Taxing UBI

Nonprofits must pay income tax on UBI — 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 considered “regularly carried on,” and raffles likely aren’t related to your exempt purpose. Keep in mind that, under the Tax Cuts and Jobs Act (TCJA), losses in another unrelated trade or business can no longer be used to offset UBI generated by your raffle.

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 running the raffle should be from volunteers. Remember to keep records to demonstrate your level of volunteer support.

Reporting winnings

Your nonprofit must report when the winnings are $600 or more and at least 300 times the amount of the winner’s wager (the raffle ticket price). You can deduct the wager amount when determining if the $600 threshold is met.

For example, you sell $4 tickets and your winner receives $2,000. Because the winnings ($1,996) are more than $600 and more than 300 times the amount of the $4 wager, you must report them to the IRS.

You should file Form W-2G, “Certain Gambling Winnings,” and give a copy to the winner to show reportable winnings along with related income tax withheld. The winner should provide you with his or her name, address and Social Security number on Form W-9 or 5754, to include on the filing. Copy “A” of the W-2G is due to the IRS by February 28 following the calendar year of the payment if you’re filing on paper. If you file electronically, you have until March 31. The winner must receive copies “B” and “C” by January 31.

What about income tax?

Federal income tax must be withheld from the winnings and remitted to the IRS if the proceeds (the difference between the winnings and the amount of the wager) are more than $5,000. If the winnings are not in cash (for example, a vacation package or motor boat), the proceeds are the difference between the fair market value (FMV) 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.

Effective for tax years beginning after December 31, 2017, you must withhold 24% (previously 25%) in tax from the winnings. Note that the 24% 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 receives $6,000. But, because the proceeds ($5,999) exceed $5,000, you must withhold $1,440 ($5,999 × 24%).

For a noncash prize with proceeds of more than $5,000, you have two options:

Taxes withheld from raffle winnings must be reported on Form 945, “Annual Return of Withheld Federal Income Tax.” Include the total amount of tax withheld that you reported on all the Forms W-2G filed for the year.

If taxes withheld are under $2,500 in total, use Form 945 and file by January 31 following the close of the tax reporting year. If they’re greater than $2,500, file them on a monthly or semiweekly basis.

More to handle

Your organization might be required to withhold 24% (formerly 28%) of raffle prizes for federal income tax backup withholding if the winner doesn’t furnish a correct Social Security number. Ask your CPA for more details on this and other raffle requirements.

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