How Would A Sweepstakes Sponsoring Company Avoid Paying Taxes on Sweepstakes Entries and Winnings?

Question

Lets say I were to host a service that allows for businesses to use me to handle their sweepstakes promotions. I would handle paid entries, alternate entry methods, use a third party to pick winners, pay out the winnings to the winner, pay out the profits to the sponsor, and send out tax forms to everyone at the end of the year. The way the service would make money is by taking a 10% cut of the profit of the sweepstakes promotions. For example if 5000 people paid $1 for the chance to win $1000, the promotion would have made a profit of $4000, so my service would take $400 of that.

The only up-front financial requirement to start the promotion would be the prize money (so that I can pay it out at the end of the promotion). How would my service avoid having to pay takes on the $1000 in prize money provided up front, as well as the $5000 worth of entries, and only pay taxes on the $400 that my service actually makes?

Answer 1

You pay income tax on earnings, not revenue

The $1,000 prize money you receive is not earnings, in an accounting sense it is a purely balance sheet item - the $1,000 cash asset comes with a $1,000 liability to pay it out to the sweepstakes winner. If you pay tax on an accruals basis, you will never be liable for tax on it. If you pay tax on a cash basis, you will pay the tax when you take the money and get a tax credit when you at it out.