Nonprofit organizations are always seeking monies to carry out their purposes. Fees for services, membership dues, donations, grants, planned giving – all are contributors to the bottom line. Events are also popular and one item that frequently is raised is the raffle. One director suggests a raffle, saying she knows where she can get some great prizes donated. Everybody loves raffles, she says. Most of the other directors jump on board. One director raises the question – aren’t there legal problems with holding a raffle? Some directors quickly assert that everyone holds raffles so it must be okay. They should not jump so quickly. There are requirements that must be met to hold a raffle legally and in ways that will not jeopardize the nonprofit’s tax-exempt status or cause it to owe taxes.
North Carolina nonprofits must look to two sources of law when considering holding a raffle – North Carolina law and federal tax law. In North Carolina and under federal law, raffles are a form of gambling, or gaming. In North Carolina, they are generally unlawful. By statute, however, North Carolina nonprofits are permitted to hold up to two raffles per year. A raffle is defined as a game in which the prize is won by random drawing of the name or number of one or more persons purchasing chances. What about door prizes? Purchasing a ticket for a dinner or some event, such as a concert or other entertainment, at which door prizes are given out counts as a raffle.
The maximum cash prize or fair market value of non-cash items per raffle is $125,000 and the total value of all prizes offered in a calendar year – whether cash or non-cash – is $125,000. If real estate is offered as a raffle prize, the total appraised value of all real estate prizes offered in a calendar year may not exceed $500,000.
Back to those paid dinners with door prizes or any event at which a raffle is held: in North Carolina, raffles may not be held or conducted in rooms where alcohol is being served or consumed. That does not mean that there may not be alcohol served or consumed anywhere on the premises where the raffle is held. It means only that none of the factors that comprise the raffle may occur in the room or rooms where alcohol is sold or consumed. For example, participants may not wander into the room to hear the raffle drawing results with drink in hand nor may they purchase or receive tickets at the cash or open bar set up for the event.
North Carolina law requires that no less than 90% of the raffle’s net proceeds must be used by the nonprofit for charitable, religious, educational, civic or other nonprofit purposes. None of the raffle proceeds may be used to pay anyone to conduct the raffle or to rent space where the tickets are received or sold or the drawing conducted. Raffles may not be held in conjunction with bingo.
Under federal tax law, gaming is generally not considered a charitable activity. Conducting gaming as an insubstantial part of a 501(c)(3) organization’s activities will not ordinarily jeopardize its tax-exempt status. What is insubstantial? There is no bright-line answer. The Internal Revenue Service will consider all the facts and circumstances, including a review of all the monies raised by and spent on the gaming activity by the tax-exempt organization and the time and other resources devoted to it, in making a determination of whether gaming constitutes a substantial part of the nonprofit’s activities.
Even if the nonprofit’s gaming activities are insubstantial and its tax-exempt status is not threatened, it may be subject to tax on unrelated business income. Generally, there are three conditions that must be satisfied for an activity, such as gaming, to be classified as an unrelated trade or business that may generate unrelated business taxable income. Two of the three conditions are nearly always satisfied with regard to gaming. The first is the activity must be a trade or business. Gaming is considered a trade or business if it generates revenue. The second – the activity is not substantially related to the nonprofit’s exempt purpose – is satisfied with regard to all 501(c)(3) and many other tax-exempt organizations. Gaming is not a charitable activity.
The last condition provides more leeway, or an exception, to classifying a nonprofit’s gaming as unrelated trade or business. Gaming must be carried on regularly. It must be conducted with a frequency and continuity similar to comparable activities carried on by for-profit organizations and pursued in a similar manner. Gaming activities, such as raffles, that occur only occasionally or sporadically do not meet this last condition. What is occasional? A raffle held at an annual fundraiser is not regular. Raffles held weekly are.
North Carolina nonprofits are limited by state law, as noted above, to two raffles per year. Therefore, nonprofits complying with this limitation should not be deemed to be engaged in an unrelated trade or business for federal tax purposes, as they are not regularly carrying on gaming activities. A North Carolina nonprofit that generates a substantial portion of its revenues from its two raffles per year may find itself, however, stripped of its tax-exempt status if the Internal Revenue Service concludes that the nonprofit’s gaming activities are substantial.
Exempt organizations must also be aware of the IRS reporting and withholding requirements that apply to raffles. The exempt organization must report raffle prizes to the IRS on Form W-2G if the amount of the winnings paid to the winner (less, at the organization’s option, the amount paid by the winner for the chance to win the prize) is $600 or more and at least 300 times the amount of the wager. If the winnings are more than $5,000, the organization must withhold 25% from the winnings and report the amount to the IRS. Failure to withhold correctly may result in the exempt organization’s being liable for the tax. If the raffle prize is a noncash prize, the winner must pay the organization 25% of the fair market value of the prize, less the amount of the wager. An award of cash to cover the tax is also subject to tax.
Raffles remain a popular and oftentimes effective means of fundraising for a nonprofit. They are not, however, without their own risk and nonprofits that hold raffles without understanding and complying with the law may themselves be engaged in gambling.
— Melanie S. Tuttle
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