Filmmakers who seek philanthropic or public funding to support their works may be considering fiscal sponsorship as a vehicle for obtaining such funding. And fiscal sponsorship can be of great value to a filmmaker. But it’s also a misunderstood and widely misapplied area of law that can create risks for filmmakers and their fiscal sponsors.
Accordingly, the parties entering into a fiscal sponsorship agreement should have a basic grasp of what the law requires in such arrangement, how to assess whether the fiscal sponsor has adequate capacity and understanding to properly sponsor the film project, what essential provisions must be in the fiscal sponsorship agreement, why certain provisions may be more important to the fiscal sponsor and certain provisions may be more important to the filmmaker, and how the relationship may be terminated. We’ll cover fiscal sponsorship and the fiscal sponsor in Part One of this article and the fiscal sponsorship agreement and termination in Part Two.
What is fiscal sponsorship?
The term fiscal sponsorship broadly refers to a number of contractual relationships that allow a person, group, or business to advance charitable or other exempt activities with the benefit of the tax-exempt status of a sponsor organization. The term is not defined in statutory law so it’s absolutely critical that any agreement creating a fiscal sponsorship relationship sets up the proper structure for allowing the filmmaker and the fiscal sponsor to get the benefits they desire within what is permissible under applicable laws.
Various fiscal sponsorship relationships are described in Greg Colvin’s seminal book, Fiscal Sponsorship: Six Ways to Do It Right. Filmmakers will likely be most interested in the following model:
- Pre-approved grant relationship (referred to by Colvin as “Model C”), in which the project is owned and run by a separate person or entity funded by the fiscal sponsor (the “Grantee”). In such model, the fiscal sponsor has determined that it will provide grants to the Grantee so long as the Grantee complies with the provisions of the fiscal sponsorship grant agreement and applicable laws. It’s important to recognize that the Grantee will have their own tax and filing obligations separate from the fiscal sponsor.
Some filmmakers may also be interested in the following model for certain film projects in which they are less concerned about ownership of the project:
- Comprehensive (referred to by Colvin as “Model A”), in which the assets, liabilities, and exempt activities collectively referred to as the project are housed within the fiscal sponsor. In such model, the parties should consider the film project to be owned by the fiscal sponsor, though it may be possible for such ownership to be assigned or licensed to another party for fair market value or in furtherance of the fiscal sponsor’s charitable purpose so long as it does not violate the 501(c)(3) prohibition against private benefit (see below).
How does fiscal sponsorship work?
Donations to fiscally sponsored projects are directed to a tax-exempt fiscal sponsor. Most commonly, the fiscal sponsor is a public charity exempt under Section 501(c)(3) of the Internal Revenue Code and a qualified recipient of charitable contributions that are deductible to the donor. The donations intended to support a particular project are treated as restricted funds dedicated to furthering that project’s charitable purpose.
The fiscal sponsor must then decide how to use those funds. It may not cede its ultimate control and decision-making authority over the funds to the project leaders. But the fiscal sponsor may delegate management of the funds to specific employees, contractors, or volunteers of the fiscal sponsor selected by the filmmaker (comprehensive fiscal sponsorship). Alternatively, it may grant the funds to a suitable grantee (the filmmaker or an entity associated with the filmmaker) that it vetted earlier (pre-approved grant relationship fiscal sponsorship).
In either of the models of fiscal sponsorship discussed here, the persons fundraising for the film project are doing so as agents of the fiscal sponsor and on behalf of the fiscal sponsor. This is often a misunderstood point. The fiscal sponsor cannot be a mere conduit without jeopardizing (1) a donor’s ability to take a charitable contribution deduction, (2) a private foundation’s position that is it making a qualifying distribution and not a prohibited taxable expenditure, and (3) the parties’ compliance with applicable fundraising laws.
What is the prohibition against private benefit?
The private benefit doctrine is the broadest of the private benefit rules that apply to 501(c)(3) organizations. It generally provides that a 501(c)(3) organization may not confer any benefit, monetary or otherwise, on any individual or entity that is not incidental, quantitatively and qualitatively, to furthering the organization’s exempt purposes. The concern behind the doctrine is that, by providing more than an incidental private benefit to an individual or entity, the organization may not be organized exclusively and operated primarily for a required 501(c)(3) purpose (e.g., charitable, educational, religious, literary, scientific, etc.).
A fiscal sponsor of a film project must pay attention to several factors in assuring that it does not violate the private benefit doctrine, including the following:
- The primary purpose of the film project must be consistent with a 501(c)(3) purpose and in furtherance of a public interest, not the filmmaker’s private interest. This requirement explains why it may be more common to see fiscally sponsored films that are documentaries or that are educational in nature rather than summer blockbusters. Independent films that are not primarily motivated by their prospects for commercial success may also make for appropriate fiscally sponsored projects.
- Compensation paid to the filmmaker or anyone else employed or contracted by the fiscal sponsor must be fair and reasonable as to the fiscal sponsor. Using the rebuttable presumption of reasonableness procedures (even if not explicitly required) and appropriate comparability data may be prudent.
- Generally, sale of the film or distribution rights to the film should contribute importantly to the fiscal sponsor’s 501(c)(3) purposes. If it does not, in addition to the private benefit issue, the resulting income may be subject to unrelated business income tax.
The Fiscal Sponsor
A filmmaker seeking a fiscal sponsor through which charitable contributions and grants can be raised to fund a film should limit their search to fiscal sponsors that are recognized as exempt under 501(c)(3) and described as public charities. The fiscal sponsor must have a purpose statement that allows it to support the film project. Preferably, the fiscal sponsor will have experience in fiscally sponsoring film projects, be in sound financial health, operate with strong financial management practices, be communicative and responsive to its stakeholders, possess adequate insurance, and comply with all applicable laws. A film project’s health may only be as strong as its fiscal sponsor’s health so it’s imperative for a filmmaker to do their due diligence (i.e., homework) in ensuring they have selected an appropriate fiscal sponsor.
How do you check 501(c)(3) and public charity status?
A fiscal sponsor’s 501(c)(3) and public charity status can generally be verified through the IRS Tax Exempt Organization Search (TEOS) available here. Information related to the eligibility of an organization to receive tax-deductible charitable contributions is updated monthly. Information related to automatic revocations of tax-exempt status are updated weekly. Contributors and grantors may rely on either TEOS or the Exempt Organizations Business Master File Extract (EO BMF).You can read more about TEOS here.
How do you check whether the fiscal sponsor is qualified to operate in the state in which the film project will do business?
This will vary depending on the state. In California, you’ll want to check with the Secretary of State’s Business Search page which lists all California corporations (including nonprofit corporations) and foreign state corporations qualified in California. “Active” status generally indicates the corporation’s authorization to do business in California. For more comfort, ask for, or order, a recent good standing certificate from the applicable state agency (e.g., Secretary of State).
How do you check the fiscal sponsor’s purpose?
The fiscal sponsor’s specific 501(c)(3) purpose is often not properly vetted. You’ll want to look at the fiscal sponsor’s governing documents (e.g., articles of incorporation and bylaws) to see if its purpose statements create any issues for sponsoring a particular film project. If, for example, the fiscal sponsor’s stated purpose is to educate children on nutrition, sponsoring a film whose primary purpose is to educate the general public on climate change would likely be outside of its purpose and problematic.
How do you check whether the fiscal sponsor is registered to allow for fundraising in applicable states?
A majority of states require registration with a state agency in order to engage in fundraising in such state, though enforcement will vary widely and may be unlikely where the fundraising activities are passive online solicitations not directed at residents of a particular state or very nominal in amount with no complaints of misrepresentations or misuse of charitable funds. In California, you’ll want to check with the Attorney General’s Registry of Charitable Trusts, which will allow you to verify whether a charitable organization has complied with the Attorney General’s registration and reporting requirements. “Current” registration status generally indicates such compliance. See also Charitable Solicitation Registration (National Council of Nonprofits).
How do you check the fiscal sponsor’s financial health and financial management practices?
You can start by asking for and reviewing the fiscal sponsor’s audited financial statements. Unaudited financial statements and copies of the fiscal sponsor’s filed Forms 990 may also provide further information. Forms 990 are available on Guidestar and also must be provided by the fiscal sponsor in a timely manner upon request.
An important indicator of financial health will be whether the fiscal sponsor has negative unrestricted net assets. This may generally indicate that the organization has insufficient assets to pay off its liabilities, which could mean that (1) a creditor could pursue a claim against the fiscal sponsor and possibly go after the fiscal sponsor’s restricted assets (including those raised for the film project), or (2) the fiscal sponsor might feel pressure to inappropriately use its restricted assets to pay off unrelated debts. Either scenario could threaten the film project’s viability with little recourse.
In California, a fiscal sponsor with negative unrestricted net assets generally must provide an explanation of its compliance with its charitable trust responsibilities and proof of directors’ and officers’ liability insurance coverage to the Attorney General’s Registry of Charitable Trusts. The relatively new requirement is codified in California Government Code Section 12599.8.
You can read about more general Top Indicators of Nonprofit Financial Health on the Nonprofit Finance Fund here.
You can further review a fiscal sponsor’s financial management practices by obtaining details of its staffing, budget, restricted fund accounting, and project reporting protocols. In addition, you may want to ask about how the fiscal sponsor processes donations; who has signing authority over checks and contracts; whether the fiscal sponsor “borrows” from any of its project funds for cash flow purposes; and what policies the fiscal sponsor has regarding internal controls, conflicts of interest, whistleblowers, expense reimbursements, and document retention and destruction.
Stay tuned for Part Two.