About Nonprofit Fiscal Sponsorships
Post edited on March 15, 2023.
What is fiscal sponsorship?
“Fiscal sponsorship” describes an arrangement between a formally recognized 501(c)(3) tax-exempt organization, called the fiscal sponsor, and a “project” seeking to have the benefits of 501(c)(3) status (among other services). This arrangement has evolved as a work-around to the long timeline, hassles, and costs involved in creating a new nonprofit corporation and applying for 501(c)(3) tax-exemption.
Fiscal sponsorship is a great option for new organizations and those organizations without enough funding to pay for staff to take care of many of the administrative requirements for maintaining an organization such as tax paperwork, bookkeeping, HR compliance, and insurance.
Note: For a general overview of fiscal sponsorship, check out this Legal Bite created by my former workplace, the Sustainable Economies Law Center.
If you are looking for a really deep dive on fiscal sponsorships, this paper has laid a foundation for the use of these terms and arrangements. A more comprehensive discussion about best practices for fiscal sponsorship can be found in the book “Fiscal Sponsorship: 6 Ways to Do It Right” by Gregory L. Colvin and Stephanie L. Petit (3rd Edition).
Clearing up some common misconceptions
1. “Fiscal sponsorship” is not a term defined in the law of tax-exempt organizations. There are no laws describing exactly what is and is not permissible in a “fiscal sponsorship” arrangement, a term made up by the nonprofit industry (a.k.a. the nonprofit industrial complex or “NPIC”). Fiscal sponsorships provide a faster way for an individual or group (or even a business) without 501(c)(3) status to make use of the 501(c)(3) status of another organization. This can occur through a few different legal arrangements (which this blog won't discuss in detail) between the fiscal sponsor and the individual, group, or other entity seeking a way to secure grants, among other benefits of 501(c)(3) status. The most common arrangement, sometimes called “Model A fiscal sponsorship,” involves the new fledgling organization or project becoming a project within a fiscal sponsor, as if it were one of many internal departments or programs of the existing 501(c)(3) nonprofit. As such, under this common arrangement, grants, donations, and all income attributed to the “project” legally belongs to the fiscal sponsor because the “project” does not exist as a separate legal entity from the fiscal sponsor.
2. Under the “Model A fiscal sponsorship” arrangement, the funds raised to support the fiscally sponsored project all belong to the fiscal sponsor. Additionally, all of the assets of the project—such as any names, brands or logos, supplies and equipment bought with funds through the fiscal sponsorship—belong to the 501(c)(3) nonprofit. I often counsel leaders of emerging nonprofit projects who think that the arrangement entails an organization with 501(c)(3) tax-exempt status assigning or loaning out its 501(c)(3) status to another organization, group, individual, for-profit LLC, etc. but that's not exactly the case in “fiscal sponsorship” arrangements. Under a typical fiscal sponsorship arrangement, the ultimate control and supervision of the project lies with the board of directors of the fiscal sponsor, not with the project leaders. This is the case even though the day-to-day management of the project will typically be delegated to a project leader who may exercise a lot of discretion in how the project is carried out. On an everyday basis, these distinctions might not seem significant; however, they can have big consequences. In the event that the 501(c)(3) tax-exempt organization acting as fiscal sponsor is mismanaged, the individual project's funds and other assets could be at risk of loss.
3. Fiscal sponsors cannot funnel limitless amounts of money to a for-profit. This is true of any 501(c)(3)--fiscal sponsors and all other 501(c)(3)s. Sometimes I work with clients who believe they can have a for-profit LLC or other for-profit enterprise that partners with a 501(c)(3) nonprofit as a “fiscal sponsor” and that any amount of money can be transferred from the 501(c)(3) to the for-profit LLC. This is generally untrue. Any 501(c)(3), including a fiscal sponsor, must ensure that funds they receive are spent according to IRS rules for 501(c)(3) nonprofits; otherwise the 501(c)(3) status of the organization may be jeopardized. This means that the 501(c)(3) may be able to contract with a for-profit to conduct some of its activities. However, the 501(c)(3) needs to ensure that under the terms of the contract they are paying no more than a fair price or no more than “market” price for the services of the for-profit. Thus, an agreement between a 501(c)(3) and a for-profit that simply promises to transfer any funds raised by a certain group of individuals to the for-profit could pose significant problems for the 501(c)(3) in an audit.
Should I start my nonprofit project as a project inside a fiscal sponsor?
I generally strongly urge leaders of new, emerging projects to consider fiscal sponsorship, or in other words, to consider having their project be incubated inside a well established organization that already has 501(c)(3) tax-exempt status. However, it's important for project leaders to understand the terms of the arrangement and to choose a fiscal sponsor wisely. I generally recommend seeking out a well-established fiscal sponsor with a good reputation for acting as a fiscal sponsor. Ask other fiscally sponsored projects of that organization about their experience first before parking your project at that organization. While the fiscal sponsor will take a fee, typically a percentage of all funds the project raises, it's usually worth it. Finding a reliable fiscal sponsor can be a great way for a fledgling organization to allow its leaders to focus their time and energy on fundraising and programs rather than on accounting, legal compliance, and paperwork.
I especially urge volunteer-run organizations (those with no paid staff or only 1 or 2 paid staff) to seek out fiscal sponsorship instead of setting up and maintaining their own 501(c)(3). It's hard to rely on volunteers to do tax and corporation paperwork, so I've known of many volunteer-driven organizations which have lost their 501(c)(3) status. It can be re-instated once lost in many cases; however, it generally entails lots of hassles, penalty fees, etc. so it's usually best to work under a fiscal sponsorship with a reputable fiscal sponsor.
Should I let my project join my existing nonprofit as a project?
From the perspective of already established 501(c)(3) nonprofits looking to incubate a project or otherwise enter a fiscal sponsorship with a project, there are many legal considerations. First, the project must be related to your organization’s tax-exempt purposes and generally consistent with activities that are permissible for 501(c)(3)s. This would require a legal analysis. Additional legal factors include whether your organization is prepared to assume the activities of another project, including its accounting, operations, and potential liabilities should something go wrong. Generally I'm not worried much about liability for most of my nonprofit clients. However, liability risks are of greater concern when the activities of the organization are more hazardous, subject to strict regulations, or where the project leaders are unable or unwilling to comply with applicable laws and to use good judgment.