Lobbying & Grants to Non-501(c)(3) Entities: Know The Rules

Investment

Although many people think otherwise, 501(c)(3) public charities are in fact permitted to engage to lobbying activities, provided such activities are an insubstantial amount of their overall activities. They are also generally permitted to fund any work of other entities, including non-public charities, that they could engage in themselves, including lobbying activities.  However, when a public charity makes grants to an entity that is not another 501(c)(3) public charity (such as a taxable entity or an individual), there are specific rules regarding how lobbying expenditures and activities of the non-public charity grantee are attributed to the grantor organization.  These types of grants may be particularly common for public charities engaging in preapproved grant relationship fiscal sponsorship or for community foundations.

These specific rules are set forth in a Treasury Regulation that essentially states that, in such a situation (which is distinguished from when the same grantor is making grants to other public charities), a grant to a non-public charity that engages in lobbying activities will be treated as a lobbying expenditure or as lobbying activity for the grantor and will count against the grantor’s lobbying limits.

For example, if a public charity were to make total grants in a given year of $50,000 to a non-public charity grantee and that grantee itself spent $25,000 on lobbying activities during the year, the public charity would have to count $25,000 of its grant as its own lobbying expenditure or activity for the year, even if the funds the grantee actually used to lobby were funds other than those granted by the public charity.

Moreover, when a public charity has made the election under Section 501(h) (which we recommend that most public charities do), its lobbying activities are divided into direct lobbying (generally a lobbying communication with a legislator or staff member or with members of the public where the public is the decision maker, like with ballot measures) and grassroots lobbying (a communication with the general public that refers to specific legislation, reflects a view on that legislation, and contains a call to action) activities.  A 501(h)-electing organization may spend no more than 25% of its maximum total lobbying expenditure limit (based on its total exempt purpose expenditures) on grassroots lobbying.

Under the Regulation, where the grantmaking public charity has made the Section 501(h) election, the lobbying expenditures made by the grantee will be presumed to be grassroots lobbying expenditures. These amounts will be counted towards the grantor’s lower grassroots lobbying limit unless the amount of the grant exceeded the grantee’s actual grassroots lobbying expenditures, in which case any excess may be attributed to direct lobbying expenditures up to the extent of the grantee’s actual direct lobbying expenditures.  If the amount of the grant from the public charity to a grantee exceeds the grantee’s grassroots and direct lobbying expenditures combined, then the excess amount of the grant will not be treated as a lobbying expenditure for the public charity.

Using the example above, if the grantee’s $25,000 in lobbying expenditures was comprised of $20,000 in grassroots lobbying and $5,000 in direct lobbying, that would be how the grantmaking public charity would attribute it for purposes of its own expenditures.  If, however, the grantee had actually spent $60,000 on lobbying during the year and $55,000 of it was on grassroots lobbying, then the full amount of the $50,000 grant would count towards the public charity’s own grassroots lobbying limit.

Because of these attribution rules, it will be important for any 501(c)(3) public charity making grants to non-public charity entities or individuals who engage in lobbying activities to have a clear understanding of its own lobbying limits, as well as a process for grantees to track and report their grassroots lobbying, direct lobbying, and total lobbying activities and expenditures.

There is, however, an exception to the attribution rule set forth in the Regulation for “controlled grants”, which are grants as to which “the donor limits the grant to a specific project of the recipient that is in furtherance of the donor’s (nonlobbying) exempt purposes; and … maintains records to establish that the grant is used in furtherance of the donor’s (nonlobbying) exempt purposes.”  If the public charity grantor makes a controlled grant following this definition, then the lobbying conducted by the grantee will not be attributed to the grantor for purposes of its limits. Accordingly, it may be advisable for most grants from 501(c)(3) public charities to non-public charities to be structured as controlled grants unless the grantmaking organization intends for such grant to in fact be used for lobbying activities.

National Network of Fiscal Sponsors Annual Gathering 2015

Manhattan Bridge

The National Network of Fiscal Sponsors held its Annual Gathering in Brooklyn on November 7. Approximately 100 leaders of fiscal sponsors from across the country came to learn about common issues, best practices, and new developments, and to share experiences.

Fiscal sponsorship refers to a contractual relationship that allows a person, group, or taxable entity to advance charitable or other exempt activities with the benefit of the tax-exempt status of a sponsor organization. The most common models of fiscal sponsorship are:

  • Comprehensive (Model A), in which the assets, liabilities, and exempt activities collectively referred to as the project are housed within the fiscal sponsor, and
  • Pre-approved grant relationship (Model C), in which the project is run by a separate entity funded by the fiscal sponsor.

Fiscal sponsors must consider in their plans and operations: technology, demographic changes, globalization, social and racial justice movements, and the sharing economy. These major forces provide both opportunities and threats. Among some of the other trends we discussed at the Gathering:

Social Enterprises & Impact Investing

The rise of for-profit social enterprises and broader social good movement are particularly noteworthy. Social enterprises (including hybrid organizations like the benefit corporation and L3C) may be promising collaborative partners, commercial co-venturers, supporters, and donors. Social entrepreneurs may also look at a fiscally sponsored project as an alternative to starting a nonprofit affiliated with their social enterprise. Further, hybrids can be used as vehicles for cross-sector joint ventures. However, they also represent competition to nonprofits for talent and dollars.

Impact investing and the new rules recognizing mission-related investments (MRIs) provide opportunities for fiscal sponsors to attract contributions intended to make MRIs in social enterprises. Fiscal sponsors would be wise to understand how to utilize MRIs and avoid conferring upon any person or entity a prohibited private benefit.

Crowdfunding

Crowdfunding is an increasingly attractive fundraising vehicle, but fiscal sponsors must understand the rules and risks along with the potential benefits. They should ensure authorized, truthful, and accurate communications; use of properly registered or exempt crowdfunding platforms; registration in states, as required (see Charleston Principles); and proper donation receipts, including when something of value is provided to a contributor in return for the gift.

Fiscal sponsors must also recognize the competition provided by individuals or groups using crowdfunding for charitable purposes without a 501(c)(3) organization. Contributors to such campaigns will generally not be entitled to a charitable contribution deduction and may be angry at the nonprofit represented as the beneficiary of the campaign. Nevertheless, many people will continue to support crowdfunding campaigns regardless of the tax-status of the beneficiary or the deductibility of the contribution.

IRS Form 1023-EZ

IRS Form 1023-EZ was released in July 2014 as an alternative short form for small organizations applying for exemption under 501(c)(3). The Form, which has been widely criticized by state charity officials and exempt organization professionals (including this one), is credited with reducing the 60,000+ application backlog that had caused common delays of determinations lasting one year and longer. The number of approvals of 501(c)(3) status in fiscal year 2014 (94,365) more than doubled the two previous years combined, and only 67 applications were disapproved. The principal reason for the criticism is that the application appears more like a self-certification than a true application to be vetted by the IRS. It’s not surprising that the processing time of Forms 1023-EZ has reportedly been as short as 2-4 weeks (though the IRS states to expect up to 90 days). But the lack of vetting has resulted in even for-profit corporations receiving favorable 501(c)(3) determinations because they checked the right boxes regardless of whether they actually qualified.

The lower barrier to obtaining 501(c)(3) status and shortened processing time may make it easier to start a nonprofit than get fiscally sponsored. Accordingly, what was once an advantage for fiscal sponsorship may now be a disadvantage in many cases. Yet, it can be pointed out to project founders and steering committees that a determination letter in response to a Form 1023-EZ can be distinguished from a determination letter in response to the full Form 1023. And funders may begin to give weight to this factor, particularly when problems associated with the Form 1023-EZ begin to surface.

Compliance / Scandals

Best practices (such as the guidelines published by NNFS for comprehensive and pre-approved grant relationship) are helping strengthen the reputation of fiscal sponsorship. Stories of fiscal sponsorship done right are similar helpful, but the media tends to favor the bad stories like this one. The “scandals” lead to drafting of legislation and/or regulations to help prevent fiscal sponsors from serving as mere conduits for monies to flow from donors and grantmakers to for-profits. Fiscal sponsors need to better educate the media, the general public, and funders about the valuable public benefit created by fiscal sponsorship. Fiscal sponsors may also want to consider listing their largest comprehensive fiscally sponsored projects on the Form 990 to evidence transparency and counter the argument that fiscal sponsors are used to “hide” bad projects.

Lobbying and Political Activities

501(c)(3) fiscal sponsors with comprehensive projects that lobby must be careful about complying with state and federal political registration and reporting requirements in addition to federal tax law limitations. They should also be aware of their potentially generous lobbying limits under 501(h) (assuming they made the very easy and generally highly recommended election) and not be overly conservative in limiting lobbying activities of their projects so long as they have the capacity to comply with the registration and reporting requirements. Similarly, fiscal sponsors should understand the political activities permissible to a public charity and not discourage their projects from such activities (e.g., voter education, issue advocacy, voter registration, get-out-the-vote drives). See Rules of the Game.

Fiscal Sponsorship: What You Should Know and Why You Should Know It

Find out more, appearing behind torn brown paper.

Erin Bradrick‘s article on fiscal sponsorship published by the American Bar Association’s Business Law Today was made available online last week. Read it here.

For lawyers who work with nonprofits and exempt organizations or individuals with philanthropic aspirations, “I want to start a nonprofit” may be the single phrase they hear most frequently. However, the most valuable advice an attorney can give to a client seeking counsel on starting a nonprofit might be to not do so. While forming a nonprofit corporation and applying for income tax exemption will be the right choice for some clients, there are often alternatives that may more efficiently and effectively allow a client to achieve his or her charitable goals. Fiscal sponsorship is one such alternative.

 

Fiscal sponsorship is a contractual relationship that allows a person or organization that is not tax-exempt to advance charitable or otherwise exempt activities with the benefit of the tax-exempt status of a sponsor organization that is exempt from federal income tax under Internal Revenue Code (IRC) Section 501(c)(3). When done correctly, fiscal sponsorship can be a great tool for fulfilling a client’s charitable goals without necessarily requiring the formation a new nonprofit entity, application for tax-exempt status, or compliance with ongoing filing and registration requirements. However, when fiscal sponsorship is done incorrectly, the Internal Revenue Service (IRS) can view it as a mere conduit relationship. This can lead to problems for both the sponsor organization and the sponsored project, as well as for donors.

This is a particularly valuable article for attorneys who are representing (1) founders of new charitable projects and/or (2) fiscal sponsor organizations. We’ve written much on the subject of fiscal sponsorship and continue to be advocates of fiscal sponsorship when set up correctly. Unfortunately, in our experience, there are many nonprofits dabbling in the role of a fiscal sponsor without the proper structures, oversight, agreements, policies, knowledge, and legal guidance. Self-regulation will go a long way in preventing additional laws and regulations that harm this valuable vehicle for promoting multiple charitable efforts without all the burdens of setting up, maintaining, and monitoring a new entity for each one.

Fiscal Sponsorship: The Risks of Being a Fiscal Sponsor

Worried About Growing Risk

Fiscal sponsorship can be an incredibly valuable tool for incubating charitable nonprofit projects and creating efficiencies through the provision of administrative support to several discrete projects. The key to its value lies in how well the fiscal sponsor meets its responsibilities and obligations and understands how to appropriately manage the risks of sponsorship. In this post, which is intended to complement the April 21 Hot Topic Call I’m participating in with Steve Moody from the Nonprofits Insurance Alliance Group for the National Network of Fiscal Sponsors (register here), we’ll discuss some of the major risks for a fiscal sponsor that provides comprehensive (or Model A) fiscal sponsorship.

The Responsibility of a Fiscal Sponsor

In a comprehensive fiscal sponsorship, the fiscal sponsor owns the project and the sponsor is responsible for all activities of the project and, generally, any of the project’s liabilities, regardless of whether the sponsor was aware of such liabilities. The rights of the other party to the fiscal sponsorship agreement (often, a project committee convened by the project founders) are typically limited to moving the project to another qualified fiscal sponsor or charity or terminating the project, though the founders and project committee members are typically involved in their individual capacities as employees or volunteers of the fiscal sponsor responsible for project management and fundraising.

The Risks of a Fiscal Sponsor

Mission Drift

An organization that serves as a fiscal sponsor must make sure its mission is advanced by each and every project. Operating outside of its mission may be a violation of its governing documents and charitable trust principles.

Reputational

An organization’s reputation is one of its most valuable assets and must be protected vigilantly. Even a single problematic project (e.g., one that publicly communicates values fundamentally different from the organization’s values) could have disastrous impact on a fiscal sponsor’s reputation and future prospects.

Liability for Activities

Because the program’s activities are the fiscal sponsor’s activities, the fiscal sponsor is ultimately responsible for ensuring that the activities are being engaged in consistent with all applicable laws and with the appropriate level of care. If some person or entity is hurt or otherwise suffers damage as a result of negligent actions or omissions of a project representative, generally, the fiscal sponsor will be responsible. The following questions with respect to each project should be considered:

Qualification

Is the fiscal sponsor qualified to carry out charitable activities in the states or jurisdictions where the project is operating? Does it have all appropriate licenses and permits? Is it exempt from state taxes in those states?

Employment

Does the fiscal sponsor have the appropriate infrastructure to employ individuals connected with the project? If the project director is responsible for employing project employees, does she or he have sufficient knowledge and training to comply with applicable employment laws? Does the fiscal sponsor provide a policy that the project director must follow with respect to interviews, background checks, hiring, training, compensation, disciplinary procedures, and terminations?

Intellectual Property

Is the project using or planning to use any intellectual property (copyrights; trademarks; patents; trade secrets, including donor lists) that might infringe on the rights of another party?

Private Benefit

What are the risks of the project conferring a prohibited private benefit (e.g., excessive payment) to an individual or business entity? If any directors, officers or other disqualified persons with respect to the fiscal sponsor involved with the project, what are the risks of an excess benefit transaction?

Lobbying and Electioneering

Will the project engage in lobbying, and, if it will, does the fiscal sponsor have appropriate knowledge and control to ensure that all registration and reporting requirements (e.g., LDA, FECA, California Political Reform Act) are met? Is it clear that the project cannot and will not engage in any activities that might violate the 501(c)(3) prohibition against political intervention, including ensuring that none of the project’s resources (including email) are used to engage in electioneering activities?

Collaborations

Will the project engage in collaborations with other entities, and is there a policy over what types of collaborations are permissible only with the approval of the fiscal sponsor? What are the risks of creating a partnership for which the sponsor may be jointly and severally liable?

Tips for Serving as a Fiscal Sponsor

Evaluating Projects

  • Are the project’s activities consistent with 501(c)(3)?
  • Are the project’s activities in furtherance of the fiscal sponsor’s mission?
  • Are the project’s goals and activities consistent with the fiscal sponsor’s values?
  • Does the project pose risks that the fiscal sponsor is particularly concerned about or have little familiarity in managing?
  • Does the fiscal sponsor have the internal capacity to oversee and support the project in a safe and responsible manner?

Vetting Project Directors

  • Would the project director be an individual that the fiscal sponsor would hire to lead a purely internal program?
  • Did the fiscal sponsor vet the project director in a similar manner as it would for an internal program manager with broad leadership autonomy?
    • Interview
    • References
    • Background check
  • Does the project director have sufficient expertise and experience to operate, manage, and raise funds for the project?

Fiscal Sponsorship Agreement

  • Does the agreement differentiate between (1) the party signing the contract with the fiscal sponsor and (2) the individuals who will be managing or working for the project whether as employees or volunteers?
  • Does the agreement provide the sponsor with the authority to approve any successor fiscal sponsor or nonprofit to which the project assets would be transferred in the event of a termination of the agreement?

Onboarding

  • Does the fiscal sponsor make clear to the project leaders that the project does not and cannot operate independent of the fiscal sponsor and that another entity operated by project leaders (if any) must be distinct in name and activity from the project?
  • Does the fiscal sponsor have a policy and practice in training a project director in any areas of deficiency that may pose a risk to the sponsor?
  • Does the sponsor equip the project with appropriate policies, including those regarding conflicts of interest, whistleblowers, document retention/destruction, gift acceptance, communications (including websites and social media), and internal controls?
  • Does the sponsor emphasize the importance of timely and accurate reporting to allow for appropriate oversight?
  • Does the sponsor communicate how the project director and leaders may access administrative and legal assistance from the sponsor?

Insurance

  • Does the fiscal sponsor have appropriate and sufficient insurance coverage that accounts for the activities of the project?

Final Thoughts: The Fiscal Sponsor’s Board

A fiscal sponsor is ultimately responsible for all of its Model A fiscally sponsored projects. Accordingly, the board members of the fiscal sponsor are ultimately responsible for all of the activities and affairs of each of its projects. The fiscal sponsor’s board may delegate management of a project to a project director and intermediate oversight to the sponsor’s administrative leaders. But management of all projects remain under the ultimate direction of the fiscal sponsor’s board notwithstanding any attempt to contract out its oversight responsibilities.

Best of the Nonprofit Law Blog 2014

Best of 2014 - The year in reviewHere are some selected highlights from NEO Law Group over the past year that we hope you’ll find helpful. 2014 was also highlighted by an addition to Erin’s family and Michele’s graduation and passage of the bar exam! Amazing year for all of us.

Blog Posts

Governance

What Issues Should a Nonprofit Board Consider Annually?

Executive Succession: 10 Tips for Boards

Executive Committees: Why You Should Limit Their Authority

Advocacy

Nonprofit Advocacy is More Than Lobbying

Charities and Issue Advocacy: Doing it Right – Part One

5 Things Nonprofits Should Know About Ballot Measure Advocacy in California

Fiscal Sponsorship

Fiscal Sponsor Due Diligence

Fiscal Sponsorship: A Valuable Option for Grantmakers and Grantees

Arts Projects: Charitable or Not?

Proposed Laws

12 Things Nonprofits Should Know About Proposed Tax Reform

California Bill to Strengthen Enforcement of Charity Registration and Reporting

Proposed Rules Affecting California Charities – Comment Period Ends Today!

UBIT / Social Enterprises

UBIT: Advertisements vs. Qualified Sponsorship Payments

Nonprofit Limited Liability Company

Nonprofit Crowdfunding Risks

Miscellaneous

Nonprofit Laws for Human Resources Managers to Be Aware Of

Retroactive Reinstatement Procedures: Simplified

Dissolution and Transfer of Remaining Assets: An Alternative to Merger

Articles

Fair or Foul: A Review of Federal Tax Laws Governing Unfair Competition, The Nonprofit Quarterly (2014)

12 Reasons Why You Should Gracefully Resign from a Nonprofit Board, The Nonprofit Quarterly (2014)

10 Issues To Address In Your Nonprofit’s Social Media Policy, The Nonprofit Times (2014)

Videos

Tips on Starting a Nonprofit: Initial Board of Directors

Tips on Starting a Nonprofit: Fundraising Before Exemption

Tips on Starting a Nonprofit: Initial Bylaws

Nonprofit Radio

Advocacy, Net Neutrality, & The Bright Lines Project

Your Board’s Role in Executive Hiring

Fraud!

Speaking Engagements

Gene

Profit for Good: How Social Enterprise Policy Affects You, Independent Sector Public Policy Action Institute

Hot Topics in Nonprofit Law, CalNonprofits Policy Convention

Small Charities – Problems and Solutions, American Bar Association, Tax Section Mid-Year Meeting

Erin

Earned Income 101 for Nonprofits, Lawline

Understanding UBIT: What Does It Mean for Your Shared Space? Nonprofit Centers Network

Navigating Legal and Ethical Issues, New Grantmakers Institute, Northern California Grantmakers

NEO Law Group’s Video on Tips for Starting a Nonprofit – Alternatives to Forming a Nonprofit

 

Today, NEO Law Group released a new 3 minute video in its series of videos on tips for nonprofits, available on YouTube.  While incorporating a nonprofit and applying for tax exemption may be the right choice in some instances,  there may often be a better way to achieve your charitable goals.  This video focuses on some possible alternatives to formation, including partnering with an existing nonprofit, fiscal sponsorship, and donor-advised funds.  We hope that you enjoy it and please stay tuned for additional videos from NEO Law Group on tips related to nonprofits.

National Network of Fiscal Sponsors – Hot Topic Call: Legal

dog on the phone

Yesterday, I had the pleasure of hosting a Hot Topic Call on legal issues for the National Network of Fiscal Sponsors. If you’re interested in viewing the accompanying slide deck, you can download it by clicking Hot Topics in Comprehensive Fiscal Sponsorship (pdf).

Preview:

The focus of the call was on comprehensive fiscal sponsorship (also referred to as Model A) and it covered intake, exits, and the existence of a separate entity operated by a project’s leaders. The call also touched on a new model of fiscal sponsorship involving a single member LLC owned by a fiscal sponsor (also referred to as Model L).

In a comprehensive fiscal sponsorship, generally, the fiscal sponsor owns the project and the sponsor is responsible for any project liabilities (including any that the sponsor was unaware of until the project leaders disappeared). Additionally, the sponsor is responsible for how the project fundraises and raises earned revenues. Sufficient due diligence must be exercised at the front end to help assure that the project will further the sponsor’s exempt purpose and not jeopardize the sponsor’s overall operations. And, as an internal project, the sponsor must exercise reasonable oversight over it (e.g., regular financials and program reports prepared by the project leaders at least annually but possibly more often, and combined with site visits and interviews, depending on the circumstances).

Sponsors must be absolutely clear themselves on what comprehensive fiscal sponsorship is if they expect the project leaders to understand it. Sponsors must be particularly careful of marketing too aggressively by promising not to interfere with management of the project; sponsors may have to interfere if there’s a compliance problem.

Resources:

 

Fiscal Sponsorship: A Valuable Option for Grantmakers and Grantees

 Houston

Yesterday, I had the honor of participating on a panel discussing fiscal sponsorship at the 2014 Grantmakers in the Arts 2014 Conference in Houston. Frances Phillips (Walter and Elise Haas Fund), Melanie Beene (consultant, former CEO of Community Initiatives), and Ian David Moss (Fractured Atlas) were my co-panelists, and we were joined by a very vocal group of attendees who made the session one of my favorites. The following post is from a handout we distributed at the session.

Fiscal sponsorship describes a number of varying contractual relationships that have through custom and practice developed between “sponsors” and “projects,” making it possible for charitable projects to receive grants and deductible contributions without having their own 501(c)(3) status. These relationships can help facilitate grantmakers’ support of worthy arts projects that are not suited for independent legal existence as public charities. But the health of the sponsor and the structure of the fiscal sponsorship agreement are critical to ensuring that your grants are made appropriately and in compliance with applicable laws.

Most common forms of fiscal sponsorship

The two most common models of fiscal sponsorship are referred to as comprehensive (Model A) and the pre-approved grant relationship (Model C). The National Network of Fiscal Sponsors (NNFS) provides the following definitions:

Comprehensive

In a Comprehensive Fiscal Sponsorship relationship, the fiscally-sponsored project becomes a program of the fiscal sponsor, and is a fully integrated part of the fiscal sponsor that maintains all legal and fiduciary responsibility for the sponsored project, including its employees and activities. This model of fiscal sponsorship is particularly valuable when a project has employees.

Pre-approved Grant Relationship

In a Pre-Approved Grant Relationship Sponsorship, the fiscally-sponsored project does not become a program belonging to the sponsor, but is a separate entity responsible for managing its own tax reporting and liability issues. In addition, the sponsor does not necessarily maintain ownership of any part of the results of the project’s work—ownership rights may be addressed in the fiscal sponsor agreement and could potentially result in some form of joint ownership. The sponsor simply assures that the project will use the grant funds received to accomplish the ends described in the grant proposal. This is the model of fiscal sponsorship primarily utilized in the arts.

 Comprehensive
Model A
Pre-Approved Grant ...
Model C
Project is housed in sponsorYesNo
Project is housed in separate legal entityNoYes
Project employeesEmployees of the sponsorEmployees of the project (sub-grantee)
SolicitationsBy agents of the sponsorBy agents of the sponsor
GrantsTo sponsor for purposes of the project (housed in sponsor)To sponsor for purposes of the project; sponsor may, but is not required to, regrant to project (sub-grantee)

An alternative to forming an independent charity

Having a charitable project fiscally sponsored by a sound and reputable fiscal sponsor may be an attractive alternative to starting a nonprofit, especially when:

  • An idea is being tested or incubated.
  • The project involves the work(s) of a single artist or collaborative group.
  • The project leaders are inexperienced or otherwise not well prepared to manage the administrative needs of a charity.
  • The project and/or funding is time sensitive.

Tips and traps for grantmakers

Tips

  • Carefully vet the fiscal sponsor (your grantee), not just the project leaders.
  • Check the fiscal sponsor’s articles/bylaws (consistency with grant purposes).
  • Check the fiscal sponsor’s financials (e.g., negative unrestricted net assets).
  • Review the fiscal sponsorship agreement (variance powers in Model C).

Traps

  • Directing a grant to the project in a Model C fiscal sponsorship.
  • Sending grants to Model A project leaders instead of the fiscal sponsor.
  • Granting to a fiscal sponsor that acts as a mere conduit to another entity.
  • Placing too much weight on overhead (incl. fiscal sponsorship fees).

Fiscal Sponsor Due Diligence

Due Diligence

Fiscal sponsorship describes a relationship between an individual or group who have initiated a charitable project, and an existing tax-exempt organization that has agreed to support said project. In the most common form of fiscal sponsorship, “Model A” or comprehensive fiscal sponsorship, the sponsor brings the project in-house. The project has no separate legal existence and, instead, is owned and operated by the sponsor. The sponsor is vested with control and administration of the project, and project staff are employees or volunteers of the sponsor.

All of the assets of the Model A project are the sponsor’s assets, and, conversely, all of the liabilities associated with the project are the sponsor’s liabilities. Accordingly, the sponsor may be held liable for the actions of a project employee acting within the scope of his or her employment. Similarly, the sponsor may be held responsible to the extent that the project has engaged in any unlawful conduct such as infringing a copyright or violating a restriction described in Section 501(c)(3) of the Internal Revenue Code (IRC). Thus, fiscal sponsors should be careful to ensure that each project is legally compliant and financially viable throughout the relationship.

The following are a few ways a fiscal sponsor can exercise due diligence before and after entering into a Model A fiscal sponsorship relationship:

  • Mission Alignment– A fiscal sponsor’s initial consideration in taking on a project is whether that project’s mission is consistent with the sponsor’s own exempt purposes. As a tax-exempt 501(c)(3) organization, the fiscal sponsor must be operated primarily for a stated charitable purpose. If the project’s activities stray away from the sponsor’s stated purpose, the sponsor may be acting beyond its power and authority (ultra vires). Sponsors should be thorough in questioning the project’s mission, leadership, and planned activities to properly assess whether the two missions are, and will remain, aligned.
  • 501(c)(3) Restrictions and Limitations– While the project is housed within the fiscal sponsor, any project activities are activities of the sponsor. Therefore, the project is subject to the same 501(c)(3) rules and restrictions as its sponsor. A sponsor should vet the project’s leaders to have comfort that they will not engage in any prohibited or restricted activities such as electioneering or substantial lobbying, and will not enter into any transactions that violate the private benefit and private inurement A sponsor should consider providing training materials to project personnel at the beginning of their relationship and periodically (e.g., annually) thereafter.
  • Minimum Level of Engagement– The level of engagement between a sponsor and a project may vary from case to case. However, at a minimum, the sponsor must retain control and discretion of the use of funds, maintain records demonstrating that the funds were used for 501(c)(3) exempt purposes, and limit distributions to projects that further the sponsor’s exempt purposes. (See Rul. 68-489, 1968-2 C.B. 210). A fiscal sponsor that fails to meet these requirements could have its tax exemption revoked. Thus, sponsors should take and keep accurate records of all sponsorship activities, question any compliance issues, and intervene when necessary.
  • Sufficient Resources– Fiscal sponsor should examine whether each project is viable with respect to financial, human, and other resources. Fiscal sponsors generally charge a fee to a project based on a percentage of project revenues. However, such fees may be insufficient for the sponsor to recoup all the costs associated with sponsoring a project that is having trouble generating income or engaging in activities that significantly drain a sponsor’s time, energy, and finances. Since fiscal sponsors assume liability for each project, they should be prepared to lay off employees and terminate inactive or waning projects if future funding and viability is in doubt.
  • Fundraising– Commonly, a project’s personnel takes the lead in soliciting donations and grants. Any project employee or volunteer making representations in this fundraising role should be doing so as an agent of the sponsor. Fiscal sponsors should take steps to assure that such representations are accurate, including training project personnel to avoid any misrepresentations of the project as a separate legal entity. Although all funds raised are the property of the sponsor, the sponsor could be restricted on how to use or distribute those funds because of charitable trust principles. Sponsors should ensure that project personnel are in compliance with fundraising laws and internal policies, and that they are properly documenting any restrictions they have agreed upon or created, by nature of a solicitation (e.g., capital campaign).