Fundraising Trips and Traps: Bingo, Casino Nights, and Revenue Sharing Arrangements

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1 Fundraising Trips and Traps: Bingo, Casino Nights, and Revenue Sharing Arrangements Clay M. Grayson, Esq. Carter N. Deupree, Esq. Haynsworth Sinkler Boyd, P.A

2 Fundraising Trips and Traps Sustainability Current State of Giving 501(c)(3) Rules of the Road Growing the Pie Bingo Casino Nights and Raffles Revenue Sharing Agreements

3 Who s Giving What? Total charitable giving in the USA was down 3.6% in 2009 to $303 billion. The Giving USA Foundation reported this was the steepest year to year decline in dollars since 1956.

4 Who s Giving What? Annual U.S. Charitable Giving (in billions):

5 Who s Giving What? 2009 Contributions: $303 Billion by Source of Contributions ($ in billions - All figures are rounded) Corporations $14.1 Foundations $38.44 Bequests $23.80 Corporations $14.1 Foundations $38.44 Bequests $23.80 Individuals $ Individuals $227.41

6 Who s Giving What? Annual Individual Giving (in billions): Year

7 Who s Giving What? Annual Corporate Giving (in billions)

8 Who s Giving What?

9 Who s Giving What? 85% of nonprofits have income of less than half a million dollars. In 2009, 42% of nonprofits providing human services ended the year with deficits. In 2009, colleges and schools faced a 3.6% drop in charitable giving following a 5.4% drop in 2008.

10 Trips and Traps For 501(c)(3)s Rules of the Road Private Inurement Excess Benefit Transactions Unrelated Business Income Tax

11 Rules of the Road IRC Section 501(c)(3) A 501(c)(3) organization must be organized and operated exclusively for religious, charitable, scientific, testing for public safety, literary or educational purposes No partof the net earnings of a 501(c)(3) organization may inure to the benefit of any private shareholder or individual

12 Rules of the Road Private Inurement Substantial economic benefit to insiders Private Benefit Substantial economic benefit to outsiders Traditionally Meant The Loss or Denial of (c)(3) Status Even relatively small or insignificant instances of private inurement or benefit can result in the loss of 501(c)(3) status. Examples of loss of tax exempt status include: Church of Scientology of California IRS Determination Letter dated March 11, 2008.

13 Rules of the Road Excess Benefit Transactions An excess benefit transaction is a common type of private inurement, and occurs when an insider receives an unreasonable benefit by entering into a transaction with the organization Examples include: Sale/ purchase of property Rental of real estate Loan of funds Excessive compensation

14 Trips and Traps Penalties Intermediate Sanctions in instances of Private Inurement IRC Section 4958 imposes excise taxes in lieu of revoking taxexempt status when an organization engages in an excess benefit transaction with a disqualified person. A disqualified person is any person in a position to exercise substantial influence over the affairs of the organization at any time during the five year period ending on the date of the transaction. Substantial Influence is a broad standard, including directors, officers, managers, persons with control of significant business activities, etc.

15 Trips and Traps Penalties Intermediate Sanctions, cont. Excise Taxes Imposed First Tier Tax: a 25% tax on the excess benefit is payable by the disqualified person Second Tier Tax: if not paid, an additional tax of 200% of the excess benefit is imposed on the disqualified person A tax of 10% is ALSO imposed on the organization managers (e.g., board members, officers) who knowingly approved the transaction

16 Trips and Traps Defenses Intermediate Sanctions, cont. Rebuttable Presumption of Reasonableness Requires: Recusal of Persons with Conflict of Interest The Board must rely on appropriate comparability data prior to making significant decisions; and Properly document each decision at the time made and include the bases for the decision.

17 Rules of the Road Unrelated Business Income is revenue that is generated from an activity that is: (1) a trade or business, (2) regularly carried on, and (3) not substantially related to furthering the exempt purpose of the organization. Unrelated Business Income Tax (UBIT) = 35% Too much UBIT will result in the loss of 501(c)(3) status

18 Growing the Pie The Search for Revenue Sources Bingo Casino Nights and Raffles Revenue Sharing Agreements with Professional Fundraisers

19 B-I-N-G-O! South Carolina Constitution Article XVII, Section 7 allows certain organizations to hold bingo games. While excepted from the definition by the South Carolina Constitution, bingo is technically still a lottery (selling a chance to share in a distribution of prizes). The Bingo Tax Act Allows bingo for nonprofit organizations, but imposes many restrictions.

20 Restrictions on Bingo Only certain nonprofit organizations are allowed to hold bingo games. The nonprofit organization must have a license from the South Carolina Department of Revenue (the various licenses range from $0 to $4000). The nonprofit organization can have only one Bingo license.

21 Restrictions on Bingo Restriction on Proceeds Restriction on Sessions and Time Restrictions on Location Restrictions on Issuance of License Multiple Classes of Bingo Licenses Admission Charges

22 Bingo: The Promoter What is a Promoter? Each Promoter is responsible for his or her own license, which costs $1,000 per year (annual renewal is required for the Promoter s license). Promoters must furnish a bond in the amount of $10,000. Promoters are limited to 5 licenses

23 Bingo: An SC Case Study A Real Life Example: Determination Letter of IRS dated March 11, 2008 For the year that the IRS Reviewed: Gross Bingo Income = $1,090,048 Amount Distributed to Charity = 3,725

24 Bingo: An SC Case Study IRS Determination Letter dated March 11, 2008 Tax-exempt status of South Carolina nonprofit organization that sponsored ballet performances was revoked. During one year, the amount of time devoted to bingo activities totaled more than half its time. That same year, 92% of the organization s gross income was derived from the bingo games. The promoter failed to distribute required minimum monthly amounts to the organization.

25 Bingo: Common Trouble Spots The Compensation Arrangement of the Promoter Private Inurement Is the promoter an insider? Key is whether the promoter may exert substantial influence over the organization. Is there a cap on the promoter s compensation? Is the contract being followed, or is the promoter taking advantage of the organization even above the contract? If yes, was the compensation excessive or unreasonable? Is this an excess benefit transaction? Is there a private benefit problem?

26 Bingo: Common Trouble Spots Unrelated Business Income Certain bingo games are excluded from the term unrelated trade or business : It meets the legal definition of bingo; It is legal where it is played; and It is played in a jurisdiction where bingo games are not regularly carried on by for-profit organizations. BUT, if the organization's gaming activity serves a non-exempt purpose and the non-exempt purpose is substantial, the organization may have its tax-exempt status revoked.

27 Casino Nights and Raffles Gambling Prohibition in South Carolina Article XVII, Section 7 of the South Carolina Constitution Prohibits lotteries except for those conducted by the State (and bingo). S.C. Code Section ( unlawful games and betting ) Gambling is prohibited under South Carolina law, and such prohibition includes games with cards or dice (e.g., Sorry and Monopoly). Games of chance are usually determined to be illegal, and games of skill are generally not. The Mount Pleasant Five

28 Casino Nights and Raffles Enforcement of Prohibition Because of enforcement measures, many nonprofits have had to cease their charity raffles. Lions Club stopped holding raffles, which raised around $500K per year and proceeds paid for eye exams/ glasses for those who couldn t afford them. St. John s Catholic Church has stopped its annual raffle due to a complaint to law enforcement. The American Legion stopped holding its raffle due to law enforcement, but previously raised $ K per year all of which went toward the group s charitable causes. South Carolina Criminal Justice Academy made to hand over proceeds of a raffle it held. Possible Changes in Legislation

29 Revenue Sharing Arrangements What is Revenue Sharing? An incentive-based system in which a person will raise funds on behalf of the organization and will receive a portion of the money raised Revenue sharing can take many forms

30 Revenue Sharing Arrangements Advantages Depending on the organization and the fundraiser, such an arrangement can help the organization to build a facility, acquire equipment, etc. Incentive-based (i.e., depending on the arrangement, fundraiser may have to raise money to get paid) Disadvantages Organization must actively avoid prohibitions against private inurement and excess benefit transactions

31 Revenue Sharing Arrangements Is there a private inurement problem? Is the fundraiser an insider? (i.e., was the fundraiser in a position to exert substantial influence over the nonprofit) If yes, was the compensation excessive or unreasonable?

32 Revenue Sharing Arrangements Is this an excess benefit transaction? Was the fundraiser a disqualified person? If so, did the benefit provided by the nonprofit exceed the value of the service received by the disqualified person?

33 Revenue Sharing Arrangements Has a private benefit been conferred? Even if the fundraiser is not an insider, a private benefit may have been conferred. Two Part Test Does the revenue sharing agreement confer a private benefit on the fundraiser? Was the benefit more than incidental?

34 Revenue Sharing Arrangements Private Inurement Recommendations Tie fundraiser s compensation to revenue raised Make sure revenue-sharing agreement consistent with comparative data Place a cap on compensation

35 Revenue Sharing Arrangements Mandatory Compensation Caps? The Supreme Court of the United States has rejected three attempts by state/ local bodies to require a mandatory cap on a fundraiser s compensation in the context of nonprofit revenue-sharing agreements Schaumburg v. Citizens for a Better Environment, 444 U.S. 620 (1980). Secretary of State of Maryland v. Joseph H. Munson Co., 467 U.S. 947 (1984). Riley v. National Federation of the Blind of North Carolina, 487 U.S. 781 (1988).

36 Fundraising Trips and Traps Take Aways Be mindful of conflicts of interest follow your Conflict of Interest Policy! Verify whether the contracts entered into or services or products purchased are for a Fair Market Value- always find comparables! Document decisions, and indicate whether anyone in the nonprofit dissents to the decision. Ask yourself how does your revenue generating activity relate to your charitable purpose?

37 Fundraising Trips and Traps Questions?

38 References A Guide to Federal Tax Issues for Colleges and Universities, Section 300: Private Inurement and Excess Benefit Transactions, Lawrence M. Brauer et. al., An Introduction to I.R.C (Intermediate Sanctions) (2002). Charity Governance, IRS Needs To Do a Better Job of Explaining the Commensurate-In-Scope Test: Where's the Memo to IRS Employees? (June 24, 2008), Ianthe J. Dugan, Strapped Cities Hit Nonprofits with Fees, Wall Street Journal (Dec. 27, 2010). Karl E. Emerson, The Private Inurement Prohibition, Excess Compensation, Intermediate Sanctions, and IRS's Rebuttable Presumption: A Basic Primer for 501(c)(3) Public Charities, GuideStar USA, Inc. (2009). Schuyler Kropf, State Court to Weigh Cards in Poker Case, The State, Oct. 18, 2010, Andrew Ryan, City to Ask More From Nonprofits, The Boston Globe (Dec. 22, 2010). Tax-Exempt Organizations and Gaming, IRS Pub (June 2010). Richard L. Thomas, Playing the Percentages on Revenue Sharing Private Inurement, Private Benefit, and Intermediate Sanctions, Journal of Taxation of Exempt Organizations, Volume 16, Number 02 (September/October 2004). Paula Wasley, Charitable Donations Fell by Nearly 6% in 2008, The Sharpest Drop in 53 Years, The Chronicle of Philanthropy (June 10, 2009).