What follows is a summary of existing IRS guidance with respect to the following hypothetical issue:
What are the United States tax withholding and reporting requirements for an entity that runs a raffle or lottery (charitable or otherwise) and offers a winning prize of an in-kind asset such as an automobile (the “Prize”).
WITHHOLDING, PAYMENT, AND REPORTING REQUIREMENTS FOR RAFFLES/LOTTERIES
Basic Withholding Requirement: Any time the winnings of a Raffle or Lottery exceed $5000 (after deducting the ticket cost), the entity hosting the Raffle or Lottery must engage in withholding. The type of withholding can be either: (a) standard withholding; or (b) backup withholding.
Standard Withholding. For any winner with a United States social security number OR a United States tax identification number, standard withholding applies. Standard withholding requires that 25% of the fair market value of the net winnings be withheld. For a Prize such as an automobile, 25% of the MSRP of the automobile should be withheld.Backup Withholding. For any other winner (i.e., a winner who has no valid US taxpayer ID), on any winnings that must be reported on a W-2G (see below), backup withholding requires that 28% of the fair market value of the net winnings be withheld.
Payment of Withholding (General Rule). For the winner of an in-kind Prize such as an automobile, the player is required to pay the entity cash in the amount of the withholding requirement. For example, a player subject to standard withholding who wins a $50,000.00 automobile in a lottery from an entity after buying a $10.00 ticket owes $12,497.50 in cash withholding to the entity (($50,000.00 - $10.00) * .25 = $12,497.50).
If withholding is not collected by the entity, then the entity will be liable for the withholding tax.
CHARITY PAYING WITHHOLDING TAX
In certain circumstances, an entity wishes to cover the withholding tax on behalf of the winner. This creates a “gross-up” problem, however, because the amount paid on behalf of the winner for withholding is also itself subject to withholding tax.
“Grossed-Up” Withholdings: An entity that wishes to pay withholding on behalf of a player subject to standard withholding must withhold an effective rate of 33.33% of the fair market value of the net winnings. In the $50,000 car example above, the entity would need to withhold $16,661.67. (($50,000.00 - $10.00) * .33 = $16,661.67)
Though there is no IRS guidance directly on point, grossed-up withholdings on a player subject to backup withholding would likely be an effective rate of 38.89% of the fair market value of the net winnings.
Reporting (W-2G) Requirements. Regardless of withholding, an entity must file an IRS Form W-2G with respect to a lottery winning if: (a) the fair market value of the winnings, reduced by the wager (at the entity’s option) is $600 or more; and (b) the payout is at least 300 times the amount of the wager. Two examples follow:
Example 1. A player buys a $10 ticket and wins a camera worth $650. No W-2G is required.
Even though the fair market value reduced by the $10 ticket is greater than $600, the prize was not at least 300 times the amount of the wager.Example 2. A player buys a $10 ticket and wins a car worth $50,000. A W-2G is required. The net prize amount is greater than $600, and the car (worth $50,000) is worth more than 300 times the $10 wager ($3,000).