At the start of the topic I stated that I wanted to offer things like art and music as prizes, hoping to get some free or donated prizes to offer players. This seems like it is going to be a problem, as I think that even though these prizes are pretty much worthless they still have a worth and thus like Hodgman was saying falls into a distinct legal area.

I have had a plan B though, it is not as fun but will allow for a different type of community experience. The prizes in plan B are only usable within the game and the accompanying forum, they include things like titles, profile pictures, access to sub-forums, and access to grander betting options. They would be non-tradable also, though that wouldn't stop people selling their accounts. It really limits what I was trying to do by offering indie/donated virtual goods but I am not here to discuss the design.

Plan A is to offer indie/donated things like stories, art, music and even small games in the hope that people would use in-game credits to gain access to them and that people would donate in order to get their name out there. This is, I am well aware, very difficult and probably won't work the way I envision.

Plan B is to offer social and profile customizing content like I have listed above, and also access to more in game features like extra events, extra betting options, and obviously a high score board. The idea would be to set up a community of people through forums and moderators who use the game and the social/customize prizes for social interaction. Linking this with social networking site, emails, etc.

Those are the two plans, I am not set in stone but I do want to do something with the system and offer something back to players as this will encourage them to return and enjoy. Though of course I don't want to be sued or reprimanded for breaking any laws.

I know that if it is a casino type of game with payouts then you may want to check this out.
http://gaming.nv.gov/

If it has prize winnings...
http://www.irs.gov/govt/tribes/article/0,,id=102552,00.html zoom down to 1099-MISC