The first question is whether the game is skill based (think chess or League of Legends) or does luck play a major part (poker, blackjack, roulette).

If it's luck based, people are paying money to enter and winning prizes then that's online gambling.  It's illegal in most states and the few that allow it require you to be licensed (costs at least $1 million per state).

Note how poker is gambling.  Even though there's a lot of skill there, there's also a lot of luck and the FBI is pretty clear on this when they shut down a host of illegal poker sites many years ago.

If it's just skill based (there's no random element) then it's not technically gambling and can be legal. But of course you will need to be 100% sure the game can't be hacked or cheated.  If it can, your players can sue you (since their chance to win isn't what it appears to be, since others are cheating).

The safest and definitely legal one are sweepstakes.  There paying to enter must be optional (there must be a way to enter without paying) and you pay out prizes.  Basically here you're hoping to make money in another way (e.g. ads alongside the gaming) which pays for the sweepstake payout.

In all cases you definitely will need a lawyer to help write the terms of service.  But you should decide which direction before you start paying an expensive lawyer. 

Thanks a lot. I don't feel inclined to be involved with anything that risky.

Thanks

The design of financial incentive in Competitive Gaming is not easy to implement. Another factor that should be taken into consideration is that gambling is banned in some states and overall in some countries, so these rules should be followed. Ensure that what you are doing is not in that category of activity. Often, if international participants are necessary, it can be important to acquire specific licenses. 

The other important aspect includes the taxation and withholding processes both domestically and internationally. While declarations in the form of US tax documentation, for example, 1099s, may be given, players usually report their victories. Considering these complexities the best course of action is to seek the services of a gaming and wagering attorney to avoid legal suits.

1099s, may be given, players usually report their victories.

Just to clarify this, you do indeed need to issue 1099s for major gambling wins, but that's not going to be an issue here.  Because to be offering legal online gambling requires very expensive (think > $1 million) licenses per state, which even then are hard to qualify for (if you had the cash).

So don't be worried about that part 🙂