What You Need to Know About Fiscal Sponsorship
Sometimes a nonprofit will be asked to act as a fiscal sponsor for another group which wants grant funding, or to allow use of its tax exempt status to facilitate contributions to another group or individual. The “fiscal sponsor” relationship is often assumed to be simple. It isn’t, so if you’re considering entering into this arrangement from any role, read this article first.
While a fiscal sponsor relationship can be beneficial to the sponsor, the funder and the ultimate recipient, it must be approached carefully to avoid both IRS problems and misunderstandings among the parties involved. In the past this has been called a “fiscal agent” or a “pass-through” relationship, but these are not good terms to use -- they raise questions with both the IRS and auditors, and they can create misunderstandings among the partners.
If a nonprofit is considering entering a fiscal sponsorship, as either the SPONSOR or the sponsored group (referred to as the PROJECT), there are a few conditions which must be met:
- The sponsor must maintain fiscal control and some degree of program control.
- The project must be within the sponsor’s mission as set forth in its articles of incorporation, bylaws and original 501(c)(3) application papers (Form 1023).
Examples of fiscal sponsorship:
1) A small organization asks a larger one to sponsor a project which is too large or complex for the small one. The amount of money involved may be so large that it could “tip” the small organization into private foundation status. The project may have complex bookkeeping, administrative or evaluation requirements that the small organization doesn’t want to undertake. Or the project organization wants to use the larger organization’s reputation, size and management expertise to reassure a funder.
Sally’s Mother (a homeless youth shelter) has learned of a large national foundation with an interest in programs for street youth. The staff have been aware of a growing problem in Jefferson County and has been trying some innovative approaches, but thinks a realistic program would have to be multi-year, several hundred thousand dollars and would be more fundable if it had a solid program evaluation. Sally’s Mother approaches Jefferson County Community Action (JCCA) about acting as fiscal sponsor for the project, handling the accounting and working with the state university on an evaluation. Sally’s Mother volunteers who are close to the street youth would be hired to operate the program from the church owned houses, giving the project the “street cred” that Sally’s Mother has earned.
2) A donor may be interested in giving money to a particular individual, but cannot take a charitable deduction for the gift.
The Evans Family Foundation (which is in effect the private giving vehicle of the Evans family) would like to sponsor a talented local oboist. However, the foundation cannot give directly to individuals and family members can’t deduct any such private contributions. The foundation approaches the Jefferson Baroque Orchestra to accept the gift and give it to the oboist. While the JBO cannot accept funds to be passed to a specific recipient, they can set up criteria for individuals to apply for funding and they can pre-qualify the oboist. As long as any other person meeting the criteria could apply for and have the same chance of receiving funds, the deal is acceptable. They contact a lawyer to set up the arrangement.
3) An individual or group has an idea for a project, but isn’t ready to undertake applying for tax exempt status. They approach a large nonprofit to take the project under it’s wing, apply for funding and either hire or contract with the first group to carry out the project. This is not infrequently done by community foundations, United Ways and Councils of Churches, and is the way many community social service organizations get started.
Bob Smith and Ron Jones start an after-school basketball program for youth in their neighborhood as a way of keeping them off the streets, playing in the local YMCA and calling the project “Teambuilders”. After two successful years they decide to add an academic component, requiring an hour of homework with volunteer tutors before practice. They also would like to expand the program in the summer. They approach the Jefferson Council of Churches (JCC) to sponsor the project and receive some small grants.
This relationship could be handled two ways.
- The simplest is that Teambuilders is a project of JCC with no separate legal existence, and Bob and Ron are employees of JCC.
The other model is for JCC to accept grant funds and re-grant them to Teambuilders. But JCC cannot just write a check to Teambuilders (pass through). For the process to pass IRS scrutiny:
- Teambuilders must make a formal request to JCC
- The JCC board must approve the grant.
- JCC & Teambuilders should sign a contract setting grant terms and reporting responsibility.
- JCC must inform the original funder of its control of the project.
After ten years the project has grown so large that Bob and Ron form their own nonprofit corporation, apply for tax exempt status and arrange with the JCC to spin the Teambuilders program off as an independent organization. Because they foresaw this possibility they have a written agreement with JCC describing the process, including what happens to any property and funds acquired by the project
4) An individual or group wants to donate and solicit large contributions for a particular project, but doesn’t want to create a private foundation.
Three wealthy business people want to preserve the old Davis Estate in East Jefferson County and establish it as a museum and nonprofit conference center. However, they and their friends would be contributing so much of the funding that the IRS would qualify the Friends of the Davis Estate (FDE) as a private foundation. They approach the Jefferson County Community Foundation (JCCF) and establish a “Supporting Organization” which has independent 501(c)(3) status as a separate corporation, but as a 509(a)(3) organization. Friends of the Davis Estate has its own office, staff, checkbook, investment manager and letterhead, but contributions are made to the JCCF which has legal (if not in practice) control. This naturally requires legal assistance to establish and strict reporting requirements.
5) A foundation with a particular interest may want to establish and fund a new program, but doesn’t want it subject to private foundation restrictions.
The Murray Foundation has a particular interest in homeless elderly and wants to establish a housing and counseling program for this target group. They ask Jefferson County Community Action, which operates both homeless and Meals on Wheels programs, to create and operate the program with Murray Foundation support.
Issues of Fiscal Sponsorship:
Lost grant opportunity: This is a serious issue for many potential sponsors. Many foundations operate on a “one grant to an organization at a time” policy. If a sponsor applies for a grant for the project, they may be giving up he opportunity to approach that funder for their own programs for the life of the project. Organizations should be clear with foundation staff before entering a sponsorship relationship -- and watch foundation behavior, sometimes foundation trustees will perceive relationships differently than their staff.
Conditions of original grant: The funder can make an unrestricted grant to the sponsor, with the informal understanding that it will be used for the project. Or the funder can make a restricted grant, specifying that funds must be used for the project. In order for this to not be an illegal “pass-through” transaction, the sponsor must pre-approve the project before funds are received, must exercise expenditure and oversight responsibility.
Record keeping: If the project itself is a 501(c)(3) organization, project funds will not show up on the sponsors financial statements. If the project is not tax-exempt, both grant revenues and project expenses will be shown in the sponsor’s formal financial statements, audit and 990.
Property: At the end of the sponsorship relationship any property and funds acquired with project grant funds must go to a 501(c)(3) organization. This can be the sponsor, the project organization (if it is exempt) or an agreed upon third party 501(c)(3) organization (if for example the project moves to a new fiscal sponsor).
Payments to the Sponsor: A sponsor can and should be appropriately paid for its services. If the project is tax exempt the sponsor is not handling funds, it might take minimal or no fees. If the project isn’t tax exempt or if the sponsor is handling funds or managing the project, they need to agree on compensation. Amounts up to 15% are common. Project organizations should be careful about working with large sponsors like universities which have high overhead and “indirect” costs.
Liabilities: The sponsor should get legal advice concerning responsibility and in some cases consider additional insurance.
Public Relations: The project will be associated with the sponsor, and both parties need to consider whether the relationship helps or hurts their reputation. They might set up agreements on press relations and printed materials.
Misuse of Fiscal Sponsorship:
Fiscal sponsorship can be knowingly or unknowingly misused, with serious consequences for all concerned.
- Acting as a conduit for gifts or grants to specific individuals.
- Channeling funds to an organization without tax-exempt status, without proper controls.
- Avoidance of the “public support test”, allowing large donors to contribute more than allowed to the project organization.
Consequences of Misuse of Fiscal Sponsorship:
- Foundation can be subject to penalty tax.
- Project organization could be reclassified and lose “non-private foundation” status.
- Damage to reputations of all concerned.
- Sponsor could be subject to unrelated business income tax, or in extreme cases lose tax-exempt status.
- IRS could impose excise taxes on boards of both organizations for misuse of funds.
For more information, a good resource is “Fiscal Sponsorship: 6 Ways To Do It Right,” by Gregory Colvin, available from http://www.studycenter.org.
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