«M. GAMBLING ACTIVITIES OF EXEMPT ORGANIZATIONS 1. Introduction Gambling, including bingo, is becoming an increasingly common activity for exempt ...»
1990 EO CPE Text
M. GAMBLING ACTIVITIES OF EXEMPT ORGANIZATIONS
Gambling, including bingo, is becoming an increasingly common activity for
The term "gambling" includes such a vast array of activities that to attempt to
create an all-inclusive definition is an exercise in futility. Whether or not a particular
activity constitutes "gambling" is defined by the case law of the state in which the activity occurs. Although there is no general prohibition against gambling under federal law, Congress has enacted several restrictions which are designed to facilitate state enforcement of gambling activities. Most of the federal restrictions on gambling activities, however, are not relevant for any determinations to be made by the specialist. In general, gambling may be defined as the wagering, betting, or laying of money or other thing of value on the transpiring of any event whatsoever, whether it be on the result of a game of chance or on a contest of skill, strength, speed, or endurance, whereby one party gains and the other loses something for nothing, whether the parties betting be the actors in the event on which their wager is laid or not. Hardison v. Coleman, 121 Fla. 892, 164 So. 520 (1935).
2. Legality The conduct of illegal activities by exempt organizations is a developing area of interest to the Service. Both the Tax Court in Aviation Country Club, Inc. v.
Commissioner, 21 T.C. 807 (1954), acquiescence, 1953-1 C.B. 109, and the Service in Rev. Rul. 69-68, 1969-1 C.B. 153, have held that the conduct of illegal gambling activities, in and of itself, by an exempt organization will not affect its exemption.
For a more in-depth discussion of how to handle exempt organizations that conduct activities that are illegal or contrary to public policy, see the Exempt Organizations Continuing Educational Technical Instruction Program for 1985, p.
3. The Gambling Glossary Although the game of Bingo may be known throughout the world, other less common forms of gambling are not so universally known. The following descriptions of gambling activities do not represent legal definitions, but are included in this discussion so as to acquaint the gambling neophyte to the terms of the gambling veteran.
"Pari-Mutuel Betting" is a form of betting on horse races through the use of a machine which records the number of bets placed on each horse to win and returns to the bettor a ticket evidencing his bet. Once a winner has been determined in the horse race, the total amount of wagers received, less a commission to the machine's owner, is divided among the bettors who chose the winning horse.
"Calcutta Wagering" is a system of wagering in which bids are made for competing golfers in an auction. The proceeds of the purchase of players are pooled for distribution to winners according to a scale of percentages."Lottery" has no precise legal definition although its meaning has been interpreted by the courts, legal scholars, and even statutes. In Horner v. United States, 147 U.S. 449 (1893), the United States Supreme Court described a lottery as a distribution of prizes and blanks by chance, a game of hazard in which small sums are ventured for the chance of obtaining a larger value either in money or in other articles. To ascertain whether or not a particular activity is a "lottery," the appropriate state statutes and case law should be consulted.
4. Gambling Activities and UBIT
The Service recently released Announcement 89-138, 1989-45 I.R.B. 41 (November 6, 1989), which provides a general summary of the rules regarding whether the income from the public conduct of bingo and other forms of gambling by tax-exempt organizations results in unrelated business income. Most of the information contained in the Announcement is dealt with below.
In general, IRC 511 and 513 provide that an exempt organization is subject to the tax on unrelated business income for revenues derived from the conduct of an unrelated trade or business, which is regularly carried on by the organization, the conduct of which is not substantially related to the exempt purposes constituting the basis for the organization's exemption under IRC 501(c). Thus, if an organization can establish that a particular activity is "substantially related" to its exempt purposes, or is not "regularly carried on" by the organization, it will not be taxed on the receipts derived from the activity. Also excluded from the definition of unrelated trade or business are qualified public entertainment activities (IRC 513(d)(2)), certain bingo games (IRC 513(f)) and activities in which substantially all the work in carrying on such trade or business is performed for the organization without compensation (IRC 513(a)(1)).
5. Substantially Related Exception
Several categories of exempt organizations, hereinafter referred to collectively as the "Social Groups," have as part of their exempt purposes the fostering of goodwill among members or other social or recreational purposes. The Social Groups, for purposes of this article, include social clubs exempt under IRC 501(c)(7), fraternal beneficiary societies exempt under IRC 501(c)(8), domestic fraternal societies exempt under IRC 501(c)(10), veterans organizations exempt under IRC 501(c)(19), and organizations exempt under IRC 501(c)(23). Although social clubs exempt under IRC 501(c)(7) and veterans organizations are defined by statute to be organized for pleasure and recreational purposes, see IRC 501(c)(7) and Reg.
1.501(c)(19)-1(c), no similar language is found in the statutory definitions of the other Social Groups, the fraternal organizations. The Service stated in G.C.M. 39061, however, that inherent in the definition of "fraternal" is the provision of social and recreational activities by a fraternal organization to its members, thereby opening the door for fraternal organizations to sponsor gambling activities for their members.
Consequently, the conduct of gambling activities sponsored by the Social Groups to the extent of members' participation has a substantial causal relationship to the exempt social and recreational purposes of such organizations and, therefore, the income derived from such activities will not constitute unrelated business income.
However, when nonmembers participate in the gambling activities of Social Groups, even if they participate as guests of members, the receipts from their participation are generally subject to the tax on unrelated business income. In G.C.M.
39061 (November 21, 1983), gambling activities conducted by two different veterans' organizations were held not to be an unrelated trade or business to the extent of participation by members of the organization. The G.C.M. states that the gambling activities conducted by the organizations provided recreation to members and, thus, to the extent of participation by members, had a substantial causal relationship to the exempt social and recreational purposes of the organizations. The G.C.M. also concluded, however, that the provision of recreational activities to nonmembers by the veterans' organizations, did not have a substantial causal relationship to their exempt purposes and, therefore, the income derived from nonmembers must be considered income from an unrelated trade or business.
While the Social Groups may claim that gambling activities have a substantial causal relationship to their exempt social and recreational purposes, organizations which are exempt under other provisions of IRC 501(c) (hereinafter referred to collectively as the "Non-Social Groups") may have far more difficulty sustaining such a claim since social and recreational purposes are not ordinarily inherent in their exempt purposes. Prior to the Tax Reform Act of 1976, revenues received by NonSocial Groups from the conduct of gambling activities (including bingo) were technically income from an unrelated trade or business, although the tax may not have always been assessed. (Churches, for example, did not become subject to UBIT until 1969, and then had a five-year phase-in for tax on pre-existing unrelated activities.) See Rev. Rul. 68-505, 1968-2 C.B. 248, which holds that a county fair association exempt under IRC 501(c)(3) that conducts a horse racing meet with parimutuel betting is engaged in an unrelated trade or business. See also Smith-Dodd Businessman's Association, Inc. v. Commissioner, 65 T.C. 620 (1975), which held that a businessman's association exempt under IRC 501(c)(4) is subject to the tax on unrelated business income on the revenues derived from the operation of public bingo games. The Tax Court concluded without elaboration that gambling activities clearly do not promote 501(c)(4) purposes and, therefore, constitute an unrelated trade or business.
6. Activities "Not Regularly Carried On" Exception
A final exception to the tax on unrelated business income is where the gambling activities are "not regularly carried on" within the meaning of Reg. 1.513c)(1). As in the volunteer workers exception, application of this exception to gambling activities is to be consistent with its application to other unrelated trades or businesses. For a discussion on whether or not activities are "regularly carried on" by an organization, see Exempt Organizations Continuing Professional Education Technical Instruction Program for 1982, p. 127.
7. Qualified Public Entertainment Activities Exception
Congress responded to Rev. Rul. 68-505, supra, by enacting IRC 513(d) as part of the Tax Reform Act of 1976. IRC 513(d)(1) provides an exception to the tax on unrelated business income for "public entertainment activity" described in IRC 513(d)(2) conducted in conjunction with public fairs or expeditions. This exception, applicable to organizations described in IRC 501(c)(3), 501(c)(4), and 501(c)(5),
(1) public entertainment activity conducted in conjunction with an international, national, state, regional, or local fair or exposition, (2) activity conducted in accordance with State law which permits the activity to be conducted only by that type of exempt organization or by a governmental entity, or (3) activity conducted in accordance with State law which allows that activity to be conducted for not more than 20 days in any year and which permits the organization to pay a lower percentage of the revenue to the State than is required from other organizations.
The legislative history of the Tax Reform Act of 1976, found in Senate Report 94-938 of the 94th Congress, indicates that IRC 513(d) was intended to reverse Rev.
Rul. 68-505. Within specified limits, IRC 513(d) allows income derived by some types of exempt organizations from parimutuel betting to escape unrelated business income taxation.
8. Certain Bingo Games Exception
In 1978, Congress added another exception to the tax on unrelated business income for income derived from certain bingo games. IRC 513(f) provides that the term "unrelated business income" does not include any trade or business which consists of conducting bingo games that are not normally carried out on a commercial basis and the conduct of which is not in violation of state or local law. Reg. 1.513c)(2) provides that bingo games are "ordinarily carried out on a commercial basis" within a jurisdiction if they are regularly carried on, within the meaning of Reg.
1.513-1(c), by for-profit organizations in any part of that jurisdiction. Normally, the entire State will constitute the appropriate jurisdiction for determining whether bingo games are ordinarily carried out on a commercial basis; however, if state law permits local jurisdictions to determine whether bingo games may be conducted by for-profit organizations, or if State law limits or confines the conduct of bingo games by forprofit organizations to specific local jurisdictions, then the local jurisdiction will constitute the appropriate jurisdiction for determining whether bingo games are ordinarily carried out on a commercial business.
At the same time Congress enacted IRC 513(f), Congress created IRC 527(c)(3) which defines what constitutes exempt function income for political organizations recognized as exempt from federal income tax under IRC 527. IRC 527(c)(3)(D) provides that the term "exempt function income" means any amount received as proceeds from the conducting of any bingo game, as defined in IRC 513(f)(2).
Reg. 1.513-5 provides that IRC 513(f) does not apply, however, with respect to any bingo game otherwise excluded from the term "unrelated trade or business" by reason of IRC 513(a) and Reg. 1.513-1(e)(1) relating to trades or businesses in which substantially all the work is performed without compensation.
9. Volunteer Workers Exception
IRC 513(a)(1) provides that the term "unrelated trade or business" does not include any trade or business in which substantially all the work in carrying on such trade or business is performed for the organization without compensation. The application of this exception to gambling activities conducted by exempt organizations should be consistent with its application to other trades or businesses carried on by exempt organizations. In general, IRC 513(a)(1) excepts 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. Although the term "substantially all" is undefined in the context of IRC 513(a)(1), an unofficial guideline, which is borrowed from other areas of the Code, is 85%. Please note, however, that few cases under IRC 513(a)(1) have applied the 85% test strictly. Instead, "substantially all" is to be applied in a general manner.
As to what constitutes compensation, an excellent discussion is contained in Waco Lodge No. 166, Benevolent & Protective Order of Elks v. Commissioner, Docket No. 15696-79, T.C. Memo 1981-546, filed September 24, 1981. The court stated that the term "compensation" has broad application. The court added that even the provision of free drinks or food to workers may be considered compensation if the facts show that the free items are more than a mere gratuity and are intended to be compensation, however little, for the workers' services. For a more detailed discussion of the volunteer workers exception see Exempt Organizations Continuing Professional Education Technical Instruction Program for 1982, p. 124.