Every charity considering a sweepstakes fundraiser hears the same reassurance: as long as you offer a free entry method, you’re not running an illegal lottery. That’s true, but only if the free entry actually works the way the law requires. Most of the compliance problems we see stem from charities that bolt on a free-entry option as an afterthought, without realizing that a token free method doesn’t satisfy the rule at all.
The three elements of an illegal lottery
Every state prohibits lotteries. A lottery exists whenever three elements are present simultaneously: a prize, selection by chance, and consideration paid by the entrant. Remove any one of the three and the promotion is no longer a lottery. It’s potentially a legal sweepstakes instead.
A sweepstakes works by removing consideration and replacing it with a free “alternative method of entry,” usually shortened to AMOE. A contest works differently, by removing chance and having winners selected on skill instead; that’s a separate set of rules and not what this post covers. Charities running prize drawings almost always go the sweepstakes route, because donors like the odds of winning and a skill-based contest doesn’t fit a donation drive.
Equal dignity: the part almost everyone gets wrong
Here’s what trips up well-intentioned charities: offering a free entry option is necessary, but it isn’t sufficient on its own. The free method must give a non-paying entrant essentially the same odds of winning as a paying entrant. Regulators and courts call this the “equal dignity” requirement, and it comes down to four things being the same for both paths:
- The number of entries available
- The pool the entries are drawn from
- The entry deadlines and timing
- The prizes being competed for
If your donation tiers scale entries with the amount given, say, $20 for one entry and $360 for eighteen, but your free method caps out at one entry per person, the free method doesn’t have equal dignity. It’s a token gesture. When that happens, a regulator can treat the consideration element as still present, because the free method never had a real chance of competing with the paid path. At that point the whole promotion can be recharacterized as an unlicensed lottery, regardless of what the official rules say.
Marketing copy can undo your own rules just as easily. We regularly see charities include the mandatory “no purchase necessary; a donation will not increase your odds of winning” language in the official rules, then market the exact opposite everywhere else on the same page: “the more you give, the more entries you get,” “triple your chances,” and so on. If your own marketing tells donors that giving improves their odds, you’ve handed a regulator, or a plaintiff’s attorney, the argument that your official rules are fiction. Rules and marketing have to say the same thing, and when they don’t, the marketing tends to win.
California doesn’t give you a fallback
Some states allow you to register a promotion as a raffle if the free-entry rule doesn’t apply. Not California. California’s raffle statute only covers raffles sold with paper tickets that have a physical, detachable stub, so a promotion that sells entries online for a donation is outside that statute from the start. More importantly, even a properly registered California raffle operator faces an unconditional ban on selling raffle entries online. Registering doesn’t undo that ban. If the AMOE doesn’t hold up, there’s no California filing that fixes it. The promotion is either an exempt sweepstakes or an unlicensed lottery, with nothing in between.
Prize value can trigger registration even when the AMOE is fine
Separately from the lottery-versus-sweepstakes question, several states require registration and bonding once a prize crosses a dollar threshold, no matter how solid your AMOE is. Florida requires registration and a bond once total prizes exceed $5,000, filed within seven days of the promotion’s start, and Florida enforces that deadline strictly. New York has the same $5,000 threshold with a thirty-day filing window, enforced less strictly in practice but still on the books. If a nationwide sweepstakes carries a prize above these thresholds, check these statutes before launch, not after a state regulator’s letter arrives.
Donations that buy a chance to win usually aren’t deductible
This is the tax mistake that costs donors real money at audit. If a donor’s payment functions as the price of a chance to win, the IRS treats the donor as having received full consideration for that payment, the same rule that makes a raffle ticket non-deductible. It doesn’t matter what the payment is labeled. Calling it a “donation” doesn’t change the analysis if the amount given is what buys the additional entries.
Where a chance to win is only a minor add-on to an otherwise ordinary payment, like a raffle drawing bundled into a gala ticket, the analysis softens into an ordinary quid pro quo problem: only the value of the chance is nondeductible, and the excess is deductible, provided the charity gives donors a written disclosure under I.R.C. § 6115 once a single payment exceeds $75. But charities that price entries per dollar given are much closer to the raffle-ticket rule than the gala-ticket rule, and they should stop telling donors their gifts are “fully tax-deductible” without qualification.
Reporting prize winnings: it’s Form W-2G, not Form 1099
One of the most common administrative mistakes we see is a charity that correctly understands a prize is taxable to the winner, then reports it on the wrong form. A chance-based prize is a wagering transaction for reporting purposes, so once a single winner’s prize reaches $600, the charity should issue Form W-2G, not Form 1099, and should collect Form W-9 from the winner first. If the prize is worth more than $5,000 and is at least 300 times the amount wagered, the charity also has a withholding obligation under the federal gambling withholding rules, separate from any personal income tax the winner owes.
The takeaway
None of this means charities should avoid sweepstakes fundraising. It means the free entry option has to genuinely work, the marketing has to match the official rules, and the tax and reporting mechanics have to be built around the fact that a chance to win is being purchased, whatever the receipt calls it. Getting these pieces right at the design stage is far cheaper than fixing them after a state regulator, the IRS, or a donor’s own accountant flags the problem.
Ellis Carter is a nonprofit lawyer with Caritas Law Group, P.C. licensed to practice in Washington and Arizona. Ellis advises nonprofit and socially responsible businesses on federal tax and fundraising regulations nationwide. Ellis also advises donors concerning major gifts. To schedule a consultation with Ellis, call 602-456-0071 or email us through our contact form. This post is for general informational purposes and does not constitute legal advice.