IRS Rules for Tax-Exempt Organizations Hosting Contests, Drawings, and Games
Raffles, drawings, and games can accomplish fundraising goals for tax-exempt organizations while also offering entertainment for participants. But these fundraising events require tax planning to keep the IRS at bay (note that separate laws apply at the state tax level). This article covers key federal tax considerations for tax-exempt entities hosting a raffle, drawing, or similar event, including the potential impacts on tax-exempt status; avoiding unrelated business income tax; recordkeeping; tax reporting; and tax withholding. The article is not a substitute for legal advice, so please contact your tax lawyer to learn how the regulations apply to your specific event.
Protecting Tax-Exempt Status
Tax-exempt organizations under section 501(c)(3) of the Internal Revenue Code must be formed and operated exclusively to serve a charitable purpose. In general, raffles, lotteries, and games are not charitable; they are either for-profit or recreational. That is true even if a tax-exempt entity uses revenue from those events to fund its charitable cause. For that reason, gaming activities should remain small relative to the entity’s other operations. The IRS will measure this in time and resources spent as well as dollars earned; to protect its tax exemption, the entity should track those metrics as well.
Additionally, tax-exempt entities should keep an eye on their revenue sources. If they generate too much revenue from games, the IRS may require them to broaden their funding base.
Avoiding Unrelated Business Income Tax
If raffles, drawings, or other gaming activity falls outside an organization’s exempt purpose, their revenue is subject to unrelated business income tax. Worse yet, engaging in too much unrelated business activity can threaten an entity’s tax exemption.
Raffles, drawings, and other games may generate unrelated business income if:
- They produce revenue;
- The organization hosts these events regularly (weekly events qualify as regular; annual events do not); and
- The events are not related to the organization’s charitable purpose (solely raising funds to further the organization’s charitable purpose is not enough to skirt this rule).
Nonetheless, certain activities are excluded from unrelated business income—meaning that their income is not subject to tax:
- Bingo does not generate unrelated business income so long as it (1) fits the statutory definition of bingo under the Code, (2) does not violate state or local laws, and (3) does not compete with bingo games carried on by for-profit organizations within the state.
- Games hosted primarily by volunteers do not generate unrelated business income regardless of the event type (raffle, lottery, or other). To show compliance, track volunteers’ hours compared to employees’ hours; as a rule of thumb, paid work should reflect no more than 15 percent of the hours to host.
- Certain public entertainment activities run by charitable organizations are excluded from unrelated business income tax so long as they comply with state and local laws.
Finally, games of chance held in North Dakota generally do not qualify as unrelated business income.
Recordkeeping
A tax-exempt organization hosting games, raffles, or lotteries should track gross revenue, prize payouts, and other related expenses. The organization should generally keep these records for three years from the filing or due date of the return, whichever is later.
Games can generate significant cash revenue. To maintain accurate records, adopt quality control measures to ensure no cash is diverted for private gains. This could mean involving separate staff or volunteers to record transactions, collect payments, prepare inventory reports, reconcile income and expenses with bank statements, and pay expenses. It would also be good practice for the board of directors to monitor revenue reports for consistency and attend the games periodically to ensure compliance with the organization’s revenue tracking systems.
Tax Reporting
If revenue from games or fundraising exceeds $15,000, the entity must report these activities on Schedule G, Form 990 or Form 990-EZ. The reporting requirements are onerous; entities must disclose:
- Gross revenue from bingo and other games;
- Cash and non-cash prizes paid out for each game;
- Expenses, including rent and facilities costs;
- Percentage of events taking place at the entity’s own facilities versus external sites;
- Percentage of volunteer labor;
- States where gaming activities took place and where the entity holds gaming licenses;
- Status of the entity’s gaming licenses;
- Names and addresses of the gaming manager and the person who prepares the books and records for gaming events; and
- Information about third parties the entity contracts with to receive gaming revenue.
In addition, if a winner or winners take home more than a threshold amount, the organization must report the winnings to the IRS. For most games, the organization must report winnings if a prize is:
- $600 or more (the organization may subtract the ticket cost), and
- At least 300 times the ticket cost.
Example 1: Tickets cost $2, and the grand prize is $1,000. The organization reports $998 in winnings.
Example 2: Tickets cost $2, and the grand prize is $600. No reporting required because the net winnings are only $598.
For certain games, the reporting threshold is higher, as shown below:
| Game Type | Reporting Threshold | Deduct the Wager Amount? |
|---|---|---|
|
Bingo or slot machines |
$1,200 |
No |
|
Keno |
$1,500 |
Yes |
|
Poker |
$5,000.01 |
Yes |
|
Other Games |
$600 and at least 300x the wager |
At the option of the paying entity |
Exempt organizations use Form W-2G to report prizes that meet these threshold amounts. That form also requires disclosing the prizewinner’s name, address, and taxpayer identification number. For paper filers, Form W-2G is due by February 28 in the year after the winnings are paid. For electronic filers, that deadline extends to March 31. Electronic filing is required for organizations with 250 or more Form W-2Gs in a year.
Organizations must also send copies of Form W-2G to the prizewinners by January 31 of the year after the winnings are paid.
Regular and Backup Withholding Requirements
There are two types of withholdings on winnings: regular and backup. If a payment is already subject to regular withholding, it is not also subject to backup withholding.
For regular withholding, the organization must withhold 24 percent (formerly 25 percent) of the prize and report it to the IRS:
- For sweepstakes, wagering pools, lotteries, raffles, or poker games, when the prize exceeds $5,000; or
- For any other game, when the prize amount is at least 300 times the ticket cost.
The ticket cost is subtracted from the prize in calculating these amounts.
Example: Raffle tickets cost $1, and the grand prize is $6,000. The winner’s proceeds from the raffle exceed $5,000 after subtracting the ticket price, so the organization must withhold 24 percent from the winnings. The 24 percent rate applies to $5,999 (proceeds from the prize less ticket cost), bringing the withholding amount to $1,440.
Non-cash prizes are subject to regular withholding as well—though the process is more complex. There are two options. The first is a tough sell for prizewinners because it asks them to pay the withholding tax to the organization. They would pay 24 percent of the fair market value of the prize after subtracting the ticket cost. The second option keeps the winner happy but costs the organization more. The organization pays the withholding tax on the winner’s behalf, but at a higher rate of 31.58 percent. The higher rate reflects that the winner acquired not only the prize, but also the value of having the organization pay the tax on it.
Alternatively, backup withholding applies if the prizewinner fails to provide the entity with a correct taxpayer identification number, there was no regular withholding on the winnings, and the winnings are at least $600 and at least 300 times the ticket cost. The backup withholding rate is 24 percent (formerly 28 percent).
Takeaway
While hosting a raffle or drawing may be a great way to earn extra revenue and build camaraderie among donors, tax-exempt entities must conduct these activities with care and remain diligent in complying with the tax reporting and withholding requirements. Failing to meet the IRS’s requirements can impact both the organization and its prizewinners. In extreme cases the organization may stand to lose its tax exemption, so the best bet would be to engage a tax professional rather than simply rolling the dice and hoping luck prevails.
Additional Resources:
I.R.S. Instructions for Forms W-2G and 5754 (Jan. 2021).
I.R.S. Publication 3079, Tax-Exempt Organizations and Gaming (Oct. 2018).
Editor’s Note: This is an updated version of a post on the same topic that was originally posted in 2016.
Contributors to this blog post
