The Pros and Cons of Fiscal Sponsorship
If your nonprofit is still in its infancy, or you’re moving forward with a temporary project that would benefit from non-profit status, a fiscal sponsorship might be a good option. Here are some considerations to keep in mind so you can measure the benefits and risks in determining the best course of action for your organization.
What is Fiscal Sponsorship?
A fiscal sponsorship arises whenever an organization with 501(c)(3) status agrees to accept tax-deductible donations restricted for a project that does not have 501(c)(3) status. There are a number of different models, however, the most common model permits grants and donations to be made to the exempt fiscal sponsor restricted for the project’s purpose. The funds raised are overseen by the fiscal sponsor. This arrangement permits the sponsored project to raise funds, relying on the sponsor’s IRS determination letter, solicitation registrations, financial controls, expertise, etc.
Here are the IRS criteria for a fiscal sponsorship arrangement:
- Grants/donations are given to a 501(c)(3) tax-exempt organization (the sponsor) that acts as a guardian of the funds for a project that does not have 501(c)(3) status.
- The sponsor must use funds received for specific charitable projects that further the sponsor’s own tax-exempt purpose.
- The sponsor must retain discretion and legal control as to the use of the funds to ensure that the arrangement is not merely a pass-through of charitable dollars to a non-exempt entity or project.
- The sponsor must maintain records that substantiate the use of funds for appropriate 501(c)(3) purposes.
The Benefits and Risks of Fiscal Sponsorship.
For sponsoring organizations:
Liability. When you engage in fiscal sponsorship, you are accepting fiduciary responsibility for the funds that are collected on behalf of the sponsored project, in addition to ensuring that the activities of the sponsored project measure up to IRS requirements for nonprofit activities. One way to minimize your liability as a sponsoring organization is to carefully consider and screen potential sponsored projects and make sure that both parties’ obligations are clearly communicated and memorialized in writing.
Project Oversight. One way to minimize your risk as a sponsoring organization is to include additional services and administrative support as part of your sponsorship package. This is especially true if the sponsored project is an informal group or a nonprofit is in the start-up phase. However, while these services can minimize your risk by equipping them with the tools and oversight to guarantee everything goes smoothly, it usually comes at a cost to your own organization. You’ll want to make sure you have the appropriate staffing and systems in place to ensure you can handle the extra workload required to ensure the sponsorship runs smoothly. It is common for fiscal sponsors to charge a project fee between 5-10% of funds raised for the sponsored project to cover these administrative and oversight costs.
Reputation and Mission Creep. It’s important for sponsoring organizations to carefully consider the reputation and objectives of any project seeking sponsorship. When you accept responsibility as a sponsor, you are putting your reputation on the line. In addition, in longstanding sponsorship arrangements, either or both parties’ missions may shift over time. This can result in a misalignment between the two missions that renders a continued sponsorship arrangement incompatible. The best way to avoid both of these problems is to ensure regular and open communication between the sponsor and the leaders of the sponsored project.
For organizations seeking sponsorship:
Reduced Costs/Administrative Burden. The primary benefit of fiscal sponsorship for the sponsored project is the ability to solicit grants and donations without having to build a tax-exempt organization to support the project. Starting and administering a new nonprofit is expensive and time-consuming. Starting a fiscal sponsorship is relatively fast and typically has no up-front cost. Fiscal sponsorship is ideal for new projects that want to test out their model before investing in building an organization and infrastructure to support the project. Other projects may be temporary and wish to avoid the expense and delay inherent in starting a new organization just to wind it down when the project is over.
Loss of Control. When entering into a fiscal sponsorship, there are some tradeoffs. Sponsored projects should be aware that legally, the funds they raise are under the control of the sponsoring organization and the sponsoring organization has the right to achieve the project goals through other means if the project’s leaders aren’t getting the job done. Further, because the sponsor is accepting a high degree of liability, responsibility, and risk to its reputation, it will likely exercise a fair degree of control over the finances and activities of the sponsored project. Of course, having to succumb to oversight can also have its benefits. Sponsored projects have the opportunity to learn from the wisdom and experience of the fiscal sponsor.
Risk of Funds. It’s important to work with a fiscal sponsor that is financially strong. There have been cases where fiscal sponsors have filed for bankruptcy, taking their sponsored projects’ funding with them. There are also cases where fiscal sponsors have taken over successful projects as their own “ typically in cases where a charity is serving as a fiscal sponsor not as part of its core mission but as a one-off and fails to document the terms of the arrangement in writing.
Difficulty Finding a Sponsor. It can be difficult to find a fiscal sponsor that is a good fit for a given project. Fortunately, there are now many organizations and resources dedicated to helping new nonprofits get on their feet. You’ll need to make sure the organization is engaged in work similar to yours. In Arizona, TAP-AZ, an affiliate of Vitalyst Health Foundation, acts as a fiscal sponsor to projects that promote health, healthy communities, and volunteerism and otherwise meet its criteria. The Tides Center and Fiscal Sponsor Directory are national resources that can be a good place to start your search.
Ellis Carter is a nonprofit lawyer licensed to practice in Washington and Arizona. Ellis advises tax-exempt clients on federal tax matters nationwide.