What is a fiscal sponsorship?  A fiscal sponsorship generally refers to a contractual arrangement in which one entity that is a 501(c)(3) tax-exempt organization (the “fiscal sponsor”) serves as the fiscal and legal “host” of a charitable project.  While the term fiscal sponsor is not officially defined in the federal tax code, the IRS has generally approved of the function of fiscal sponsors. The critical requirement is that the fiscal sponsor must retain the legal right to ensure that the project funds are used to accomplish the tax-exempt purposes of the sponsored project.

Benefits of a Fiscal Sponsorship

There are many benefits to using a fiscal sponsorship to conduct a charitable project. Here are a few key reasons that frequently drive the decision to set up a fiscal sponsorship.

1. Ability to receive tax-deductible contributions. Donors will only receive a charitable tax deduction for financially supporting the project if the legal recipient of the donation is a 501(c)(3) tax-exempt organization.  A fiscal sponsor’s tax-exempt status and role as the legal fiduciary of the donated funds qualify them as tax-deductible.  Tax-deductible contributions, whether from the project organizer or from the public, are typically critical to funding the requirements of the project.
2. Piloting an innovative new program. Project organizers often seek to test a new approach to solving an issue, but are uncertain whether the project will have long-term viability and be worth the time and money it takes to establish a nonprofit organization.  A fiscal sponsorship can provide a convenient vehicle to pilot the project more quickly and at less cost than setting up a new tax-exempt entity.
3. Receiving the legal, financial, and administrative support of a fiscal sponsor. A fiscal sponsor takes on the legal responsibility for the funds raised. In the Direct Project Model (discussed below), it also takes on all of the legal obligations of the project. Having the benefit of a fiscal sponsor’s team to handle the legal, financial and administrative aspects of the project can allow the project organizers to focus on fundraising and implementation of the program.
4. Temporary fiscal sponsorship while awaiting independent 501(c)(3) tax-exempt status. Some organizations decide to enter into a fiscal sponsorship while their tax-exempt application is pending review. This allows them to begin receiving tax-deductible donations for the project much sooner. As of August 19, 2021, the IRS website says that applications postmarked after January 15, 2020 have not yet been assigned for review.  That seven-month queue doesn’t include the additional time needed for review once the application is assigned.  Although expedited application processing is available under limited circumstances, there is no guarantee that it will be granted.  Setting up a fiscal sponsorship may take time as well, but generally should not take as long as the IRS tax-exempt application review process.

What are the Roles and Responsibilities of a Fiscal Sponsor?

1. Project selection responsibilities
   1. Mission fit. The fiscal sponsor must ensure that any project it sponsors is consistent with, and within the scope of, the fiscal sponsor’s legal and tax-exempt mission and purposes. For example, a fiscal sponsor whose legal purposes are focused on environmental conservation will generally only take on projects that are consistent with that core mission.
   2. Written fiscal sponsorship agreement. The terms of the relationship between the fiscal sponsor and the sponsored project should be clearly outlined in a written agreement detailing the terms and expectations of the parties. Key terms include: (1) the duration of the fiscal sponsorship; (2) a clear description of the project; (3) fiscal sponsorship service fees, if any; (4) confirmation of which party will be responsible for key compliance obligations on behalf of the project; (5) the timing and process for distributing funds to, or using funds for, the sponsored project; (6) ownership of intellectual property; and (7) a clear outline of how the project will be transitioned at end of the relationship.
2. Financial responsibilities
   1. Use of project funds. The fiscal sponsor should only utilize funds raised for the project for the stated charitable purposes of the project.
   2. Donation tax receipts. The fiscal sponsor is responsible for issuing tax receipts to all donors in accordance with applicable law.
3. Legal oversight responsibilities
   1. Compliance with laws. The fiscal sponsor should comply with all applicable federal, state, and local laws and regulations. This includes annually filing its Form 990 with the IRS, and maintaining its registration with applicable state charity regulatory agencies, based on where the fiscal sponsor (including all of its projects) are operating and soliciting charitable contributions.  Project organizers should ensure that they select a fiscal sponsor that is aware of and willing to comply with all of the compliance requirements necessary to support the needs of the project.

What are the Most Common Types of Fiscal Sponsorships?

The two most common types of fiscal sponsorships are the Direct Project Model and the Pre-Approved Grant Model.

Direct Project Model:  In this model, the project has no separate legal existence from that of the fiscal sponsor.  That said, the fiscal sponsorship agreement outlines how the fiscal sponsor provides ultimate oversight of the project, in accordance with its fiduciary duties, while delegating the day-to-day operation of the project to the project organizers.  All revenues/expenses and assets/liabilities of the project are attributed to the fiscal sponsor, and are incorporated into the fiscal sponsor’s financial reports, and all legal compliance obligations (e.g., federal and state compliance filings; execution of contracts; hiring of employees) are undertaken by the fiscal sponsor.  Project organizers should consider whether the fiscal sponsor has appropriate insurance policies reflective of the activities and risks associated with the project (e.g., employer practices liability insurance; cybersecurity insurance).

Pre-Approved Grant Model: In this model, the fiscal sponsor is the legal recipient of all donations in support of the project, and issues donation tax receipts to the project donors.  The fiscal sponsor distributes the funds raised as a grant to a separate project grantee.  The fiscal sponsor must pre-determine that the project grantee, a separately incorporated entity lacking 501(c)(3) tax-exempt status, is an appropriate recipient of grant funds to carry out the purposes of the project.  Once funds have been raised for the project, the fiscal sponsor grants the funds to the project grantee, pursuant to certain oversight requirements.  For example, the project grantee must provide reports to the fiscal sponsor on how granted funds have been used in furtherance of the charitable purposes of the project.  This model is often used by organizations that are in the process of applying to the IRS for 501(c)(3) tax-exempt status.

Beginning at the End

While the start of a new project is exciting, one of the most important steps in selecting a fiscal sponsor is to plan for the end of the relationship.  The fiscal sponsorship agreement should outline a clear process for the project to be transitioned to a successor tax-exempt organization (including a newly formed organization whose 501(c)(3) tax-exempt status has been approved), subject to the fiscal sponsor’s ultimate discretion to ensure that the successor is capable of carrying out the project.

[1] For many people who have a long-term vision for their charitable program, the best approach may be to set up your own separate tax-exempt organization. An FAQ on setting up a new nonprofit organization is available here.

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But what if the fiscal sponsor is really just a pass-through? What if it automatically turns the money over to the non-exempt entity without exercising any discretion or control? Will the arrangement still hold up? Will the contributions still be tax-deductible?

As it turns out, for almost sixty years, the IRS has said that fiscal sponsorships are acceptable unless the tax-exempt group is a “mere conduit” for the distribution of the money. If it is a “mere conduit”, meaning it has no discretion or control over the funds, the arrangement fails and the transaction is treated by the IRS as one directly between the donor and the non-exempt entity, and therefore it is not tax-deductible. (See Rev. Rul. 62-113 1962-1 C.B. 10. See also IRS 1996 CPE Text ”Conduit Organizations – Charitable Deductibility and Exemption Issues” by  Ruth Rivera Huetter and Bill Brockner http://www.irs.gov/pub/irs-tege/eotopice96.pdf).

To avoid this predicament, it is essential in drafting fiscal sponsorship agreements to make certain that the sponsoring charity has some discretion and control over the donated funds and their use. A high degree of control is not required; it is likely sufficient that the sponsor have discretion to withhold payments when there is reason to suspect that the recipient entity will use the funds for activities that are non-charitable, illegal or improper.

Another way to avoid “mere conduit” status is to have both parties agree to a pre-approved budget for the funds. Items in the budget are then presumed to be legitimate; others may have to be approved by the sponsor before the funds can be released or spent. In addition a sponsor could require the non-exempt entity to request funds periodically, each time specifying how the funds will be used and reporting on funds already expended.  Future distributions are then conditioned on the receipt of satisfactory reports.

Increasingly, fiscal sponsors are taking an alternative approach.  As sponsor, they handle all the funds and make distributions directly to the payees as requested by the non-exempt group. That not only gives them discretion and control, but it also simplifies the accounting process.

At the end of the day, there is no standard form of fiscal sponsorship. Specific provisions of this relationship are negotiated between the entities. The key in establishing them is to avoid any requirement that the donated funds be directed to a non-exempt group without some discretion on the part of the tax-exempt charity. But the arrangement also has to be viable for the non-exempt group to efficiently operate. Best practice dictates that care is taken in establishing the relationship such that both sides fully understand the arrangement and can work with it.

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