Nonprofits have long been at the forefront of creative fundraising strategies and initiatives, but a large majority of them are woefully unaware of the restrictions placed on their organization once they initiate a fundraiser that involves games of chance. Furthermore, depending on your geographical location, these activities may be deemed illegal with serious criminal penalties to follow. Even placing items up for auction can lead to serious and unintended consequences for both donors and the nonprofit organizations alike, meaning leaders in these organizations should take care to ensure their fundraising activities are on the up-and-up throughout the entire process.
Learn the Rules
Depending on your state, you may or may not be allowed to conduct raffles, bingo, auctions, or other games of chance. Those states that allow regulated gambling for charitable causes may require an application for a license before the event takes place.
The IRS has its own rules for games of chance that affect both the donors and the recipients of the winnings:
– Because the income generated by the games of chance is considered unrelated business income, the charitable organization will owe tax on the income.
– Prize winners owe tax that must be withheld by the donor.
– States like Pennsylvania require proceeds from games of chance to be kept in a special bank account.
– Bingo events must meet special IRS definitions. https://www.irs.gov/charities-non-profits/bingo-defined
– Raffle events that yield a prize greater than $600 must be taxed and withheld by the issuer or sponsor of the drawing.
– Initiating games of chance may require background checks on the CEO and staff of the event’s host.
– Several state and federal laws require nonprofits to keep and maintain certain records and file specific reports about the event and its winners.
– If staff members are involved in organizing or operating the event, state laws may require adherence to standard employment laws.
– Nonprofits may be required to pay Gaming Excise taxes.
– Nonprofits that serve alcohol as part of a charity fundraising event may require a separate alcohol license.
– Some states restrict how nonprofits may utilize proceeds from games of chance and prevent proceeds from being used to pay employees or building fees.
Can Donors Deduct Their Winnings?
No, donors are not allowed to deduct any sum won at an auction or game of chance. Furthermore, donors are unable to deduct their contributions toward playing the game or bidding at an auction.
The difference lies in method. Because a donation to a charitable organization issued during a game of chance or auction includes an implication of potential rewards, the money given is considered similar to a purchase rather than a discreet contribution or voluntary gift.
About Unrelated Business Income Tax
Despite holding tax exempt status, nonprofit organizations may still be required to pay taxes on unrelated business income, or any income generated from a trade, business venture, or regularly scheduled activity that isn’t directly related to the basis of the organization’s tax exempt status.
Organizations that expect to generate more than $1,000 of gross income from unrelated business ventures must file Form 990-T and pay the estimated tax if it expects its annual taxes to exceed $500.
There are several exceptions that exempt nonprofit income from tax liability:
– Use of volunteers to conduct the event or raffle
– Selling of donated merchandise
– Operation of bingo or similar activities
Most importantly, you should never tell attendees of a bingo night, casino night, or lottery raffle that the money they spend or receive is tax deductible.
Specific IRS Rules for Bingo and Other Games
In order to avoid allegations of abuse or tax evasion, your organization should adhere to these specific IRS requirements for nonprofits involved with gaming activities.
– Nonprofits must report any and all winnings by participants over a given amount by using Form W-2G.
– Nonprofits must withhold income tax from the winnings.
– Nonprofits may be required to pay unrelated business income tax on profits earned from the games.
– Nonprofits may have to pay a wagering excise tax to the IRS.
Nonprofits engaging in gaming activities must keep all records of gross receipts, prize payouts, and other related disbursements to help support their filings to the IRS.
Record Keeping – Best Practices for Regularly Scheduled Events
Exempt organizations are responsible for keeping and maintaining complete books and records to assist in determining tax liabilities at the end of the year. These include cash receipts, disbursement journals, ledgers, accounts payable journals, source documents, and copies of federal tax returns filed from previous years.
Depending on the nature of the gaming activities, organizations are generally required to maintain those records until the statute of limitations expires (usually three years after initial filing or returns). Furthermore, employment tax returns for four years following the date of filing or payment.
Because of the large amount of income generated by gaming activities and the liability placed on the organization involved, it’s important to maintain proper oversight and remain engaged in the conduct of the games on an ongoing basis. In the case of a regularly scheduled bingo event with multiple sessions planned each week, exempt organizations should ensure the following:
– Enlisting a gaming manager that oversees the execution of the games, payouts, and records transactions as part of a daily report.
– Employing a cashier that receives funds and records serial numbers of games.
– Keeping a third individual as a cash controller whose responsibilities also include inventory and payout reports, independently verifying cash receipts, and matches those receipts with reports prepared by the gaming manager. This person is also responsible for preparing and executing bank deposits.
– Use of a fourth individual who controls inventory and reviews daily sheets from the gaming manager to determine inventory and profits. This person may also directly receive bank statements and ensures that all deposits from the daily sheet match statements from the bank.
– Maintaining a third-party accounting service that writes checks on behalf of the organization to pay for gaming expenses.
– Schedule regular board meetings to compare daily sheets with previous reports in order to ensure all internal controls are operating effectively.
State and local governments often enforce their own laws and regulations regarding gaming activities. Contact the appropriate agency in your area for more information on specific guidelines.
Employment Rules and Restrictions for Exempt Organizations Operating Gaming Events
Any worker at your organization’s gaming activities is considered part of one of three categories by the IRS:
- Employee – an individual whose work and labor falls under the directive of your organization.
- Independent Contractor – an individual contracted by your organization to provide a specific service or product. Your organization does not hold the right to supervise or guide the individual’s labor or efforts.
- Volunteer – any individual working for your organization for no compensation – monetary or otherwise.
Types of Compensation
Any pay you provide to an employee for services rendered is considered wages subject to federal employment taxes unless an exemption applies. Whether the compensation is in cash, salaries, bonuses, commissions, or fringe benefits, the end result is the same: you must pay federal employment taxes on behalf of your employees.
Furthermore, payments in the form of goods, food, or services are subject to employment taxes based on fair market value at the time of delivery.
Tips are also considered taxable income – any amount over $20 in a given calendar month are subject to employment taxes.
Reporting Winnings and Withholding Income Tax
If you pay the winner or winners of a game over a certain amount, you must report the amount and the information about the winners to the IRS. The taxable threshold is largely dependent on which type of game was involved.
Unless the winnings derive from poker, bingo, keno, or slot machines, you must report all winnings (including raffle prizes) when the amount exceeds $600 or more OR if the amount paid is at least 300 times the amount of the wager.
Each time you pay out reportable winnings, your organization must complete Form W-2G in order to report the winnings to the IRS and to the payee. You’ll need to gather the payee’s name, address, and taxpayer identification number or social security number from either a valid driver’s license, social security card, or voter registration card.
For more information on how to navigate the complex tax restrictions placed on nonprofits operating gaming activities, reach out to Jacobson Jarvis & Co – the leading resource for nonprofit accounting in the Pacific Northwest.