Many nonprofit organizations engage in some type of gaming activity on a regular basis, whether it’s through annual fundraising events or social events for their members. The main purpose behind these types of activities is to raise funds that are then used to further the organization’s exempt purpose (see Insights volume 1, issue 3 “Understanding a Charitable Organization’s Exempt Purpose” for discussion of “exempt purpose”). It’s important to note that gaming activities in and of themselves do not further the exempt purpose of most organizations, and therefore could be treated as taxable unrelated business income. Gaming Activities Examples of gaming activities include, but are not limited to, raffles, bingo, casino, and card games, scratch-offs, slot machines, and other games of chance. Although the IRS does not define all gaming activities, it does generally distinguish between games of chance and games of skill:

• Raffles are games of chance where the participant is required to give something of value in order to participate: cash or a required purchase of goods or services. Raffles are also referred to as lotteries.
• Contests are games of skill, where chance doesn’t determine a winner. Generally, contests aren’t considered gaming activities, even if those who participate are required to pay to play.
• Sweepstakes are games of chance where a participant isn’t required to give anything of value in order to participate (i.e., no purchase necessary) and are generally not considered gaming activities.

In all cases, wagers and similar payments aren’t considered to be charitable contributions, regardless of whether the participant wins or not. The entire purchase price of the raffle ticket or wager placed is deemed to be payment for goods and services. Not all states define gaming the same. Before engaging in any activity you believe could be considered gaming, be sure to check how the state where you’re holding the activity defines gaming and whether special licenses or permits are required to conduct gaming activities. As well, avoid online gaming activities if at all possible, as they can easily be considered interstate gambling activity, which is a violation of both federal and state gaming laws. 501(c)(3) Organizations and Gaming To qualify as a 501(c)(3) organization, the nonprofit has to operate exclusively for religious, charitable, scientific, literary, or educational purposes. Gaming activities are commonly thought of as charitable if run by a nonprofit organization. The proceeds from those activities may be used to cover expenses related to its charitable programs, but gaming activities themselves do not further any charitable purpose, and therefore must be an insubstantial part of a 501(c)(3) organization’s operations. There are no specific quantitative factors explicitly stated by the IRS to determine whether an activity is substantial or not, but all aspects of the activity will be taken into consideration when evaluating it: amounts raised, expenses paid, time spent, resources devoted. Section 501(c)(3) public charities must also be cognizant of their public support test and how their gaming and unrelated business activities might negatively impact their public support percentage. Funds raised from unrelated business income like gaming are not considered part of the “public” portion of the support test. If a public charity receives too much of their financial support from these non-public sources, they risk failing their public support test and could be classified as a private foundation. Private foundations also cannot have substantial financial support from activities classified as unrelated trade or business. Gaming activities could also be subject to unrelated business income tax, and the organization would need to report the unrelated business income from gaming activities on Form 990-T. Sections 501(c)(3) organizations also must not be organized or operated for the benefit of private interests or inure profits for the benefit of any private shareholder or individual. Any profits received from gaming activities must support the organization. Other Organizations and Gaming Social clubs and fraternal organizations classified as 501(c)(7), 501(c)(8), or 501(c)(10), as well as 501(c)(19) veterans’ organizations are exempt as providers of social and recreational activities for members and their guests. Those organizations are permitted to engage in gaming activities that involve only their members without risking their tax-exempt status. If such an organization opens its activities to the public, then its tax-exempt status would be at risk, and the income generated from those public gaming activities could also be subject to the unrelated business income tax. Social welfare organizations classified as 501(c) (4), and 501(c)(5) and 501(c)(6) labor and agriculture organizations and business leagues are treated similarly to 501(c)(3) organizations in that gaming activity cannot be a substantial portion of the organization’s activities, or it will jeopardize its tax-exempt status. Unrelated Business Income Tax As a general rule, gaming is considered unrelated to an organization’s exempt purpose and, therefore, should be subject to unrelated business income tax. There are exceptions and exclusions for certain types of gaming activities conducted by certain types of tax-exempt organizations, as outlined above. Three conditions must be met before an activity is classified as an unrelated trade or business activity: 1. The activity must be considered a trade or business. 2. The activity must be regularly carried on. 3. The activity must not be substantially related to the organization’s exempt purpose. Read the full Winter issue of Insights, the HBK Nonprofit Solutions quarterly newsletter.