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.

5 thoughts on “Fiscal Sponsorship: What You Should Know and Why You Should Know It

  1. catherine meetre

    Our community newspaper, a worker cooperative but not a 501c3, has an established relationship with a fiscal sponsor through which we received a grant to redo our website – a project fitting well under the charitable purposes of the sponsor. The question has arisen as to whether the website is a depreciable asset bought out of income to the paper, i.e. whether the income from the grant is taxable and therefore whether the website is an asset that must be depreciated. Things i read indicate that in this Model C arrangement, any results are usually owned by the ultimate recipient of the funds. But it isn’t clear if that ownership implies any tax liability. The paper is a cooperative mostly run by volunteers, but because when we do make a profit, that profit is shared among the volunteers, we have never sought 501c3 status. Thanks for any guidance you offer!

    • Gene Takagi

      Depending on the circumstances of a “grant” such as the one described, it can be gift income not subject to income tax or taxable income. The characterization may be based in part on whether the fiscal sponsor truly exercised independent discretion in making the grant (it was not legally directed by the donors to the fiscal sponsor and intended for their private benefit) and whether the grant was a gift or an exchange for services. It’s not always clear that a website of a community newspaper is operated consistent with furthering 501(c)(3) purposes, so a fiscal sponsor in such circumstances may have to manage the potential private benefit issues, which may also be an ancillary factor in how the income to the recipient is characterized.

  2. Brandon

    Thanks, Gene. Your examples are very helpful. I think we are saying the same thing but in different ways. By the way, I really enjoy your blog. Thanks for putting it out there!

  3. Brandon

    With the grant theory of fiscal sponsorship, how can a fiscal sponsor be assured that it is not conferring a “private benefit” on a private individual? I know there are private letter rulings to the effect that one 501(c)(3) can make grants to other 501(c)(3)s with a similar exempt purpose. But in such a case there has been no official determination of whether the sub-grantee’s purposes are exempt from federal income tax. On this basis, is the fiscal sponsor essentially just relying on its due diligence investigation of the sub-grantee/project to conclude that the IRS would, if faced with an application from the sub-grantee, conclude that it is organized and operated for exempt purposes?

    • Gene Takagi

      In a Model C (pre-approved grant relationship) fiscal sponsorship, the 501(c)(3) fiscal sponsor must be careful in its selection of a suitable grantee, particularly if the grantee is not itself a 501(c)(3) organization, which is often the case in the arts where the grantee may be a private individual. The purposes of the grant must clearly be consistent with the exempt purposes of the fiscal sponsor, and the fiscal sponsorship grant agreement must contain appropriate restrictive language. The private benefit concerns exist for any grantmaker (not just a fiscal sponsor) that makes grants to individuals. But the test is not if the grantee would obtain 501(c)(3) status if it applied. Rather, it’s whether the grant purposes are consistent with 501(c)(3) and the grant is actually used consistent with such purposes and not in violation of private benefit and other applicable prohibitions. Accordingly, a for-profit pharmaceutical company may be a permissible grantee if the grant funds are used to develop a drug for use to save lives in developing countries under circumstances in which the R&D to develop the drug would otherwise not be commercially viable. A composer may be a permissible grantee in creating a symphony that might not otherwise be created because of its limited commercial appeal. And so on …

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