This ticket to revenue carries compliance concerns
Raffles are tried-and-true fundraising vehicles. They can be attractive to your constituents, easy to put together and profitable. But organizations need to put on their “compliance hats” when holding this activity. Each state has its own set of laws regulating raffles. And all organizations must comply with federal income tax requirements about unrelated business income, reporting and tax withholding.
Nonprofits must pay income tax on unrelated business income (UBI). The IRS defines UBI as income from a trade or business, regularly carried on, that isn’t substantially related to a nonprofit’s exempt purpose. The tax agency considers raffles to be a form of gaming, which is a trade or business. 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.
But raffle income can be exempted from UBI tax, if the raffle is conducted with “substantially all” volunteer labor. The term “substantially all” 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. Document the hours worked by staff and volunteers to demonstrate your degree of volunteer support.
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.
Say that you sell $4 tickets and your winner receives $2,000. Because the winnings ($1,996) are more than $600 and more than 300 times the amount of the $4 wager, you must report them to the IRS.
File Form W-2G, “Certain Gambling Winnings,” with the IRS, generally by February 28 following the year of the payment. Give a copy to the winner by January 31 to show reportable winnings along with related income tax withheld. The winner must provide you with his or her name, address and Social Security number and return a signed copy of the W-2G if he or she is the sole winner. Form 5754 should be completed if there are multiple winners.
Federal income tax must be withheld from the winnings and remitted to the IRS if the proceeds (the difference between the winnings and the amount of the wager) are more than $5,000. If the winnings aren’t in cash (for example, a vacation package), the proceeds are the difference between the fair market value (FMV) of the item won and the wager amount. When the value of a noncash prize isn’t obvious, obtain a valuation before the drawing.
You must withhold tax, equal to 24% of the total proceeds, from the winnings. Imagine that you hold a raffle with $1 tickets. The winner receives $6,000. But, because the proceeds ($5,999) exceed $5,000, you must withhold $1,440 ($5,999 × 24%).
For a noncash prize with proceeds of more than $5,000, you may 1) have the winner reimburse you the amount of withholding tax required, or 2) pay the withholding tax on behalf of the winner, calculated at 31.58% of the FMV of the prize, less the wager. Taxes withheld from raffle winnings must be reported on Form 945, “Annual Return of Withheld Federal Income Tax,” and deposited as nonpayroll withholding.
There are differing deposit requirements, depending on whether the total taxes withheld annually are under or over $2,500. Also note that your organization might be required to withhold 24% of raffle prizes for federal income tax backup withholding if the winner doesn’t furnish a correct Social Security number.