Chinese auctions and raffles are a go-to fundraising tool for many nonprofits, combining excitement with high donor engagement. But what seems like a simple charitable event can carry hidden legal and tax obligations, including the often misunderstood “no purchase necessary” requirement.
Are your events following the rules, or could a simple mistake lead to costly consequences?
Promotional Devices
Fundraising games come in different flavors: Games of Skill, Games of Chance, and Sweepstakes.
Games of Skill select winners based on an entrant’s performance. Common campaigns using games of skill include trivia contests, writing contests, and sports competitions, where winners are determined by ability rather than chance. Because the outcome depends on performance, these contests are generally exempt from gaming laws—although fairness and transparency are a must to avoid raising red flags. State or local laws regulating games of skill may also apply. For example, in NY, Interactive Fantasy Sports are a game of skill but still must register and comply with specific laws.
Games of Chance are defined by three components: consideration, i.e., paying for your ticket; random drawing, i.e. win by a lucky draw; and a winning prize. If all three elements are present, the game legally functions as a game of chance and is generally subject to state gaming laws. The states that allow for-profit entities to conduct gaming generally limit it to small areas, such as Atlantic City. Most states allow charities to utilize gaming; however, complying with all the regulations can be burdensome, especially if you want to operate online games or conduct games in multiple states.
So how does an organization woo donors, offer a high-energy promotion, and raise funds without triggering gaming rules?
The answer for many organizations is Sweepstakes.
Sweepstakes are also chance-based and can be utilized by both for-profit and nonprofit entities. The key distinction between a game of chance and a sweepstakes lies in eliminating “consideration” by offering a free entry option, commonly called an Alternate Method of Entry (AMOE).
The Alternate Method of Entry is the “get-out-of-jail-free card” that most clearly differentiates a sweepstake from a game of chance. It is also the area most often overlooked. Many organizations will just write, “no purchase necessary” and never provide an actual AMOE.
Sweepstakes must have official rules, and usually include:
- No purchase necessary
- Clear eligibility criteria
- Timing of the promotion
- Instructions for entering, including the AMOE
- Winning odds
- Description of prizes and values, and
- Method of determining winners.
There may be additional federal or state requirements. For example, if you send out sweepstakes using the US postal service, you will be subject to the Deceptive Mail Prevention and Enforcement Act, which has its own unique requirements.
Most states do not require registration or bonding; however, New York does require it when the total value of prizes exceeds $5,000. They also require filing a list of winners with the state after the event is over.
A sweepstakes structure avoids unintended classification as a game of chance and therefore circumvents many state restrictions. Bottom line: Done right, the sweepstakes option is a nonprofit’s preferred fundraising device.
Regulatory and Tax Context
From a federal perspective, an important consideration for nonprofits is unrelated business taxable income (UBTI). Under IRS § 512 and 513 and Treasury regulations, if a tax-exempt charity (§ 501(c)(3)) conducts a trade or business that is regularly carried on and is not substantially related to its exempt purpose, the net income may be subject to tax (see IRS Publication 598).
Gaming income can fall into this category if it is recurring or structured as a business activity, rather than serving the charity’s mission. If, for example, a nonprofit hospital runs weekly raffles to raise money for patient programs, offering prizes of high-end electronics, the funds raised will be taxable.
Prize winners also have obligations. Their winnings are generally taxable, and charities may need to issue Form W-2G for games of chance, 1099-MISC for sweepstakes, and in some cases may withhold taxes. Sweepstakes organizers must comply with tax reporting obligations. For sweepstakes organizers, compliance with federal, state, and sometimes local tax reporting obligations are also binding.
Organizations take note: Study and implement all legal requirements carefully before unleashing your creativity on new and exciting fundraising initiatives.
Key Takeaways
To see success, fundraising requires creativity—and a heavy dose of compliance. While many options exist, sweepstakes take the lead as a powerful tool that excites donors and draws in funding, a win-win for nonprofits. Staying on top of tax, prize, and state requirements can keep campaigns smooth, legal, and mission-driven, which allows nonprofits to spend less time on paperwork and red tape and more time on making an impact.
This material has been prepared for informational purposes only, and is not intended to provide or be relied upon for legal or tax advice. If you have any specific legal or tax questions regarding this content or related issues, please consult with your professional legal or tax advisor.
