CAUTION! Fiscal Sponsorship Agreements – An Alternative to Seeking 501(c)(3) Status

By: Eitan Davis

Growth, in its many iterations, is a common focus among most entrepreneurs. On the other hand, profit, though related, can sometimes be a mere afterthought to effecting the core mission of the project.

Fledgling nonprofit organizations with limited funding may find difficulty in making the most of their incoming capital, especially in consideration of the myriad measures that need be met in order to achieve tax-exempt status.  To obtain 501(c)(3) status, an organization begins by filing IRS Form 1023.  The requirements are many, and, at nearly 30 pages itself, Form 1023 is lengthy, commonly requiring an additional 20 pages of attachments.  The cautious (and deep-pocketed) entrepreneur can afford to reorganize and seek help through costly consultation with accountants and attorneys.  However, founders whose circumstance dictates a more economical approach, or those with more finite project-durations, may benefit by seeking fiscal sponsorship from reputable, established nonprofits in their space.  To that end, a chief concern is choosing the right sponsor.

What is Fiscal Sponsorship? 

In a fiscal sponsorship relationship, an existing nonprofit organization (sponsor) confers its tax-exempt and/or legal status to the sponsoree so that the sponsoree can take on grants and donations that it could not otherwise receive – all of which must be in conjunction with activities related to the organization’s mission, and the specific purpose of the project being sponsored.  Without having to adjust its status (e.g., from an LLC to a nonprofit corporation), a smaller charitable project is able to utilize the name, tax treatment, and other unique administrative services offered by the sponsor.  These arrangements typically involve certain administrative services, covered by the sponsor, who recoups a portion of these costs by requiring a fee in the range of about 5-15% to be “paid back” by the sponsoree on any funds received.

Two Common Forms of Fiscal Sponsorship

The Direct Project

In a Direct Project model, the founding members of a project approach the sponsor with an original program idea.  Once adopted, the project is taken in-house and made an extension of the sponsor holding no separate legal entity.  Essentially, the project would be no different than any of the other activities engaged in by the sponsor directly, even though, in theory, it would be operated by its founding members.  The members conducting the project then take on an employer-employee relationship whereby the sponsor both owns the results of the project outright, and also takes on total liability for the acts of its new employees.

Preapproved Grant Relationship

In a Preapproved Grant Relationship, the project remains a separate legal entity from the sponsor, which allows founders more control over the project’s operations.  A grantor-grantee relationship is established, limiting the sponsor’s liability to 3rd parties, as opposed to the employer-employee relationship found in the Direct Project model.  Here, the project would specifically outline its intended activities in an application for one or a series of grants from a sponsor.  If an agreement is made, the project would then go on to solicit donors who would make contributions to the sponsor on behalf of the project. After this point, the sponsor would disburse funding to the project respectively.  Donations can be one-off or ongoing, according to the provisions of the contract.

Maintaining Control

Typically, the founders of a project will need to give up a degree of discretion and control (outlined in contract) in order to enjoy the benefits of a fiscal sponsorship.  Sponsors who fall into the two categories above are, at the very least, fiscally responsible for the projects they engage.  That liability requires that they exercise more or less complete control over a project’s funds, ensuring that funding is used for only for proper project purposes.  Unwanted tax liabilities may be incurred if it is found that funds have been used by the project for substantially private benefit.  The sponsor’s necessity for oversight is made far more pressing when, as in the Direct Project model, a project becomes an integral part of the sponsor, holds no separate legal identity, and imposes liability on the sponsor for all of the acts of those working conducting the project.

Even where the project isn’t a separate legal entity, founders will still sacrifice some elements of practical autonomy.  Take for example the project who seeks to engage in fundraising activity for a political candidate.  The sponsor’s liability makes it unlikely that they will allow the activity because 1) the candidate may not align, either personally or politically, with the sponsor’s mission, and 2) tax implications having to do with fiscal sponsorship require that funds specifically advance the project’s objective, and prohibit substantially private benefit.  Were the IRS to determine that involvement in political fundraising does not advance the objective initially laid out in the fiscal sponsorship agreement, and then the project channels funds raised from such activity through the sponsor, legal issues would likely arise.

This isn’t to say that the sponsor will be dictating what you can and can’t do at every move. It is however important to bear in mind that, one way or another, your project will be subject to certain limitations of control, which can differ greatly depending on the model of sponsorship you seek, and the particular sponsor with whom you engage.

Know Thine Sponsor

Any number of reasonable hypotheticals will clearly emphasize the importance of choosing the right fiscal sponsor.  To that end, consider whether your proposed sponsor is right for you.  Research and due diligence are integral to making this determination.  Is the sponsor in good standing in their respective community?  Are they well-funded?  How have they treated past fiscal sponsorees?  Have they afforded a great deal of autonomy or been (by your standards) overly conservative in their operations?  Also consider how your sponsor has communicated their expectations for this project in particular – do they expect ownership or are they merely acting as an incubator to help get you off your feet?

As with any impactful contract, before committing, make sure the terms and parties align with your vision for your project.  Fiscal sponsorship agreements often take longer than a few weeks to hash out, and you shouldn't feel rushed into signing anything until you’ve received satisfactory answers to all of the questions you’ve thought to ask.