Are the odds in your favor?

Raffles are commonly used by nonprofit organizations as a way to raise funds. But that doesn’t mean that raffles are without challenges. IRS rules surrounding gaming apply, as do state and local laws. Not knowing the rules may come back to haunt your organization.

UBI Ramifications

Nonprofits must pay income tax on unrelated business income (UBI), defined as income from a trade or business, regularly carried on, that isn’t substantially related to the organization’s exempt purpose. The IRS considers raffles to be a form of gaming, which is a trade or business. Thus, your raffle income may be subject to UBI tax.

If you routinely hold raffles, it’s possible they could be considered “regularly carried on,” and raffles likely aren’t related to your exempt purpose. In addition, losses in another unrelated trade or business can’t be used to offset UBI generated by your raffle.

But, raffle income can be exempted from UBI tax if the raffle is conducted with “substantially all” volunteer labor. The term hasn’t been formally defined, but the IRS’s unofficial guideline is that 85% or more of the labor running the raffle should be from volunteers. Keep records to document your level of volunteer support.

Raffle income can be exempted from UBI tax if the raffle is conducted with “substantially all” volunteer labor.

IRS Reporting

Your nonprofit must report when the winnings are $600 or more and at least 300 times the amount of the winner’s wager (the raffle ticket price). You can deduct the wager amount when determining if the $600 threshold is met. For example, let’s say you sell $5 tickets and your winner receives $2,500. Because the winnings ($2,495) are more than $600 and more than 300 times the amount of the $5 wager, you must report the winnings to the IRS.

You should file Form W-2G, “Certain Gambling Winnings,” and give a copy to the winner to show reportable winnings along with any related income tax withheld. The winner should provide you with their name, address and Social Security number on Form W-9 or Form 5754, to include with the filing.

Income tax withholding

Your organization will need to withhold federal income tax from any winnings and remit that amount to the IRS if the proceeds (the difference between the winnings and the amount of the wager) are more than $5,000. If winnings aren’t in cash (for example, a vacation package or motor boat), the proceeds are the difference between the fair market value (FMV) of the item won and the wager amount. If the value of a noncash prize isn’t obvious, obtain a valuation before the drawing.

You must withhold 24% in tax from the winnings. Note that the 24% rate applies to the total amount of the proceeds from the wager, not just the amount that exceeds $5,000. Say that you hold a raffle with $2 tickets and the winner receives $7,000. Because the proceeds ($6,998) exceed $5,000, you must withhold $1,680 ($6,998 × 24%). For noncash prizes valued at more than $5,000, your organization has one of two options:

1. The winner reimburses you the amount of withholding tax that you must pay to the IRS, or
2.  You pay the withholding tax on behalf of the winner, calculated at 31.58% of the FMV less the wager amount.

Taxes withheld from raffle winnings must be reported on Form 945, “Annual Return of Withheld Federal Income Tax.” Include the total amount of tax withheld that you reported on all the Forms W-2G filed for the year. File by January 31 following the close of the tax reporting year. If taxes withheld are under $2,500 in total, you may remit to the IRS when filing Form 945. If they’re greater than $2,500, you must remit them electronically on a monthly or semiweekly basis, depending on the total tax.

Finally, confirm that winners furnish a correct Social Security number to your organization. Otherwise, you will usually be required to withhold 24% of raffle prizes for federal income tax backup withholding.

A Winning Ticket

Everyone likes the idea of raffles, but be sure you know what tax reporting may be necessary before you feature one in a fundraiser. In addition to your federal tax ramifications, it’s important to follow all state and local tax obligations. Contact us to make sure your raffle meets all the requirements.