Gaming activities are a significant

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1 The PPC Nonprofit Update, October 2010, Volume 17, No. 10 THE PPC NONPROFIT UPDATE Winning Score for Nonprofits: Gaming Activities Fun, UBI Taxes Zero! Gaming activities are a significant revenue source for many tax-exempt organizations. Others use such activities as an integral part of fundraising events or as part of their exempt function activities. The tax rules applicable to gaming activities are extensive and often complex. The Games People Play Gaming includes (but is not limited to) standard bingo, pull tabs/instant bingo, poker and other card games, raffles, coin-operated gambling devices (e.g., slot machines and video games), and virtually any other game of chance. UBIT Implications There are some categories of organizations [i.e., Section 501(c)(7), 501(c)(8), 501(c)(10), and 501(c)(19) organizations] whose exempt function activities include social or recreational activities for members and their guests. For these organizations, gaming itself may further an exempt purpose. However, for most organizations, gaming is similar to the conduct of any other trade or business carried on for profit. Although the activity generates revenue to fund exempt activities, gaming does not further their exempt purposes. Nevertheless, a gaming activity may not be subject to unrelated business income tax (UBIT) even though it is regularly carried on and is not substantially related to the organization s exempt purposes. Four exceptions are: z certain bingo games; z activities conducted with substantially all volunteer labor; z qualified public entertainment activities (as defined in Reg ); and z games of chance conducted in North Dakota. The Bingo Exception Exclusion of bingo game revenue from unrelated business income (UBI) outside of North Dakota requires satisfying three conditions. It must: z Meet the definition of bingo under the Code and regulations. One requirement In this Issue: Winning Score for Nonprofits: Gaming Activities Fun UBI Taxes Zero! Tax Briefs AICPA Updates Nonprofit Financial Reporting Alert AICPA Updates Audit Guide for Yellow Book and Single Audits This newsletter is also available online. Please call (800) , or order online at ppc.thomsonreuters.com.

2 2 The PPC Nonprofit Update, October 2010, Volume 17, No. 10 is that wagers (i.e., the cost of the bingo card) must be placed, winners must be determined, and prizes must be distributed, in the presence of all persons placing wagers in that game. Several games, although called bingo, are not conducted in this manner and, therefore, are not excluded from UBI under the bingo exception. They include satellite and Internet bingo, instant bingo, and similar pull-tab and scratch-off bingo games. z Be legal under local law. The fact that a jurisdiction is lax in enforcing its law prohibiting bingo does not mean the game is deemed to be legal. z Be played in a jurisdiction where bingo games are not regularly carried on by for-profit organizations. Although jurisdiction normally encompasses the entire state, it can be local under certain conditions. The bingo exclusion from UBI is separate from the volunteer labor exception discussed below. Thus, if gaming satisfies the bingo exception, the income is not UBI, even if workers are paid, provided state or local law does not prohibit payment. However, many jurisdictions require that an exempt organization conduct its gaming activities entirely with volunteer labor as a condition of receiving a gaming license. Therefore, if an organization pays (or patrons tip) the bingo workers, the bingo exception to UBI would not apply if the compensation rendered the game illegal. The Volunteer Exception Any activity in which substantially all of the work is performed by unpaid volunteers is not an unrelated trade or business [IRC Sec. 513(a)(1)]. An organization s paid staff may be directly involved with an activity without precluding this exemption, provided sufficient volunteer effort is also present. Substantially all is not defined in the UBI context. However, the unofficial guideline applied in other areas of exempt organization law is that substantially all means 85% or more. So, as a general rule, if at least 85% of the work (measured by the total number of hours of labor involved) is carried on by persons who work without compensation, the activity will not be taxable. The IRS interprets compensation broadly including payments to bartenders, wait staff, maintenance workers, and security workers. It may surprise some organizations to learn that the IRS considers compensation to include: z tips workers receive from patrons; z goods or services received by workers at a discount in return for services; and z non-monetary worker benefits such as free drinks or food if such items are more than a mere gratuity and are intended as compensation. A worker who merely receives insignificant monetary or non-monetary benefits is considered a volunteer. To determine whether a benefit is insignificant, consider the value of the benefit and (1) the quantity and quality of the work performed, (2) the organization s cost of the benefit, and (3) the relationship between the benefit received and the services performed. Moreover, a contribution made by the organization conducting the gaming activities to another exempt organization in return for the grantee s providing volunteer labor is considered compensation in applying the volunteer labor exception. To exclude gaming from UBI under this exception, it is essential that an organization maintain detailed records of the hours worked by both paid and volunteer workers. Raffles Raffles are a type of gaming and are generally subject to all the rules discussed in this article. Raffles involve drawing names or tickets from all the game s entries. However, not every drawing is a raffle. The distinction is whether a ticket must be purchased separately from the event admission ticket in order to be eligible to win a prize. If so, the drawing of these separately purchased tickets is a raffle. However, if all attendees of an event are automatically eligible to win a door prize through a drawing, the drawing is not a raffle. Reporting Winnings When a gaming participant wins more than a specified threshold amount, the winnings must be reported to the winner and the IRS on Form W-2G (Certain Gambling Winnings). The threshold level at which winnings are reported depends on the type of game involved. For most types of games, an organization reports winnings (including raffle prizes) when the amount paid is $600 or more and at least 300 times the wager. Example: Mr. G buys a $2 raffle ticket. At the raffle, his ticket is drawn and he wins $1,000. Because the winnings ($998) are greater than $600 and more than 300 times the amount of the wager, Mr. G. s winnings must be reported on Form W-2G. If Mr. G s prize had a value of only $600, no reporting would have been required, since the winnings would have been only $598 ($600 minus $2 ticket cost) and, therefore, less than the threshold amount. Certain games have a higher threshold before winnings must be reported. For example, winnings from a bingo or slot machine are reportable beginning at $1,200

3 The PPC Nonprofit Update, october 2010, Volume 17, No before reducing for the amount of the wager. The threshold for keno winnings is $1,500 after reducing by the amount of the wager. Poker tournament winnings are reported when they exceed $5,000, after deducting the entry or buy-in fee. In order to properly complete Form W-2G, an organization must get the winner s name, address, and taxpayer identification number (e.g., social security number). This information should be verified to the extent possible from the person s driver s license, social security card, or other identification. Income Tax Withholding In addition to reporting winnings, an organization may also have to withhold and deposit Federal income tax on the winnings to avoid penalties for failure to withhold. Tax withholding is generally required when the proceeds from the wager are more than $5,000 and the wager was placed in a sweepstakes, wagering pool, lottery, raffle, poker tournament, or any other wagering transaction if the proceeds are at least 300 times the amount wagered. Tax withholding is not required on the winnings from bingo, keno, or slot machines. The proceeds from a wager are the difference between the amount of the winnings and the amount of the wager. If the payment is other than cash, such as a car won in a raffle, the proceeds from the wager are the difference between the fair market value of the item won and the amount of the wager. Tax must be withheld at the unmarried individual rates on the proceeds from the wager. Withhold on the entire proceeds (defined in the previous paragraph), not just on the amount in excess of $5,000. Under current law, the withholding rate is 25% for 2010 and 28% for 2011 and thereafter. The tax withholding on non-cash winnings must be computed at 33.33% (through 2010) if the organization pays the withholding tax on behalf of the winner. This higher rate reflects the fact that the winner receives not only the value of the prize but also the value of having the income tax paid by the organization. Big Brother is Watching The IRS and state regulatory agencies are sharing information on organizations involved in gaming activities. The IRS is comparing state information on these activities to what the organizations have (or have not) reported in their Forms 990 and 990-T. Conversely, states are using IRS data to determine whether organizations reporting gaming activities have properly registered such activities with them. The governing body and officers of an organization that conducts, or is considering conducting, gaming should be familiar with IRS Pub. 3079, Tax-Exempt Organizations and Gaming. A copy is accessible at Tax Briefs CHARITABLE DEMOLITION? The recent case of Hendrix, 106 AFTR 2d (DC OH), illustrates a creative (but, in this case, futile) charitable donation strategy. The taxpayers (T) wanted to remove a house on their lot and build a larger one. Rather than pay $10,000 for demolition, T allowed the local fire department to use the property for training exercises and then burn or demolish the structure as part of the training. The fire department used the house for four months and then demolished it. T got an appraisal of the house and lot and claimed a substantial charitable contribution deduction. The IRS disallowed the deduction and the court supported the disallowance. A donor must satisfy two requirements in order to sustain a charitable deduction of more than $5,000 for most property other than cash or listed securities. The donor must obtain a qualified appraisal and a contemporaneous written acknowledgment of the contribution by the donee charity that meets the requirements of IRC Sec. 170(f)(8)(B) and Prop. Reg A-16(d). The court concluded that T failed both requirements. Consequently, the court did not determine whether a deduction would have otherwise been allowable. FAQs CONCERNING REVOCATION FOR FAILURE TO FILE. The IRS has published a list of 16 frequently asked questions and answers (FAQs) (three of which are questions related to group exemptions) that pertain to automatic revocation of tax-exempt status for failure to file an annual return or notice. These FAQs can be accessed at article/0,,id=221600,00.html.

4 4 The PPC Nonprofit Update, October 2010, Volume 17, No. 10 AICPA Updates Nonprofit Financial Reporting Alert The AICPA has updated its Financial Reporting Alert, Not-for-Profit Entities Accounting Issues and Risks 2010 (Financial Reporting Alert). The Financial Reporting Alert provides nonprofit organization management and their audit committees with an overview of recent economic, technical, regulatory, and professional developments that may affect financial management and reporting. This article summarizes the many of the economic, legislative, regulatory, and financial management issues discussed in the Financial Reporting Alert. We ll highlight additional content of the Financial Reporting Alert in an upcoming issue. Understanding the Current Economic Environment to Assess Risks The Financial Reporting Alert reminds nonprofit organization management that the entity s financial statements are subject to specific risks of material misstatement arising from the current economic environment. Although the nature of the entity, the extent of regulation, and other external forces affecting the entity will vary, the Financial Reporting Alert can help management assess these risks and develop appropriate controls to strengthen the integrity of financial management and reporting. In assessing these risks and developing appropriate controls, management should understand how the following factors affect the entity: z Current economic conditions. z Nature of the industry in which the entity operates and how it is changing. z Industry, regulatory, and other external factors. z Financial performance of the entity (current, past, and projected). z Objectives, strategies, and the related business risks that may result in a material misstatement of the financial statements. z Internal control within the entity (including the selection and application of accounting policies). Economic, Legislative, and Regulatory Developments The Financial Reporting Alert discusses the effect current economic conditions may have on nonprofit organizations. Key economic indicators [including the gross domestic product (GDP), the unemployment rate, the federal funds rate, the consumer-price index, and interest rates for below-market-rate loans] are discussed. The Financial Reporting Alert addresses the state of nonprofit organizations governance and accountability, corporate sponsorships (including in-kind giving), funding administrative costs, maintaining operating reserves, acceptance of cyber donations, and the decline of contributions to colleges and universities. Recent legislative and regulatory developments have also had an effect on nonprofit organizations. The Financial Reporting Alert discusses the effect of the American Recovery and Reinvestment Act of 2009 (including its effect on Single Audits) and the Uniform Prudent Management of Institutional Funds Act (UPMIFA) on nonprofit organizations. The following IRS activities are also discussed in the Financial Reporting Alert: z E-postcard requirement for small exempt entities. z Form 990 changes for the 2009 tax year. z New health insurance tax credit for exempt organizations. z New employment tax credits for exempt organizations. z Issuance of IRS Priority Guidance Plan for z Issuance of proposed regulations regarding abusive tax avoidance transactions. z Prohibition against political activities. z Internet-based workshop for exempt entities. z Fast Track Settlement (FTS) Program. z Issuance of resource materials related to compliance initiatives for tax-exempt entities. z Changes to student loan programs. In addition, the Financial Reporting Alert discusses new filing and audit requirements for ERISA-covered Section 403(b) employee benefit plans and the Red Flags Rule issued by the Federal Trade Commission, which requires organizations to develop, implement, and administer programs to address the threat of identity theft. Financial Management Issues and Developments Operating in the current economy results in various challenges for nonprofit organizations and requires management to put forth effort to meet those challenges, including managing liquidity, maintaining and improving controls and risk management, and providing increased transparency to donors and lenders through financial statement disclosures. The Financial Reporting

5 The PPC Nonprofit Update, october 2010, Volume 17, No Alert discusses the following considerations that may help management plan short- and long-term business strategies during these difficult times: z Don t panic! Rash decisions often result in undesired consequences. z Assess the organization s cash management practices, and improve if possible. z Assess liquidity risk. z Assess succession and talent management planning. z Consider outsourcing. z Consider enterprise risk management. z Assess internal control and processes. The Financial Reporting Alert notes that given the current economic situation, lenders, donors, and regulators will expect increased disclosures in a nonprofit organization s financial statements. Management should review prior disclosures to determine their appropriateness and ensure they are not misleading in the current environment. Organizations should also consider the effects and possible disclosure of events that occur after the balance sheet date. The Financial Reporting Alert suggests consideration of expanded disclosures in the following areas: z Liquidity and capital resources. z Material impairments. z Pension plan assets. z Fair value determinations. z Critical accounting policies and estimates. z Risk factors. z Relationships with distressed businesses. The Financial Reporting Alert also suggests that management consider disclosing the organization s strategy in dealing with current market conditions, as well as how the organization has been, and may continue to be, affected by the current economic downturn. The Financial Reporting Alert is available on Checkpoint or may be ordered from the AICPA (print product number ) at (888) or AICPA Updates Audit Guide for Yellow Book and Single Audits In mid-august, the AICPA released the May 2010 update of its audit guide, Government Auditing Standards and Circular A-133 Audits (GAS/A-133 Audit Guide). The GAS/A-133 Audit Guide provides guidance on performing and reporting on audits performed in accordance with Government Auditing Standards (covered in Part I of the guide) and OMB Circular A-133 (covered in part II of the guide). This newest edition of the GAS/A-133 Audit Guide has been updated for authoritative guidance issued through May 1, As you plan and perform this year s Yellow Book and Single Audits, you should become familiar with and consider the updated content in the guide. The GAS/A-133 Audit Guide is an interpretative publication that is, it provides recommendations on applying Statements on Auditing Standards (SASs) in specific circumstances, such as engagements related to specialized industries. If you do not apply applicable interpretative publications, you should be prepared to explain how you complied with the underlying SAS requirements. What s New? Guidance for Compliance Audits. If you perform Single Audits, you ll want to review Part II of the GAS/A-133 Audit Guide carefully as it has been updated significantly with guidance about how to apply SAS 117. SAS 117 applies in the compliance portion of an audit conducted with all of the following: GAAS, Government Auditing Standards, and a governmental audit requirement such as in a Single Audit. SAS 117 supersedes SAS 74 for audits of periods ending on or after June 15, 2010, so You can learn more about SAS 117 (AU 801) in the March 2010 edition of the PPC Nonprofit Update and the 2010 editions of PPC s Guide to Single Audits (GSA) and PPC s Guide to Audits of Nonprofit Organizations (NPO).

6 6 The PPC Nonprofit Update, October 2010, Volume 17, No. 10 it s applicable for your Single Audits with June 30, 2010 year ends. Reporting Guidance. In March of this year, the OMB provided guidance for applying the new internal control definitions in SAS 115 (AU 325) in a Single Audit, and the AICPA subsequently revised the Auditing Interpretations at on communicating internal control related matters identified in a Single Audit. The GAS/A-133 Audit Guide provides new illustrative auditor s reports under Circular A-133 that incorporate all of this new guidance and also reflect the requirements of SAS 117. The single audit report illustrations in NPO and GSA have been updated for SAS 117 and the AICPA s recent report revisions (the GSA reports have also been updated for SAS 119). For Checkpoint Guide subscribers, the updated reports are available in your regular Checkpoint edition of the Guide. Other customers may download pdf files of the revised reports from the Thomson Reuters customer support website at support.rg.thomsonreuters.com (select PPC s A&A Guides and Appendix Updates then Appendix Updates ). The reports in the Checkpoint Tools for those Guides should be updated later in October. Recovery Act Guidance. Several chapters include new sections on the American Recovery and Reinvestment Act of 2009 (Recovery Act). The discussions focus on how Recovery Act requirements can have an impact on Single Audits. The audit guide also explains where auditors can find additional information about the Recovery Act. GSA includes the latest guidance from the OMB Circular A-133 Compliance Supplement, including extensive new Recovery Act guidance. PPC also offers a new software product called PPC s SMART Practice Aids Single Audit (SMART Single Audit) to assist auditors in determining major programs; low-risk auditee status; and appropriate compliance requirements, objectives, and audit procedures (including new Recovery Act guidance). SMART Single Audit also prepares the schedule of expenditures of federal awards. This product can be obtained by calling (800) Where to Start? We recommend that you start by scanning Appendix C of the GAS/A-133 Audit Guide to see the extent and types of revisions that were made this year. It will be easy to see how extensive the changes required by SAS 117 were, and you ll probably conclude, as we did, that so much of the content has been changed that you need to identify and read several relevant portions of the guide. The PPC Nonprofit Update is published monthly by Thomson Reuters/Tax & Accounting, P.O. Box 966, Fort Worth, Texas , (800) COPYRIGHT 2010 BY THOMSON REUTERS/ PPC. Reproduction is prohibited without written permission of the publisher. Not assignable without consent. This publication is designed to provide accurate information regarding the subject matter covered. It is sold with the understanding that the publisher is not engaged in rendering legal, accounting, investment, or other professional advice. If such assistance is required, the services of a competent professional should be sought. Reports on products or services are intended to be informative and educational; no advertising or promotional fees are accepted. Tax & Accounting Research and Guidance P.O. Box 966 Fort Worth, Texas PRSRT STD U.S. POSTAGE PAID Thomson