Raffles have long been a popular fundraiser for nonprofits. They’re easy to produce, affordable for participants and reliable revenue generators.
But they’re also subject to strict rules, particularly in the area of tax law. State laws on nonprofit-sponsored raffles can vary significantly, but every nonprofit that holds a raffle must comply with federal income tax requirements linked to unrelated business income, reporting and withholding.
Unrelated business income
Nonprofits are required to pay income tax on unrelated business income (UBI). It’s 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. If you routinely hold raffles, it’s possible they could be “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 should be volunteer. If relying on this exemption, make sure you keep records to demonstrate your level of volunteer support.
Winnings must be reported when the amount is $600 or more and at least 300 times the amount of the winner’s wager (the raffle ticket price). You can deduct the amount of the wager when determining if the $600 threshold is met.
For example, you sell $2 tickets, and your winner receives $1,000. Because the winnings ($998) are more than $600 and more than 300 times the amount of the $2 wager, you must report them to the IRS.
Form W-2G, “Certain Gambling Winnings,” must be filed with the IRS and provided to the winner to show reportable winnings along with the related income tax withheld. The winner should provide you with his or her name, address and Social Security number to include on the filing.
If you report using a paper form, you must file copy “A” with the IRS by February 28 following the calendar year of the payment. If you file electronically, you have until March 31. The winner must receive copies “B” and “C” by January 31.
Income tax must be withheld from the winnings if the proceeds (the difference between the amount of the winnings and the amount of the wager) are more than $5,000, and remitted to the IRS. If the winnings are in the form of a noncash payment (for example, an automobile or artwork), the proceeds are the difference between the fair market value of the item won and the wager amount. When the value of a noncash prize isn’t obvious, it’s wise to obtain a valuation before the drawing.
You must withhold 28% (the third lowest tax rate for single individuals) in tax from the winnings. Note that the 28% 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 $1 tickets. The winner nominally wins $6,000. But, because the proceeds ($5,999) exceed $5,000, you must withhold $1,680 ($5,999 × 28%).
For a noncash prize with a fair market value (FMV) of more than $5,000 after deducting the wager, you have two options:
- The winner reimburses you the amount of withholding tax that you must pay to the IRS.
- You pay the withholding tax on behalf of the winner, calculated at 33.3% of the FMV less the wager.
Taxes withheld from raffle winnings are nonpayroll withheld taxes and must be reported on Form 945, “Annual Return of Withheld Federal Income Tax.” The amounts you report must include the total amount of tax withheld that you reported on all the Forms W-2G filed for the year.
The payments, if under $2,500 in total, are due with Form 945 by January 31 following the close of the tax reporting year or, if greater than $2,500, on a monthly or semiweekly basis.
Handle with care
Raffles can pay off for nonprofit organizations of all kinds. But if you want to come out a true winner, you also need to satisfy the tax and filing requirements.
Sidebar: You may need to do “backup” withholding on raffle prizes
Your organization might be required to withhold 28% of raffle prizes for federal income tax backup withholding. Specifically, backup withholding applies when:
- The winner doesn’t furnish a correct Social Security number,
- The regular income tax hasn’t been withheld, and
- The winnings are at least $600 and at least 300 times the wager.
For example, you hold a raffle, selling tickets for $2 apiece. One of the participants wins $1,200 but refuses to provide you with his Social Security number. You’ll pay this winner $865 ($1,200 less $335, or 28% of $1,198), rather than the entire amount of winnings, since your organization must pay the IRS the $335. If you mistakenly pay out the entire amount to the winner, without any withholding, your organization still owes the IRS the backup withholding amount. Give us a call and let us know if you have any questions.