farms.
- Compensation” is interpreted broadly. It may include payments to bartenders, waitresses, snack bar staff, maintenance workers, security, and other workers, as well as the tips that any workers receive. See Executive Network Club. A worker who obtains goods or services at a reduced price in return for his services may also be considered to be compensated. See Waco Lodge. At the same time, there must be a "but-for" connection between the payment and the services, such that the payment would not otherwise be received but for the provision of services. See St. Joseph Farms.
- De minimus amounts received by workers are not compensation. Free food and beverages may be considered payment of compensation; however, the facts and circumstances of each case must be examined to determine if the amounts in question are de minimus. For example, in Waco Lodge the court concluded the drinks and food given to workers were not compensation within the meaning of IRC Section513(a)(1), because the average worker received the equivalent of only $0.63 an hour.
- All workers involved in the operation of the activities must be taken into account. This includes workers involved in advertising the activity, the set-up and the cleanup of the facilities, the actual operation of the activity, concessions, accounting and legal services, and security. See Waco Lodge (bartenders) and S. Cmty. Ass'n (security guards).
- Work provided by third-party contractors is not volunteer labor. If the organization conducting trade or business activities makes a payment to a third party in return for supplying labor, the amount paid is considered compensation in applying the volunteer labor exception. It is irrelevant that the workers are not compensated directly by the organization. See S. Cmty. Ass'n.
- Volunteer labor must be a significant factor in the production of income. In Rev. Rul. 78-144 the IRS reasoned that volunteer labor exception applies only where the performance of service is a material income-producing factor in carrying on the business and therefore didn’t apply to leasing activity.
Issue Indicators or Audit Tips:
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, but not the sole determinative factor. To determine “substantially all” the facts and circumstances of each case must be taken into account.
- Secure a description of the duties of employees, contractors, and volunteers for the year under examination.
- Secure any time records kept of workers time for the year under examination.
- Tour the facility and look for indications of tipping.
- Attend a gaming session (if applicable).