As a new charitable project that is just starting out, the process of obtaining funding and applying for tax-exempt status may seem daunting, even prohibitive. A great option for these small organizations is to work with a fiscal sponsor. The term “fiscal sponsorship” refers to an arrangement by which an established public charity (referred to as the “Fiscal Sponsor”) facilitates fundraising for a charitable project (the “Sponsored Project”) by, among other things, allowing the Sponsored Project to solicit tax-deductible contributions from individuals or grants from private foundations that the Sponsored Project is not itself eligible to receive directly. Typically, the Fiscal Sponsor is legally responsible for the use of the donated funds which are restricted for the Sponsored Project’s charitable purposes. Typically, the Fiscal Sponsor handles all of the back office functions for the Sponsored Project. In this way, the Sponsored Project can focus on its work while the Fiscal Sponsor deals with the administrative details. However, recent events have become a cautionary tale to charitable projects or new nonprofits wishing to partner with a Fiscal Sponsor.
International Humanities Center
In early 2012, International Humanities Center (the Center), a Fiscal Sponsor to more than 200 charitable projects, abruptly closed its doors. The mismanagement of donated funds by the Center resulted in the loss of an estimated $1 million in funds donated to benefit over 200 Sponsored Projects. Many factors contributed to the Center’s insolvency, but perhaps some of the most telling signs of financial problems went largely unnoticed by the Sponsored Projects until it was too late.
As a California nonprofit corporation the Center was required to have an audit for any fiscal year when its revenues exceeded $2 million. This threshold was reached in 2006, but an audit was not performed until 2008. At the end of 2007, the Center reported unrestricted assets of $46,412. However, during the Center’s first audit in 2008, the auditors adjusted this number to -$300,073. At the end of 2008, the Center’s deficit in unrestricted assets increased to -$613,971. Financial audits revealed that what appeared to be a financially healthy organization at the end of 2007 was, in reality, an organization with growing financial challenges.
Additionally troubling for the Center was the investment of the Center’s cash in a fraudulent investment scheme. The employee involved in the scheme was dismissed in 2009 and reportedly fled the country. Despite the alleged theft of hundreds of thousands of dollars by a key employee, the Center failed to report the incident to the authorities or take any legal action. Instead, the Center and the employee agreed to sever their relationship so that neither party was ever prosecuted for the theft.
Choosing an Appropriate Fiscal Sponsor
The Center’s actions and the consequences for all of the small projects using the Center as a fiscal Sponsor is a cautionary tale for charities considering entering into a fiscal sponsorship arrangement. While this situation is thankfully rare, it does highlight the dangers of entrusting donated funds to another organization. The National Network of Fiscal Sponsors (NNFS), an organization formed through the cooperation of some larger, well known and reputable fiscal sponsorship organizations, has published guidelines for Fiscal Sponsors. While its guidelines are geared toward Fiscal Sponsors and not the projects they sponsor, they do include some advice for organizations wishing to partner with a Fiscal Sponsor. The basic tenets of fiscal sponsorship, as related by the NNFS guidelines, are as follows:
- The Fiscal Sponsor expresses a clear mission intended to advance the public interest, and all programs and related activities support that mission.
- The Fiscal Sponsor fulfills all legal, tax and regulatory requirements of philanthropic and charitable nonprofit organizations and complies with the letter and the spirit of all laws.
- The Fiscal Sponsor manages all funds, assets and other resources under its control with a high degree of responsibility, integrity, transparency and accountability. (This provision requires Fiscal Sponsors to obtain an annual audit; something that may have alerted the Center’s sponsored charities to its financial distress.)
- The Fiscal Sponsor manages all administrative duties and responsibilities professionally and with a high degree of integrity and accountability.
The steps listed above are general guidelines that a responsible Fiscal Sponsor should follow to ensure that it is operating in the best interests of its Sponsored Projects. The following steps are ones that charitable projects looking for a Fiscal Sponsor can take to conduct due diligence on potential Fiscal Sponsors:
- Review the organization’s last three Form 990s (these are available for free at guidestar.org)
- Review the identity of the directors and officers “ is the board led by a diverse group of community leaders or by a small group of lesser known individuals
- Check with the state to see if the organization is in good standing (in Arizona, this is done through the Arizona Corporation Commission website)
- Check with any state in which the Sponsored Project would like to solicit to see if the Fiscal Sponsor is registered to solicit funds (in Arizona, this is done through the Arizona Secretary of State website)
- Ask for a copy of the most recent audited financial statements (check the notes for disclosures of adjustments, any weaknesses or irregularities)
- Ask how long the organization has been sponsoring charitable projects, what policies and procedures it has in place to ensure the integrity of funds it receives for Sponsored Projects, and how many projects it is currently sponsoring
- Review the fiscal sponsorship agreement carefully to ensure the funds are restricted for the purpose of the project and that there is a clear process to terminate the agreement and transfer the donated funds to another qualified charity
- Perform a basic Google search for the company “ look for any negative reviews and/or comments
- Ask for references
- Ask colleagues about the organization and its reputation
Ellis Carter is a nonprofit lawyer licensed to practice in Washington and Arizona. Ellis advises tax-exempt clients on federal tax matters nationwide.