Financial obstacles often hinder the creation or development of new projects, programs, or organizations. Without appropriate and stable financial backing, many worthwhile projects remain mere ideas.
Traditionally, fiscal sponsorship refers to an arrangement where an established nonprofit provides financial support for a project that may be independent or that yet has to obtain its own tax-exempt status. This is not to be confused with fiscal agency, where a nonprofit is retained as the legal agent to a project. In fiscal sponsorship, the relationship is the reverse: An established nonprofit takes a new project under its wings as an extension of its own charitable purposes.
It is important to clarify the relationship between the fiscal sponsor and the project. The sponsor needs to be aware of the limitations the IRS sets for tax-exempt organizations. The project managers need to understand how the form of sponsorship they choose will influence their ability to control the product.
Presently, there are six forms of fiscal sponsorship recognized by the IRS. These are outlined below. The first five describe situations where the project is closely dependent on the sponsor. The last one is a technical relationship between two charities.
In the first case, the project is carried out as if it were integrated into the sponsoring organization. There is no structural separation between the employees of the project and the organization. This model provides the most control for the sponsor: Its board is directly overseeing the development of the project; all checks are payable to the sponsoring organization; and, even if the project personnel do the fundraising, the money raised goes to the sponsoring organization, often as a restricted grant. In short, it is difficult to distinguish the project from the other programs of the sponsoring organization.
Independent contractor project
In this situation, the project creates a contractual relationship with the sponsoring organization. A written agreement designates who actually will carry out the project, which is usually those who conceived the idea. The agreement spells out the terms: deadlines, fees, ownership/copyright of the final product, and restricted trust funds. This arrangement is particularly suitable for short-term projects.
Pre-approved grant relationship
In this case, there is a double grantor-grantee relationship: The sponsor receives funds from a donor and makes a grant to the project. The sponsor does not control the project but is furthering its own charitable purposes indirectly by financially supporting another entity (project or person) whose work is closely related to its mission. The bylaws of the sponsor need to state that it retains full control and discretion over the contributions it receives. This is critical as part of the control mechanism. It is important for the tax-exempt status of the sponsoring organization that it has full authority over the funds, and the donor needs an assurance that the funds are used for tax-deductible charitable purposes.
Under this model, the project is already an independent entity. It holds an affiliate relationship with the sponsor and is able to acquire 501(c)(3) status without specific application. Umbrella organizations that create new chapters is an example of this model. A group exemption assumes that the project is under general supervision or control of the sponsor and that it independently meets the requirements for a charity. The project is required to obtain its own Federal Employer Identification Number. As a separate legal enterprise, the project is able to do its own fundraising. So that it won’t compete with the sponsor, an affiliation agreement may require that the fundraising efforts be carried out in coordination.
In this situation, the connection between the sponsor and the project can vary to a great degree from considerable influence to total control. The project can obtain its own tax-exempt status under the IRC Section 509(a)3 but the status is based on its support of the sponsor’s purposes/mission. The important issue is to show that the project independently engages in activities that the sponsor normally could carry out. This model is best suited for projects which, on their own, would fall under the private foundation category because their number of funding sources is very limited.
Many small and new organizations lack some technical capacity to allow them fulfill their mission. They may need assistance with their financial management, fundraising, administrative or legal issues. Another nonprofit may provide this help. To create a sponsorship relationship, the assistance has to be free or below-cost. In this case, the sponsor can fulfill its own exempt purposes by helping another charity even though the actual assistance is not ‘charitable’ by nature.
In each of the above cases, it is important to stress the need for legal counsel before setting up a fiscal sponsorship. Three specific aspects demand particular attention:
- IRS attention to conduit relationships.
- Illegality of private inurement (benefit).
- Activities that are too new or short-lived to justify an independent tax-exempt status.
101 Resource | Last updated: June 21, 2016
Resource: The above examples are described in Fiscal Sponsorship: 6 Ways to Do It Right by Gregory L. Colvin.