IRS proposes revoking exemption for charitable gaming activities

Plain-English summary

The IRS proposed revoking an organization’s exemption under IRC § 501(c)(3) after finding that its charitable gaming operations were not incidental to its exempt activities. The organization operated pull-tab and other gaming sessions while also running a traveling heritage museum and educational programs. The examination report found that only a small portion of gross gaming receipts was used for charitable purposes, that pull-tab inventory was unaccounted for, and that some proceeds were not deposited or substantiated. The IRS concluded that the organization operated for substantial nonexempt and private purposes, and separately analyzed whether the unaccounted gaming proceeds would be unrelated business income if exemption remained in place.

Ruling snapshot

• Question: Does the organization continue to qualify for exemption under § 501(c)(3), and would unaccounted gaming proceeds be unrelated business income if it remained exempt?
• Outcome: Revocation proposed, with an alternative unrelated-business-income analysis.
• Key authorities: IRC §§ 501(c)(3), 170, 511, 512, and 513; Treas. Reg. §§ 1.501(c)(3)-1, 1.512(b)-1, and 1.513-1.

Full text (IRS public release)

DEPARTMENT OF THE TREASURY
INTERNAL REVENUE SERVICE
TE/GE EO Examinations
1500 Ormsby Station Court Suite A - Stop 700
Louisville, KY 40223

DIVISION

October 9, 2008

Release Number: 201405017
Release Date: 1/31/2014
UIL Code: 501.03-00 Taxpayer Identification Number:
ORG
Form(s):

Tax Year(s) Ended:
Person to Contact/ID Number:
Contact Numbers:

Telephone:

Fax:

Dear

The purpose of this letter is to provide information that was discussed over the
telephone on October 8, 20XX.

We have enclosed a copy of our draft report of examination explaining why we
believe an adjustment of your organization’s exempt status is necessary.

If you accept our findings, please sign and return the enclosed Form 6018, Consent
to Proposed Adverse Action, by October 23, 20XX. We will then send you a final
letter modifying or revoking exempt status. You will also be required to file Forms
1120 for the periods listed above. Additional tax returns may also be required. These
returns can be filed at a later date.

If you do not agree with our position or have additional information to present,
please mail all information to the address in the heading of this letter so that we
receive it by October 23, 20XX.

2

If we do not hear from you by October 23, 20XX, we will issue a final report. After we
issue the report, you will have 30 days from the date the letter is mailed to file an
appeal. Information on this process will be with the final report (if required).

If you have any questions or would like to arrange a conference with my manager,
please call me at the telephone number listed under the contact information.

Thank you for your cooperation.

Sincerely,

Jason Jarvis
Internal Revenue Agent

Enclosure: Draft Report of Examination
Form 6018
Envelope

Form 886A Department of the Treasury - Internal Revenue Service Schedule No. or
Explanation of Items. Exhibit
Name of Taxpayer Year/Period Ended
ORG 20XX - 20XX
LEGEND
ORG ~- Organization name XX - Date State - state Motto - motto
President - president Treasurer - treasurer CO-1 & CO-2 - 1% & 24
COMPANIES
Issue:

Whether ORG (ORG) continues to meet the requirements of Internal Revenue Code (IRC) section 501(c)(3), and
therein continues to qualify for exemption from Federal income tax.

Facts:

ORG was incorporated as a non-profit corporation under the laws of State on August 20, 19XX, with the name of
ORG The purposes of the Corporation were:

1. To assist the local educational systems to implement curriculums that will be most informative of the
   Heritage and Culture of Indigenous People, .

2. To maintain a mobile heritage museum to be used at school and other functions to aid children in
   understanding Culture and History,

3. To respect and advocate the educational resources of other organizations and programs in the community,

4. To support traditional community events and provide the mobile “ORG” for educational

classes for youth and adults so as to enrich their knowledge of

On September 17, 19XX, articles of correction were filed to change the name to ORG

In October of 20XX, ORG was granted exemption under section 501(c)(3) of the IRC.

During our examination we requested documentation showing the amount of time devoted to your exempt activities
and to your motto activities for calendar years 20XX - 20XX. ORG indicated that they did not have any
documentation.

ORG provided the following information relating to exempt vs. non-exempt activities.

O ORG indicated that five (5) board members usually devote approximately two (2) hours per quarter for
board meetings. The board minutes were requested, but ORG failed to produce any minutes.

O ORG stated that the Project Coordinator conducts the charitable gaming operations and devotes about
eleven (11) hours per week.

O ORG stated that the Secretary averages about fifteen (15) to twenty five (25) hours per week. The duties
include taking care of the charitable gaming records, (work motto sessions, contact schools, libraries, museums, etc.
to schedule showings), taking care of correspondence, maintain the museum, show the museum, conduct educational
programs, organize benefit activities for the museum, etc.

O ORG has two motto sessions per week. Each session is staffed by pull-tabbers (sell pull-tabs), counter
workers (sell motto paper and computers), motto caller, security guards, and a janitor.

B According to ORG, pull-tabbers and the motto caller usually devote eight (8) hours per week. The counter
workers usually devote eleven (11) hours per week.

Form 886-A cRev.4-68) Department of the Treasury - Internal Revenue Service
Page: -1-

Form 8 86 A Department of the Treasury - Internal Revenue Service Schedule No. or
Explanation of Items Exhibit
Name of Taxpayet Year/Period Ended
ORG 20XX - 20XX

Based off of motto session sign-in sheets, it is estimated that six (6) pull-tabbers, two (2) counter helpers, and one (1)
caller were present at each session.

On May 6, 20XX, an interview was conducted with Treasurer. Treasurer was the Treasurer and stated he attended
almost every session in 20XX. Treasurer stated that the pull-tabbers did receive tips from the players and ORG did
not want to know about the practice.

Gross Exemption Function Income vs. Gross Motto Income

The Form 990 for 20XX reported $ from charitable gaming activities and $ of donations that were received at the
motto sessions.

The Form 990 for 20XX reported $ from charitable gaming activities and $ of donations that were received at the
motto sessions.

The Form 990 for 20XX reported $ from charitable gaming activities and $ of donations that were received at the
motto sessions.

The quarterly gaming reported filed with the State Office of Charitable Gaming (OCG) reported charitable
expenditures in the following amounts.

g 20XX $
Oo 20XX $
Q 20XX $

In 20XX, transfers from the gaming account to the general account were $ occurred. Of these funds, approximately $
was used in the purchase of a truck. The truck was used to haul a traveling museum.

The $ in expenditures made in 20XX consisted of a $ check to the CO-1 and a $ check to the CO-2 (CO-2).

Assuming that the expenditures (contributions and expenditures on the truck) were made for an exempt purpose, over
the three-year period ORG used % of the gross receipts for a charitable purpose.

A review of the pull-tab inventory for the 4th Quarter of 20XX, noted that 114 boxes were unaccounted for. ORG
stated that these boxes were returned to the suppliers. ORG was unable to provide any documentation to prove that
the boxes were returned to the suppliers. The suppliers were contacted and stated that the boxes were not returned.

The sale of these boxes would have reported gross income of $ and a net profit of $. These sales were never
recorded, the income was not deposited into the bank, and the funds were not used for a charitable purpose.

In the state of State, all workers at a motto session must be volunteers. Workers at the motto session (pull-tabbers,
chairperson, callers, and counter help) are not allowed to accept tips.

**If issue goes unagreed, additional information may be added **

Law:

Section 501 (a) of the Internal Revenue Code exempts from taxation organizations described in subsection (c) or (d)
under this subtitle unless such exemption is denied under section 502 or 503.

Form 886-A crev.4-68) Department of the Treasury - Internal Revenue Service
Page: -2-

Form 8 86 A Department of the Treasury - Internal Revenue Service Schedule No. or
Explanation of Items Exhibit
Name of Taxpayet Year/Period Ended
ORG 20XX - 20KX

Section 501(c)(3)of the Code exempts from taxation: “Corporations, and any community chest, fund, or foundation,
organized and operated exclusively for religious, charitable, scientific, testing for public safety, literary, or
educational purposes, or to foster national or international amateur sports competition (but only if no part of its
activities involve the provision of athletic facilities or equipment), or for the prevention of cruelty to children or
animals, no part of the net earnings of which inures to the benefit of any private shareholder or individual, no
substantial part of the activities of which is carrying on propaganda, or otherwise attempting, to influence legislation
(except as otherwise provided in subsection (h)), and which does not participate in, or intervene in (including the
publishing or distributing of statements), any political campaign on behalf of (or in opposition to) any candidate for
public office.”

Section 501(c)(3) of the Code provides for the exemption from Federal income tax of organizations organized and
operated exclusively for charitable, educational, or scientific purposes, no part of the net earnings of which inures to
the benefit of any private shareholder or individual.

Treasury Regulation 1.501(c)(3)-(a)(1)provides, in part, that: “In order to be exempt as an organization described in
section 501(c)(3), an organization must be both organized and operated exclusively for one or more purposes
specified in such section. If an organization fails to meet either the organizational test or the operational test, it is not
exempt.”

Section 1.501(c)(3)-1 of the Income Tax Regulations provides:

(c) Operational test--(1) Primary activities. An organization will be regarded as “operated exclusively” for one or
more exempt purposes only if it engages primarily in activities which accomplish one or more of such exempt
purposes specified in section 501(c)(3). An organization will not be so regarded if more than an insubstantial part of
its activities is not in furtherance of an exempt purpose.

Section 1.501(c)(3)-1(c)(2) of the Income Tax Regulations provides that an organization is not operated exclusively
for one or more exempt purposes if its net earnings inure in whole or in part to the benefit of private shareholders or
individuals.

Section 1.501(c)(3)-1(d)(1)(ii) provides that the burden of proof is on the organization to establish that it is not
organized and operated for the benefit of private interests.

Church in Boston v. Commissioner, 71 T.C. 102, 107 (1978), provides, in part, that the word “exclusively” does not
mean “solely” or “without exception.” An organization which engages in nonexempt activities can obtain and
maintain exempt status so long as such activities are only incidental and insubstantial. (World Family Corp. v.
Commissioner, 81 T.C. 958, 963 (1983).) Neither the Internal Revenue Code, the regulations nor the case law
provide a general definition of “insubstantial” for purposes of 501(c)(3). This is an issue of fact to be determined
under the facts and circumstances of each particular case. (World Family Corp. v. Commissioner, supra at 967.)

In Help The Children, Inc. v. Commissioner 28 TC 1128 (1957), the court held that an organization engaged in fund-
raising activities through operation of motto games and whose actual charitable contributions consisted of
contributions to charitable institutions of insubstantial amounts when compared to its gross receipts from operation
of motto games, did not qualify for exemption under section 501(c)(3) of the Code.

Petitioner's fund-raising activities consisted of the operation of motto games at the Lodge of the Fraternal Order of
the Eagles. It also operated a soda bar, and miscellaneous activities. Income from the soda bar and miscellaneous

activities was reported on the returns as $ for19 and$ for 19 . The gross receipts from the
fixed charge or donation for the use of the motto cards were $ for 19 and$ for 19
Form 886-A (rev.4-68) Department of the Treasury - Internal Revenue Service

Page: -3-

Form 8 86 A Department of the Treasury - Internal Revenue Service Schedule No. or
Explanation of Items Exhibit
Name of Taxpayer Year/Period Ended
ORG 20XX - 20XXK

Petitioner did not operate any charitable institutions and its actual charitable function consisted of contributions to
various individual doctors and institutions. These contributions totaled $ in19 and $3 inl9 . Its
principal activity was the profitable operation of motto games on a business or commercial basis. The principal
source of gross receipts was from the fixed charge or donation assessed against each player for the use of the motto
cards.

Therefore, the court held that the petitioner failed to establish that it is entitled to a tax-exempt status in the taxable
years in question.

In Make a Joyful Noise, Inc. v. Commissioner, 56 TCM 1003 (1989), the court held that operating regularly
scheduled motto games on behalf of other exempt organizations was a trade or business unrelated to the
organization's exempt purposes.

In that case, the court concluded that the petitioner failed to carry its burden of proving that its participation in motto
games was an insubstantial part of its activities.

In P.L.L. Scholarship Fund, v. Commissioner, 82 TC 196 (1984) the Tax Court held that petitioner was not operated
exclusively for exempt purposes under the provisions of section 501(c)(3), I.R.C. 1954, and section 1.501(c)(3)-
1(c)(1), Income Tax Regs. Therefore, it is not exempt from Federal income tax.

Petitioner was incorporated as a nonprofit corporation for the purpose of raising money to be used for providing
college scholarships. The money was raised from the operation of motto games on the premises of a commercial
establishment.

The court stated that: “After careful consideration of the entire record, this Court finds that the petitioner has not
carried its burden of showing that it was operated exclusively for an exempt purpose under the required standards.”

The court further stated that: “Since the record in this case does not show that the petitioner was operated exclusively
for exempt purposes, but rather indicates that it benefited private interests, exemption was properly denied.”

In People of God Community v. Commissioner, 75 TC 127 (1980), the court held, that part of petitioner's net
earnings inured to the benefit of private shareholders or individuals and that petitioner was not exempt as an
organization described in section 501(c)(3), of the Internal Revenue Code of 1954.

The court stated that the burden falls upon petitioner to establish the reasonableness of the compensation. The court
indicated that by basing compensation upon a percentage of petitioner's gross receipts, apparently subject to no upper
limit, a portion of petitioner's earnings was being passed on to an individual.

The court stated that: “The statute specifically denies tax exemption where a portion of net earnings is paid to private
shareholders or individuals. We hold here that paying over a portion of gross earnings to those vested with the
control of a charitable organization constitutes private inurement as well. All in all, taking a slice off the top should
be no less prohibited than a slice out of net.”

Revenue Ruling 64-182, 1964-1 (Part 1) C.B. 186, concluded that an organization qualified for exemption under
section 501(c)(3) of the Code where it used the proceeds from a business activity to conduct a charitable, program,
“commensurate in scope” with its financial resources, of making grants to other charitable organizations. Thus, an
organization whose principal activity is operating games of chance may nevertheless qualify for exemption, provided
it uses the proceeds of that business activity in a real and substantial charitable program (such as charitable grant
making) commensurate in scope with its financial resources, and otherwise meets the requirements of exemption.

Form 886-A ev.4-68) Department of the Treasury - Internal Revenue Service
Page: -4-

Form 8 86 A Department of the Treasury - Internal Revenue Service Schedule No. or
Explanation of Items Exhibit
Name of Taxpayer Year/Period Ended
ORG 20XX - 20K

Christian Echoes National Ministry, Inc. v. United States, 470 F.2d 849 (1972), held, in part, that “tax exemption is a
privilege, a matter of grace rather than right”.

Government’s position:

Based off of the information that you have furnished, approximately % of ORG time was devoted to charitable
gaming activities.

On average, there were six (6) pull-tabs that worked eight (8) hours per week (2,496 hours per year), two (2) counter
person that worked eleven (11) hours per week (572 hours per week), and one (1) project coordinator that worked
eleven (11) hours per week. All of the time devoted was related to the motto operation which does not serve any

. charitable purpose.

The Secretary devoted approximately 1040 hours per year. Their duties included activities related to the motto |
operation and the museum. An allocation of % was used.

Even if the five (5) board members met and discussed exempt purpose business, a total of 40 hours per year would
be devoted to exempt purpose activities.

Gross income from your exempt function activities was $.
% of your gross income came from your charitable gaming activities.

You are operated similar to the organizations described in Make a Joyful Noise v. Commissioner; Help the Children
v. Commissioner; and P.L.L. Scholarship Fund, v. Commissioner. Those cases involved organizations engaged
primarily in fund raising activities through motto games. The courts held that neither organization qualified for
exemption under section 501(c)(3) of the Internal Revenue Code because they were not operated exclusively for
exempt purposes.

The examination revealed that you underreported pull-tab sales in 20XX by §$, and failed to deposit the net proceeds
of $.

Since you were unable to substantiate that the funds were used for legitimate motto expenses and/or IRC 501(c)(3)
purposes, they are considered to have been used for nonexempt purposes for the private benefit of your motto
workers and motto managers.

Such expenditures do not serve charitable or other purposes within the meaning of section 501(c)(3) of the Internal
Revenue Code.

Because a substantial part of your activities is not in furtherance of an exempt purpose, we have determined that you
are not operated exclusively for an exempt purpose pursuant to section 501(c)(3) of the Internal Revenue Code and
section 1.501(c)(3)-1(c)(1) of the Income Tax Regulations.

We have determined that a substantial amount of income from your motto operation inured to the private benefit of
your motto workers and motto managers.

In addition, by engaging in substantial activities that serve private rather than public interests, you are not operated
exclusively for one or more exempt purposes pursuant to section 1.501(c)(3)-1(d)(1)(ii) of the Income Tax
Regulations. (See Church in Boston v. Commissioner and World Family Corp. v. Commissioner.)

Form 886-A crev.4-68) Department of the Treasury - Internal Revenue Service
Page: -5-

Form 8 86 A Department of the Treasury - Internal Revenue Service Schedule No. or
Explanation of Items Exhibit
Name of Taxpayer Year/Period Ended
ORG 20XX - 20KX

The amount of income distributed from the motto account for charitable and other IRC 501(c)(3) purposes in the
year ended 20XX was $ , year ended 20XX was $0, and year ended 20XX was $ ($7,500 listed as
charitable contribution and $111,479 in truck payments) respectively. The percentage of gross motto income
distributed for charitable purposes was approximately 0. % for the year ended 20XX, 0.0% for year ended 20XX,
and approximately % for the year ended 20XX.

Based on the amount of gross motto income that was distributed for charitable purposes, we have concluded that the
amount of the proceeds received from your motto activities to conduct charitable and educational programs is not
“commensurate in scope” with the financial resources of your motto operation. (See Revenue Ruling 64-182, 1964-1
(Part 1) C.B. 186)

Taxpayer’s position:
The taxpayer’s position is unknown at this time.

On a telephone call on October 8, 20XX, President indicated that they will have no choice but to agree.

‘

Conclusion:

Based on the analysis of your activities and the sources and amounts of your gross income and expenses, we have
determined that you no longer meet the requirements for exemption under section 501(c)(3) of the Internal Revenue
Code.

You are operated similar to the organizations described in Make a Joyful Noise v. Commissioner; Help the Children
v. Commissioner; and P.L.L. Scholarship Fund, v. Commissioner. Those cases involved organizations engaged
primarily in fund raising activities through motto games. The courts held that neither organization qualified for
exemption under section 501(c)(3) of the Internal Revenue Code because they were not operated exclusively for
exempt purposes.

Based on the amount of gross motto income that was distributed for charitable purposes, we have concluded that the
amount of the proceeds received from your motto activities to conduct charitable and educational programs is not
“commensurate in scope” with the financial resources of your motto operation. (See Revenue Ruling 64-182, 1964-1
(Part 1) C.B. 186)

Because a substantial part of your activities is not in furtherance of an exempt purpose, we have determined that you
are not operated exclusively for an exempt purpose pursuant to section 501(c)(3) of the Internal Revenue Code and
section 1.501(c)(3)-1(c)(1) of the Income Tax Regulations.

We have determined that a substantial amount of income from your motto operation inured to the private benefit of
your motto workers and motto managers.

We also determined that you failed to deposit approximately $ of gross pull-tab proceeds in the bank account for
ORG for the year ended December 31, 20XX.

Since you were unable to substantiate that the funds were used for legitimate motto expenses and/or IRC 501(c)(3)
purposes, they are considered to have been used for nonexempt purposes for the private benefit of your motto
workers and motto managers.

Form 886-A ev.4-68) Department of the Treasury - Internal Revenue Service
Page: -6-

Form 8 86 A Department of the Treasury - Internal Revenue Service Schedule No. or
Explanation of Items Exhibit
Name of Taxpayer Year/Period Ended
ORG 20XX - 20XX

By engaging in substantial activities that serve private rather than public interests, you are not operated exclusively
for one or more exempt purposes pursuant to section 1.501(c)(3)-1(d)(1)(ii) of the Income Tax Regulations. (See
Church in Boston v. Commissioner and World Family Corp. v. Commissioner.)

Based on the facts, law and conclusions cited above, we have determined that you no longer qualify for exemption
under section 501(c)(3) of the Internal Revenue Code.

Therefore, your exemption under section 501(c)(3) of the Internal Revenue Code is revoked effective January 1,
20XX, the first day of the year that we determined that you are not operated exclusively for exempt purposes.

Contributions made to you after January 1, 20XX , are not deductible under section 170 of the Internal Revenue
Code.

You are required to file Forms 1120 and pay Federal income tax for all years beginning after January 1, 20XX.
You are also required to file Forms 11-C & 730 for all required periods after January 1, 20XX.

These forms can be filed at a later date, and may be prepared by the Internal Revenue Service.

Alternative Position:

In the event that ORG remain tax-exempt, are the unaccounted for pull-tab sales considered unrelated business
income (UBI)?

Facts:
Same as above.
Law:

Section 511(a) of the Code imposes a tax on the unrelated business taxable income of organizations described in
section 501(c), which includes section 501(c)(3).

Section 512(a)(1) of the Code provides that as a general rule, except as otherwise noted, the term “unrelated business
taxable income” means the gross income derived by any organization from any unrelated trade or business (as
defined in section 512) regularly carried on by it, less certain allowable deductions and modifications.

Section 512(b)(3)(A) of the Code provides that, with certain exceptions, one of the modifications referred to in
section 512(a)(1) is that there shall be excluded from the term “unrelated business taxable income” all rents from real
and personal property.

Section 513(a) of the Code defines the term “unrelated trade or business” as any trade or business the conduct of
which is not substantially related (aside from the need of such organization for income or funds or the use it makes of
the profits derived) to the exercise or performance by such organization of the charitable, educational, or other
purpose or function constituting the basis for its exemption under section 501.

Form 886-A rev.4-68) Department of the Treasury - Internal Revenue Service
Page: -7-

Form 886 A Department of the Treasury - Internal Revenue Service Schedule No. or
Explanation of Items Exhibit
Name of Taxpayer Year/Period Ended
ORG 20XX - 20XX

Section 513(a)(1) of the Code 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.

Section 1.512(b)-1(c)(2)(i) of the regulations provides that, in general, rents from real and personal property, and the
deductions directly connected therewith, are excluded in computing unrelated business taxable income.

Section 1.512(b)-1(c)(5) of the regulations provides that for purposes of section 1.512(b)-1(c), payments for the use
or occupancy of rooms and other space where services are also rendered to the occupant, such as for the use or
occupancy of rooms or other quarters in hotels, boarding houses, or apartment houses furnishing hotel services, or in
tourist camps or tourist homes, motor courts, or motels, or for the use or occupancy of space in parking lots,
warehouses, or-storage garages, does not constitute rent from real property.

Section 1.513-1(a) of the regulations provides that gross income of an exempt organization subject to tax imposed by
section 511 of the Code is includible in the computation of unrelated business taxable income if: (1) it is income
from a trade or business; (2) such trade or business is regularly carried on by the organization; and (3) the conduct of
such trade or business is not substantially related (other than through the production of funds) to the organization’s
performance of its exempt functions.

Section 1.513-1(b) of the regulations provides that, in general, any activity of an exempt organization which is
carried on for the production of income and which otherwise possesses the characteristics required to constitute
“trade or business” within the meaning of section 162 of the Code is a trade or business for purposes of sections 511-

513. Further, the term “trade or business” generally includes any activity carried on for the production of income
     from the sale of goods or performance of services.

Section 1.513-1(c)(1) of the regulations provides that in determining whether gross income from a trade or business
is “regularly carried on” within the meaning of section 512 of the Code, regard must be had to the frequency and
continuity with which the activities productive of the income are conducted and the manner in which they are
pursued.

Section 1.513-1(d)(1) of the regulations provides that, in general, gross income derives from “unrelated trade or
business,” within the meaning of section 513(a) of the Code, if the conduct of the trade or business which produces
the income is not substantially related (other than through the production of funds) to the purposes for which
exemption is granted. The presence of this requirement necessitates an examination of the relationship between the
business activities which generate the particular income in question-- the activities, that is, of producing or
distributing the goods or performing the services involved--and the accomplishment of the organization’s exempt
purposes.

Section 1.513-1(d)(2) of the regulations provides that trade or business is “related” to exempt purposes, in the
relevant sense, only where the conduct of the business activities has causal relationship to the achievement of exempt
purposes, and is “substantially related,” for purposes of section 513 of the Code, only if the causal relationship is a
substantial one. Thus, for the conduct of trade or business from which a particular amount of gross income is derived
to be substantially related to purposes for which exemption is granted, the production or distribution of the goods or
the performance of the services from which the gross income is derived must contribute importantly to the
accomplishment of those purposes. Where the production or distribution of the goods or the performance of the
services does not contribute importantly to the accomplishment of the exempt purposes of an organization, the
income from the sale of the goods or the performance of the services does not derive from the conduct of related
trade or business. Whether activities productive of gross income contribute importantly to the accomplishment of any
purpose for which an organization is granted exemption depends in each case upon the facts and circumstances
involved.

Form 886-A crev.4-68) Department of the Treasury - Internal Revenue Service
Page: -8-

Form 8 86 A Department of the Treasury - Internal Revenue Service Schedule No. or
So Explanation of Items Exhibit
Name of Taxpayer Year/Period Ended
ORG 20XX - 20XX

Section 1.513-1(e)(1) of the regulations refers to section 513(a) of the Code which specifically states 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.

FINAL-REG, TAX-REGS, §1.513-5. Certain motto games not unrelated trade or business
§1.513-5. Certain motto games not unrelated trade or business

(a) In general. —Under section 513(f), and subject to the limitations in paragraph (c) of this section, in the case of an
organization subject to the tax imposed by section 511, the term “unrelated trade or business” does not include any
trade or business that consists of conducting motto games (as defined in paragraph (d) of this section).

(b) Exception. —The provisions of this section shall not apply with respect to any motto game otherwise excluded
from the term “unrelated trade or business” by reason of section 513(a)(1) and §1.513-1(e)(1) (relating to trades or
businesses in which substantially all the work is performed without compensation).

(c) Limitations

(1) Motto games must be legal. —Paragraph (a) of this section shall not apply with respect to any motto game
conducted in violation of State or local law.

(2) No commercial competition. —Paragraph (a) of this section shall not apply with respect to any motto game
conducted in a jurisdiction in which motto games are ordinarily carried out on a commercial basis. Motto games are
“ordinarily carried out on a commercial basis” within a jurisdiction if they are regularly carried on (within the
meaning of §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 motto games are ordinarily carried out on a
commercial basis. However, if State law permits local jurisdictions to determine whether motto games may be
conducted by for-profit organizations, or if State law limits or confines the conduct of motto games by for-profit
organizations to specific local jurisdictions, then the local jurisdiction will constitute the appropriate jurisdiction for
determining whether motto games are ordinarily carried out on a commercial basis.

(d) Motto game defined. —A motto game is a game of chance played with cards that are generally printed with five
rows of five squares each. Participants place markers over randomly called numbers on the cards in an attempt to
form a preselected pattern such as a horizontal, vertical, or diagonal line, or all four corners. The first participant to
form the preselected pattern wins the game. As used in this section, the term “motto game” means any game of motto
of the type described above in which wagers are placed, winners are determined, and prizes or other property is
distributed in the presence of all persons placing wagers in that game. The term “motto game” does not refer to any
game of chance (including, but not limited to, keno games, dice games, card games, and lotteries) other than the type
of game described in this paragraph.

(e) Effective date. —Section 513(f) and this section apply to taxable years beginning after December 31, 1969.
Government’s Position:

A review of the pull-tab inventory of 20XX, noted that 115 boxes were unaccounted for. ORG stated that these
boxes were returned to the suppliers. ORG was unable to provide any documentation to prove that the boxes were

returned to the suppliers. The suppliers were contacted and stated that the boxes were not returned.

The sale of these boxes would have reported gross income of $ and a net profit of $. These sales were never
recorded, the income was not deposited into the bank, and the funds were not used for a charitable purpose.

Form 886-A Rev.4-68) . Department of the Treasury - Internal Revenue Service
Page: -9-

Form 886A Department of the Treasury - Internal Revenue Service Schedule No. or
Explanation of Items Exhibit
Name of Taxpayer Year/Period Ended
ORG 20XX - 20XXK

Since you were unable to substantiate that the funds were used for legitimate motto expenses and/or IRC 501(c)(3)
purposes, they are considered to have been used for nonexempt purposes for the private benefit of your motto
workers and motto managers.

The net profit of $ is considered UBI in the event ORG remains tax-exempt.

Taxpayer’s Position: |
The taxpayer’s position is unknown.
Conclusion:

In the event that ORG remains tax-exempt, the unaccounted for pull-tab sales of $ are considered UBI.

Form 886-A cev.4-68) Department of the Treasury - Internal Revenue Service
Page: -10-