Sometimes, those operating a charitable activity do not wish to fully formalize what they’re doing into an actual 501(c)(3) nonprofit entity. The reasons for this vary, but often the services of a fiscal sponsor is needed. Properly setup, fiscal sponsorships can be a great solution to very specific needs.
A fiscal sponsorship involves an existing 501(c)(3) nonprofit offering to provide its tax-exemption and associated benefits to another group, usually a charitable project. The project should generally be aligned with the overall mission of the sponsoring charity.
Donors wishing to support the activity give directly to the sponsoring organization, designating their gift to the activity. Tax-deductibility of the gift is provided by the fact that the sponsor has 501(c)(3) status.
Fiscal sponsorship is an often-misunderstood and misapplied area of nonprofit operations. But when properly utilized, these arrangements can be beneficial, especially for those being sponsored.
As mentioned above, charitable projects are a great example of an appropriate use case. Many times these projects are small, community-based activities that are temporary in nature. It makes little sense to go through all of the formality of incorporating at the state level, then applying for IRS 501(c)(3) status, for a project that is expected to wind down within 3 years or less. It could easily take a year or more just to get incorporated and receive an IRS letter of determination.
In such a situation, those managing the project may seek out the assistance of an existing nonprofit to provide fiscal sponsorship. The sponsoring charity will not directly operate the project, but it is responsible for reasonable oversight. As mentioned above, donors to the project give to the sponsor for tax-deductibility, and the sponsor manages those funds on behalf of the project.
There’s no universally-accepted definition of a micro-charity. What we mean by that is an ongoing charitable activity that is intended to be operated indefinitely, and is small enough that those operating it would prefer to not formalize their own nonprofit organization. Examples of this include a married couple moving abroad to operate a religious missions project, or a small neighborhood tutoring program. In the former example, the missionary couple may seek the fiscal sponsorship services of a church. The tutoring program may find a private school to be a fiscal sponsor.
It’s important to emphasize is that in these two examples, the potential fiscal sponsor’s mission is obviously closely aligned. This is preferable. But, it is not required that the alignment be this obvious. There are many nonprofits providing fiscal sponsorship to activities whose alignment is much less direct.
For the Sponsor
The decision by an existing nonprofit to provide fiscal sponsorship services to a group or project is not to be done without careful consideration. Legally, the sponsor is the organization that the project’s donors are financially supporting. There are several important things to keep in mind:
- Even if 100% of designated funds are given over to the project, it’s the sponsor that is fully responsible for those monies.
- The sponsor receipts the donors for tax purposes.
- The sponsor has accountability for the actions of the project.
- The sponsor must have sufficient visibility into the project to ensure it is operating in a manner consistent with 501(c)(3) requirements.
- Money designated to a sponsored project is considered restricted funds.
For the Project
Those operating the project have their end of the bargain to uphold, as well. Factors to consider include:
- In order to benefit from a compliant fiscal sponsorship arrangement, the project is considered subordinate to the sponsor. Even though most sponsors exercise little control over their projects, those operating the projects must understand that they don’t control their destiny the same as they would had they chosen to formalize their own charity.
- Any funds passed through from the sponsor that is used for personal compensation is potentially subject to employment or independent contractor treatment.
- Donations given straight to the project that bypass the sponsor are not tax-deductible and the donor must be alerted to that fact.
- Should a fiscal sponsor decide for any reason to no longer provide that service to your project, it no longer has tax-exempt coverage. Most projects in this situation either seek another sponsor or start their own 501(c)(3).
There are many ways to structure fiscal sponsorship arrangements so that they pass legal muster. However, there is a framework that works best to ensure compliance and accountability.
Acknowledging and thanking donors is essential to continued financial support. Too often, however, sponsors are slow to respond to project supporters. That shouldn’t be. Best practice is for the sponsor to send a written or electronic “thank you” to each donor. It is OK for the project leaders to acknowledge the gift, too, as long as the letter makes clear that the sponsor is the 501(c)(3) providing tax-deductibility for the gift.
It is perfectly legal for a fiscal sponsor to pass-through, dollar-for-dollar, the money designated by donors to a project. That’s not the best way for a number of reasons, including transparency, accountability, and potential tax issues for those operating the project.
The better way is for the sponsor to set up a fund…or even a separate bank account…for each sponsored project. The money is retained in the 501(c)(3) until requested in writing for a specified purpose by the project. Then, funds can be dispersed in a controlled manner for known reasons.
The project operators should provide an expenditure accountability report back to the fiscal sponsor, detailing exactly when and for what purposes the money was spent. Because the sponsor is accountable for expenditures, these periodic reports will assist in preparation of the sponsor’s Form 990 at the end of the year. Ideally, the sponsor will provide a template report to the project on a monthly or quarterly basis. Annual reporting can work, but doesn’t provide the visibility truly necessary for compliant oversight.
Some fiscal sponsorship arrangements are conducted for free. This is more likely the case when there is a very close association between project and sponsor, or when a sponsor only has one project they’re assisting, or maybe both. Other arrangements have a price tag, which is perfectly fine within reason.
We commonly see arrangements where the sponsor keeps 5-10% of designated donations to cover the costs associated with providing services to the project. Some sponsors will cap the maximum expense allocation at a certain dollar amount when reached. Though a cap is not required, it is helpful to the project to know that they will max out their costs.
Fiscal sponsorships are a great way for temporary and smaller charitable projects to operate with most of the same benefits available to organizations with 501(c)(3) status. Properly structured, all parties can be well-served, from the donor, to the project, to the sponsor themselves.
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