The prizes are an interesting technical question, but they aren’t interesting enough for me to look into it in a comprehensive way. So here are my unresearched thoughts.
I don’t see the prizes earned by Scouts as a problem for the chartered organization’s tax-exempt status. The problem arises when any part of the earnings inures to the benefit of a private individual. The profits from pack fundraising are part of the earnings of the organization. However, the prizes are not. These are really in the nature of sales commissions earned by the Scouts themselves. This is their share of the take on the product sale. It is promised to them by the product vendor, and the organization never really has access to it.
The prizes are gross income of the Scouts and should be reportable on the Scouts’ income tax returns based on their fair value. For nearly all of them, the total amount, coupled with any other income they may have, will not rise to the level that would create a filing requirement.
I’m calling them “prizes,” because that is what the vendors call them. From a tax perspective, a prize is something one wins at a contest. These “prizes” are actually sales commissions. As Scouts sell more product, they earn larger commissions. So, the next question becomes whether the fair value of these “prizes” should be reported as earnings from self-employment or as other income. If they are net earnings from self-employment, the Scouts would be subject to self-employment tax, if the value of the prizes received was $400 or more.
The key element in determining whether the prizes are self-employment earnings or other income is whether the Scout is engaged in the trade or business of selling the products. This determination is made based on the facts and circumstances of the situation. Although Scouts do not engage in these product sales all year, many activities constitute trades or businesses even if conducted only seasonally. Suppose I rent an ice cream truck for four months every year. I am clearly engaged in the business of retail ice cream sales. Scouts may engage in the selling of popcorn for several weeks each fall, and that pattern may push the analysis toward concluding it’s a business.
On the other hand, Scouts have no capital invested in this activity and bear no risk of financial loss. They can either earn the prizes or earn nothing. It can never cost them anything. This differs from a lemonade stand, where the Scouts must invest in the lemons and other ingredients, and may lose money, if they fail to sell lemonade. So the lack of risk indicates that Scouting product sales may not be a trade or business.
There really is no cookie cutter answer to this. Different conclusions about different Scouts could be reached based on their individual fact patterns.
If a Scout is engaged in a trade or business, s/he would be entitled to deduct ordinary and necessary business expenses. An example might be bus fare to the mall, where the products will be sold.
Also, a Scout engaged in the trade or business of selling products would be entitled to make a contribution to an IRA, based on his or her earnings. S/he could probably even adopt a Simplified Employee Pension (SEP) plan and make contributions to it, based on his or her profits. However, model SEP agreements generally restrict participation to those 21 and older. So, s/he would have to engage a professional to draft a custom document for the plan. Of course, legal fees paid would be deductible as ordinary and necessary expenses incurred in carrying on a trade or business.