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Fiscal Sponsorship Can Be an Alternative to Forming a 501(c)(3) Corporation

Monday, October 1, 2012


Starting a nonprofit can be a daunting task. Developing a strong mission, finding board members, filling out the application for tax exemption, identifying space to lease or finding volunteers to support your programs are all tasks that are difficult and time consuming. That’s all in addition to developing and cultivating programs that further your mission. Additionally, funds need to be raised to support those programs, hire employees or lease office space and pay for back office functions. For some, starting a brand new nonprofit organization may not be the most effective use of time or resources. 

Fiscal sponsorship is an interesting alternative available to individuals or groups performing charitable services and wishing to give their donors the ability to take a charitable contribution deduction, but not wanting to spend valuable time and resources to comply with the IRS’ extensive filing requirements, tax and corporate governance compliance, and other legal obligations associated with incorporation and tax exemption. Tax–exempt nonprofits, recognized under Section 501(c)(3) are subject to an expansive set of filing and regulatory requirements under local, state and federal law.  Those formalities must be followed to maintain exemption from tax. The most recent example of the failure to follow these formalities ending in dire results has been the Auto–Revocation List. The IRS requires that tax–exempt nonprofits file an informational return each year, in most cases either a Form 990 or Form 990–N. After an organization fails to file for three consecutive years, the IRS automatically revokes the organization’s exemption and publishes a list of those organizations on its website. Organizations that fail to comply with their governance obligations risk losing their tax exemption and become subject to income taxes. Directors and officers can be held personally liable if they do not ensure that their organizations comply with the law.  Individuals who form a new nonprofit corporation often find themselves spending a lot of time and energy on corporate and tax compliance instead of focusing on the important work of developing and starting up their charitable programs.

When piloting a new program, the leadership of a new organization is driven to develop its mission and visibility.  Fiscal sponsorship is a good option for organizations starting their charitable programs and wishing to test the feasibility of their ideas before forming a new corporation, in order to focus their attention on the delivery of program services.  In most cases, fiscal sponsorship involves an arrangement under which an existing 501(c)(3) tax–exempt public charity assists an organization with a charitable project by permitting the group to solicit tax–deductible contributions or grants through the fiscal sponsor. The tax–exempt entity becomes a repository for funds intended for the new program and are deposited with the fiscal sponsor, which then disburses them to the program. Typically, the sponsored organization or program seeks out a fiscal sponsor that has a similar or consistent mission.

There are some advantages to the fiscal sponsorship, including:

  • Quicker startup: The application for tax exemption with the Internal Revenue Service can take as short a period as six weeks to about one year to be approved. A fiscal sponsor provides the new program an opportunity to jump right into programming. With the administrative support of the sponsor, the new program may also begin charitable fundraising without the delays associated with incorporating and filing for tax–exemption. 
  • Tax Deductible Contributions: Donors that contribute to the new program will be able to normally deduct the contribution as a charitable deduction. The new program can immediately accept tax–deductible donor support, a draw for individual and foundation funding.
  • Credibility: If the fiscal sponsor is well regarded among donors, the new program may benefit from its relationship to the sponsor. Programs can take years to develop name recognition and credibility where pre–existing relationships with funders are not available. The sponsored program may be in a better position to secure funding if their fiscal sponsor is a reputable charity.
  • Back office support: Fiscal sponsors may provide new programs with additional support such as insurance, payroll and accounting services, office space, publicity, capacity building or fundraising assistance.  This assistance gives new programs the flexibility to focus on mission, potentially at a lower cost.  Depending upon the size of the charitable organization, a fiscal sponsor may be able to negotiate lower insurance rates, more reasonable rents or accounting services than a fledgling nonprofit may be able to obtain on its own.

In most fiscal sponsorships, the fiscal sponsor charges an administrative fee for its services, usually a percentage of the budget of the sponsored organization or program. Some organizations remain in a fiscal sponsorship relationship for a long time, deciding that their mission can be achieved in that structure without the need to be recognized by the IRS as an independent tax–exempt entity. Fiscal sponsorships should be memorialized in a written agreement between the fiscal sponsor and the sponsored organization. The agreement should specify that the fiscal sponsor is responsible for all legal compliance relating to receiving, reporting, and acknowledging charitable donations, and also describe the administrative fee that the sponsored organization will provide to its fiscal sponsor.

Both the fiscal sponsor and the new program should make sure to do a few things to protect themselves. First, both entities should do the proper due diligence regarding leadership, reputation, activities, mission and financial health of the other entity. Secondly, the written sponsorship agreement should not only address fees for services and transferring of charitable donations but also should include exit provisions for the new program. In the event that the program decides it would like to create a wholly separate tax-exempt nonprofit, there should be some provisions for the types of assets (intellectual property rights, supplies, etc.) that will move with the new organization. Lastly, the fiscal sponsor must maintain strict oversight over the sponsored program’s activities to make sure the program is meeting its legal obligation to utilize donor funds correctly.

Nonprofits are in the business of providing charitable services to the community. They are also expected to be good stewards of their donations. Funders are likely to take notice of the advantages that fiscal sponsors offer and are receptive to funding programs that find homes with credible sponsors. These fiscal sponsors also play a part in vouching for a project’s credibility to prospective funders. Fiscal sponsorship can allow a program to recognize its strengths as a mission-driven organization while addressing the need for efficient back office support and fiscal controls. 501(c)(3) tax exemption may be a long term goal, but fiscal sponsorship may be a sound first step.