Many people know that charities can be tax-exempt from many forms of taxation and that their donors commonly receive tax benefits for their donations to the organization. Charities also receive the benefit of a formal structure that puts the organization’s mission and interests above the personal interests of those involved. This proper corporate or trust structure provides the Directors, Officers, and/or Trustees of the charity protection from liability.
But forming a nonprofit organization also comes with its share of added responsibilities and costs as well. These include administrative costs, various governmental filings, an increase in the information available to the public, as well as a potential lengthy delay in obtaining IRS recognition of tax-exempt status that can be as long as nine months once the application is submitted. In some cases, it might be possible for a charity to start operations faster by entering into what is called a fiscal sponsorship. A fiscal sponsorship can provide a place for the charity to grow and thrive without all of the added responsibilities that come with forming and operating a nonprofit organization, at least until it is ready for the charity to operate on its own, if the charity so desires.
What is a Fiscal Sponsorship?
A Fiscal Sponsorship is a formal arrangement where a current nonprofit agrees to serve as an incubator of sorts for a charitable program that was created by other persons. According to Fiscal Sponsorship: a 360 Degree Perspective, “[a] fiscal sponsor is a nonprofit organization that provides fiduciary oversight, financial management, and other administrative services to help build the capacity of charitable projects,” usually in exchange for an administrative fee. A fiscal sponsor is the presently formed organization that is “hosting” the not-yet tax-exempt organization that is called the fiscal sponsee. The two parties can also be referred to as the sponsoring organization, i.e. the fiscal sponsor, and the sponsored organization, i.e. the fiscal sponsee. For the purposes of this article the terms fiscal sponsor and fiscal sponsee, respectively, will be used throughout.
In other words, a fiscal sponsor can be a “home” for a startup nonprofit, a charity, or a fledgling nonprofit program looking for funding even if it lacks tax exempt status. This can be helpful for new charities because the fiscal sponsor will often take on a number of responsibilities that they might struggle with on their own, including receiving and administering contributions, dealing with some of the operating issues of a nonprofit, etc. This also can be useful for charitable programs of for-profit organizations or all-volunteer organizations that cannot sustain the administrative costs. Finally, current stand-alone nonprofit organizations that for one reason or another need to downsize could benefit from a fiscal sponsor in this endeavor to provide the administrative support it needs.
Operating in a fiscal sponsorship arrangement usually will provide a benefit to the donors of the fiscal sponsee because the donations will be deductible where they would otherwise not be. This does seem to be an arrangement that is decreasing both in popularity and opportunity to find willing “homes” for a variety of reasons. This aspect of fiscal sponsorships is largely beyond the scope of this article, but it appears that this is generally due to the creation of the Form 1023EZ that made it much easier and cheaper for smaller nonprofits to be formed and a form of fiscal sponsorship mentioned below, the single-member LLC, which is not quite a fiscal sponsorship as normally understood.
Types of Fiscal Sponsorships
These fiscal sponsorships come in three different variations: a comprehensive fiscal sponsorship, a pre-approved grant relationship, and through the creation of a single-member LLC. The comprehensive fiscal sponsorship is referred to as “Model A.” This type of relationship essentially results in the fiscal sponsee becoming a program of the fiscal sponsor. It is under this form of fiscal sponsorship that an administrative fee is charged by the fiscal sponsor. Under Model A, the fiscal sponsor must account for the significant administrative burdens and costs and the risks associated with acting as a fiscal sponsor to a project, including managing issues with charitable solicitations, donations, and grants, completing all financial reporting, audits, government filing requirements, obtaining appropriate risk management tools like insurance, and all the other issues involved with operating a business.
A pre-approved grant relationship is referred to as “Model C.” Under this model, the fiscal sponsee is controlled by a grantee who owns and/or controls the program to which the fiscal sponsor agrees to provide funds. There are no administrative fees under this model, but there are certain limitations to fundraising because the fiscal sponsee is not a tax-exempt organization. The grantee can fund raise for the project, but they must do so as an agent of the fiscal sponsor. A connected issue that more closely affects Model C’s, but can also affect Model A’s, is the issue of control. In order for this type of arrangement to survive IRS scrutiny, the fiscal sponsor needs to have a level of control over the grant funding. To that end, the fiscal sponsor must have the ultimate decision whether to provide the funds to the fiscal sponsee or risk being viewed as a “mere conduit” that impermissibly funnels tax-exempt donations to a non-tax-exempt organization.
The final type of fiscal sponsorship is an alternative to the standard methods used to create such a relationship. This method is where an organization is created as a single-member LLC. Here, the organization that would have been the fiscal sponsee is instead the LLC and the fiscal sponsor is instead the single-member or owner of the LLC. A single-member LLC can opt to disregard its corporate entity and be governed by the rules that govern its member. In this way, the organization is itself tax-exempt and its donations can be deducted from the donor’s taxes with some potential exceptions or difficulties if they are restricted donations or in-kind donations. This is similar to a comprehensive fiscal sponsorship arrangement.
General Considerations for Fiscal Sponsorships
In addition to the three types of fiscal sponsorships, there are a few general considerations or “best practices” to use when creating these type of arrangements. First, when creating a fiscal sponsorship relationship, it should be done in writing to protect both parties involved and ensure that all parties understand their obligations and requirements so that the relationship does not violate any IRS rules or regulations. Also, these contracts should include exit provisions for the parties, information regarding whether the fiscal sponsee can be spun-off and how, and other normal contract provisions.
Before entering into a fiscal sponsorship relationship there are several factors that the fiscal sponsor and sponsee should consider before agreeing to the contract. For the fiscal sponsee, the organization should consider, among other things:
- the financial health of the fiscal sponsor;
- the amount of the administration fee;
- whether the personnel of the fiscal sponsor are a good fit to work with organization; and
- the fiscal sponsee should have a belief that the fiscal sponsor understands and can perform their roles and responsibilities.
For the fiscal sponsor, the organization should consider, among other things:
- the amount of work that operating the program would take;
- how much that operation might cost; and
- whether the program is related to the tax-exempt purpose of the fiscal sponsor.
However, even when taking these factors into consideration, there are still pros and cons for both the fiscal sponsor and sponsee that should be taken into account when deciding whether to enter into a fiscal sponsorship arrangement.
Pros and Cons of a Fiscal Sponsorship
There are a number of advantages and disadvantages to consider when deciding whether to enter into a fiscal sponsorship in addition to the considerations mentioned above. First, there are several obvious advantages to this type of a relationship for both the sponsor and the sponsee. The fiscal sponsee benefits from the resources, infrastructure, and expertise of an established nonprofit organization. The fiscal sponsor gets a new project to start expanding the support it provides to the community and better fulfill its mission faster with little work on the sponsors part to actually formulate the idea itself. Additionally, the fiscal sponsor can bring in the creators of the fiscal sponsee’s program to help run the project to gain the benefit of their intimate knowledge with the project.
Another benefit for the fiscal sponsee is the reduction or elimination of the time and cost barrier to forming a nonprofit. Entering the world of nonprofit organizations is complex and highly regulated requiring a significant amount of basic ground work and decisions before beginning the process of officially organizing as a nonprofit organization. Once these decisions are made, there are a number of filings necessary to start a nonprofit and then, once it is formed, nonprofits have costly and time consuming ongoing reporting requirements to fulfill or risk losing their nonprofit status. In this way, a fiscal sponsor can eliminate these costs by absorbing the fiscal sponsee as a program of the already formed nonprofit.
The fiscal sponsee, particularly ones that will eventually operate as its own nonprofit organization, will benefit from being able to see how a nonprofit Board of Directors works. This benefit can either come in the form of operating under an engaged and creative Board where the charity would want to eventually emulate such behavior or form a poorly run Board that the charity would want to avoid emulating. But, nevertheless the charity is getting valuable information from how the Board of the fiscal sponsor operates. Similarly, the fiscal sponsor can get a benefit from the people being brought in, if any, with the charity who might have a different perspective that would help, cause the Board to be more attentive, or cause the Board to change some of its practices to function in a better fashion.
A fiscal sponsorship can provide short term benefits to a charity or fledgling nonprofit program that is in the process of receiving its tax-exempt status, but wants or needs to begin operating rather than waiting for the IRS to rule on its application for tax-exempt status. In this situation, the fiscal sponsor can provide the sponsee with the necessary tax-exempt status to begin operating until the sponsee can run on its own as a tax-exempt organization. In return, the fiscal sponsor receives an administrative for minimal effort due to the nature of the situation where the sponsor does not need to provide the same level of support it would under a situation where the fiscal sponsee will essentially be absorbed by the fiscal sponsor.
On the other hand, there are a number of disadvantages or cons that come along with a fiscal sponsorship relationship that may outweigh the advantages for your organization. For the fiscal sponsee, the major disadvantages are the loss of control requisite for an appropriate fiscal sponsorship and the administrative fees paid to the fiscal sponsor. In order to create a valid fiscal sponsorship relationship, the fiscal sponsor must have control over the funds being given to the fiscal sponsee and be able to direct large parts of its operations. For some, this loss of control makes a fiscal sponsorship unworkable, but if the fiscal sponsee can bear the loss, then it can still be beneficial to both parties.
This type of relationship puts a lot of strain on the fiscal sponsor due to the increased administrative and oversight work created by adding another program to an organization. The fiscal sponsor must adequately manage the fiscal sponsee, it must perform due diligence prior to agreeing to the relationship, and obtain sufficient insurance to cover the additional program. If the fiscal sponsor does not effectively manage all of its responsibilities, then it can be subject to unexpected liability due to a penalty or fine from the IRS, a lawsuit from an injured party, failure to complete any additional registration, licensing or reporting, or any other number of additional issues that might arise when entering into a fiscal sponsorship.
Fiscal sponsorships can provide the charities (or the fiscal sponsees) with the necessary support to get started and begin providing the community with a great service to those who need it most. It can be used to incubate great ideas before they are ready to be spun-off into their own nonprofit organization. It can be used to provide a startup nonprofit organization with room to operate before it is fully recognized by the IRS. Fiscal sponsorships also provide the fiscal sponsor with additional programming to expand their services. It can provide great young talent in the form of the people involved with the charity that is being sponsored. Fiscal sponsorships can provide all involved with significant benefits.
However, this type of relationship also comes with costs and disadvantages. The fiscal sponsee loses some level of control over its operation and programming. The fiscal sponsee is at risk of liability due to issues with a program that it might not understand or staff that it cannot easily control. This type of relationship can create friction between the fiscal sponsor and fiscal sponsee.
The decision to enter into a fiscal sponsorship is an entirely subjective decision that involves numerous factors. None of the advantages or disadvantages listed here are intended to recommend one type of fiscal sponsorship over another or even whether it is a good idea for your specific organization to enter into this type of arrangement either as a fiscal sponsor or a fiscal sponsee. This information is meant to provide more information when you are making your decision as to what is best for your organization. Even though no recommendations are made here about whether you should or should not enter into a fiscal sponsorship, hopefully it has provided enough information for your organization to at least consider this type of arrangement and then make an informed decision regarding entering into a fiscal sponsorship.
Attorney Zac Kester provides generalist and strategic nonprofit legal and consulting services. He holds a Master of Laws, a post-law school advanced degree, in which he studied the unique needs of tax-exempt nonprofit organizations. His legal and consulting career has focused on nonprofit organizations.
With highly experienced legal and training personnel, Charitable Allies provides all manner of legal and educational services for boards, officers, management and staff of myriad charities throughout the sector. From basic one-time questions about a single matter to training for boards and officers to complex reorganization or merger of activities, Charitable Allies is your go-to cost-effective provider of legal services to nonprofit organizations.