Legal Issues of Online Raffles for Nonprofit Fundraising

The boundary line between online raffles and gambling is a fine one. That can mean problems for those nonprofit organizations wishing to set up raffles for fundraising. Are they legal? There are federal restrictions and rules that apply, and some states outlaw them completely. Anyone thinking of setting up an online raffle, even to raise funds for a good cause, needs to do careful research about how such ticket sale activities are viewed in their jurisdiction.

Raffles have been around for centuries, although the concept of online raffles is a relatively new phenomenon. In a raffle, people buy tickets for a chance to win prizes, and the raffle organizers determine the winner, usually by drawing a ticket at random. For example, a school may sponsor a raffle where students sell tickets for a meal in a fine local restaurant, and a ticket number is chosen randomly to determine the happy winner.

Although raffles have been around for years and can be relatively insignificant in terms of potential winnings, raffles in general are considered to be gambling by the Internal Revenue Service for tax purposes. The result is that the IRS sets up rules for raffles, including restrictions and reporting requirements to be certain that the winner pays taxes on the value of the prizes.

With the advent of online raffles, additional restrictions and even prohibitions are imposed by states. That means that, even for charitable organizations, it doesn't pay to simply jump into fundraisers via online raffles without learning how they are treated under relevant federal and state laws.

The IRS has imposed a variety of reporting requirements for nonprofit raffles, whether online or not. First, nonprofit organizations must report raffle prizes to the IRS whenever the value of the payout to the winner is at least 300 times the amount of the wager. This is only applicable if the prize value exceeds $600, with the amount of the entry being first deducted. The nonprofit organization must prepare Form W-2G, submitting the original to the IRS with a copy to the winner.

The person who wins the prize must report it as income using IRS Form 5754. To ensure that the tax is paid, the nonprofit is also required to do backup tax withholding before making a lottery payout if the prize is over $5,000 in cash. One quarter of the amount must be withheld. What happens if it is not a cash prize, but a vacation to Fiji? As long as the fair market value of the prize is over $5,000, the winner must pay 25 percent of the value, after deducting the cost of the raffle ticket, to the nonprofit to be sent to the IRS. If the winner does not provide the nonprofit with their tax information, the nonprofit must withhold 28 percent of the prize income.

In addition, the nonprofit must pay federal income taxes, too. Though a nonprofit is usually exempt from federal income tax, they must usually pay income tax on revenues gained from raffles. This money is classified as unrelated business income since it is not substantially related to the nonprofit's exempt purpose.

Although the Federal Wire Act was initially interpreted to restrict online raffles by nonprofits, that is less of a concern today. The Federal Wire Act was enacted to restrict organized crime operations from conducting illegal bookmaking activities, punishing those who accepted bets over the telephone or telegraph. Its language was initially interpreted to apply to all forms of online gambling. However, this was clarified by the U.S. Department of Justice in 2011. The agency released a formal opinion on the Federal Wire Act, stating that it applied only to online sports betting based in the United States, rather than to all online gambling.

The federal government, especially the IRS, has enacted a variety of reporting and tax regulations that impact a nonprofit that attempts to raise funds using online raffles. But in addition to federal restrictions on raffles, nonprofits are also faced with state laws impacting their activity. These vary significantly from state to state, so it is imperative to check with local authorities before starting a fundraising effort online.

That is because many states outlaw all gambling, including online gambling. And a raffle, no matter the status of the organization organizing it, is a type of gambling. An individual who participates in a raffle buys a ticket in hopes of hitting the jackpot, and this qualifies as gambling, even when the funds finance a good cause.

In some states, gambling and online gambling are strictly illegal. While certain states, like California, make legal prohibitions for nonprofit organizations, many states do not. A nonprofit should not make online raffles available in states that outlaw gambling and which do not make any exceptions that apply to nonprofits or online raffles. This means that the nonprofit needs to conduct research into the gambling laws for their state, as well as for neighboring states. The raffle should be open only to those in states where the practice is legal.

One state that permits nonprofits to hold raffles to raise funds is California. The state constitution prohibits lotteries, including raffles, but an exception is made for charities and certain other private nonprofit organizations. They are permitted to conduct raffles if at least 90 percent of the total money gained from these raffles (calculated on gross receipts) goes directly to beneficial or charitable purposes in California.

California Penal Code Section 320.5 describes the types of organizations that qualify for this exception and describes how the raffles must be conducted. Generally, California law requires that nonprofit organizations register with the Attorney General's Registry of Charitable Trusts before the raffle is held. The law also requires that the nonprofit file a financial disclosure report that includes all raffles held during the reporting year.

Note that Penal Code Section 320.5 is a criminal statute. That means that any violations of the law can be prosecuted by the district attorney. Action by the California Attorney General is also possible for violations. The provisions of the Nonprofit Corporation Law allow actions against nonprofits for breach of fiduciary duty or waste of charitable assets. In addition, the state can suspend the nonprofit's raffle registration and prohibit any new fundraising by raffle.

California is by no means the only state that permits nonprofits to hold online raffles. In fact, most states do – 45 states, according to some websites. All of these states impose certain limitations, generally focused on making certain that the organizations are truly nonprofits and actually using the funds for their charitable purposes.

That still leaves a handful of states that bar nonprofit online raffles completely. These include Alabama, where state charitable gaming laws ban raffles outright, and Hawaii also forbids charity raffles online, as do Kansas and New Jersey.

Unless the law in a particular state is crystal clear that nonprofits can raise money with online raffles, it is wise to consult an attorney before organizing the fundraising event. The laws can be complex and the consequences severe for violations.