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As the time and hassle of obtaining exempt status recognition under section 501(c)(3) increase, charitable-minded individuals and groups are turning more and more to so-called fiscal sponsorship arrangements with existing nonprofit 501(c)(3) organizations.

You may be familiar already with the typical scenario—a donor or a community group brings a great idea to your 501(c)(3) organization and tells you that donors have an interest in supporting the project financially. At first glance, the project seems like one your organization would support, but legal questions abound: Can your organization receive tax-deductible contributions and then grant those funds to a project that does not have separate 501(c)(3) status? What are the risks involved with making grants to such a project? What happens if the project fails? What is your organization's potential liability for the actions of the project?

Fiscal sponsorship, a relationship whereby a 501(c)(3) organization extends its tax-exempt status to a project or new organization that is not tax-exempt under section 501(c)(3) but nevertheless seeks to advance charitable purposes, may provide the answers to these questions. When done correctly, fiscal sponsorship is a valuable tool for new projects or organizations to attract tax-deductible donations from the public and receive grants without going through the time and expense of obtaining separate 501(c)(3) status and for established organizations to incubate such projects—or to receive donations and grants temporarily while waiting to receive their separate 501(c)(3) status.

Forms of Fiscal Sponsorship

As fiscal sponsorship is not defined by law, the relationship between a sponsor 501(c)(3) organization (fiscal sponsor) and the fiscal sponsored project or organization (sponsee) may take many different forms. Likely the most common approach involves the sponsee becoming an internal program, operation, or fund of the fiscal sponsor. Other approaches occasionally utilized involve the fiscal sponsor entering into an independent contractor arrangement with the sponsee or the fiscal sponsor organization developing a pre-arranged grant relationship with the sponsee. For example, the pre-arranged grant relationship may be appropriate when the fiscal sponsorship arrangement will exist for only a short period of time, such as when the sponsee has submitted or intends to submit its own application for tax exemption but has not yet received a determination from the IRS that it is exempt from tax under section 501(c)(3).

Among the key considerations with any fiscal sponsorship relationship is that the fiscal sponsor must maintain discretion and control over the use of grant funds it receives, though the sponsee may name advisors to give input to the fiscal sponsor on how applicable funds should be spent. Agreements with individuals and entities that are seeking the fiscal sponsorship relationship should make that clear.

Internal Program of Sponsor Charity

The most common model is one that offers the most control for the fiscal sponsor, as the sponsee becomes a program of the fiscal sponsor and the project staff become employees or volunteers of the fiscal sponsor. This approach allows the sponsee to obtain the benefit of the fiscal sponsor's back-office and administrative capabilities, which permits the project staff to spend more time pursuing program activities. Funds raised in support of the project legally belong to the fiscal sponsor, which will have final discretion and control over the use of such funds. Most sponsor organizations will charge a sponsorship fee (often around 8-10% of funds raised) for administering the fiscal sponsored project (e.g., check-writing, payroll and benefits, assisting with grant reporting, etc.). While such fees are not insignificant, they are often much lower than the administrative and start-up fees typically incurred when forming and qualifying a new 501(c)(3) organization. Furthermore, by operating as an internal program under the umbrella of the fiscal sponsor's 501(c)(3) status, the sponsee may be eligible for grants and donations that it would not otherwise receive.

If the fiscal sponsor is concerned about liability associated with the sponsee's operation of the project, the fiscal sponsor and sponsee could arrange for the sponsee to be formed as a limited liability company (LLC), with the fiscal sponsor as the sole member. For federal tax purposes, the sponsee will be treated as a division or program of the fiscal sponsor and will not have to file a separate tax return.1 At the same time, because the sponsee is a separate legal entity under state law, the fiscal sponsor will generally be shielded from liability for the sponsee's activities. Forming an LLC involves drafting and filing articles of organization and drafting an operating agreement. In addition, the LLC may be subject to state or local filing and licensing requirements.

Fiscal Sponsor's Oversight Obligations for Sponsee

In order for the fiscal sponsor to ensure that funds it receives in support of the fiscal sponsored project are used in furtherance of the fiscal sponsor's own charitable purposes, the fiscal sponsor should:
  1. Conduct a due diligence review of the potential sponsee prior to entering into the fiscal sponsorship relationship;
  2. Have a written agreement setting forth the terms of the fiscal sponsorship; and
  3. Require reports from the sponsee on the use of funds.

Importantly, the written agreement should establish the fiscal sponsor's ultimate control and discretion over the amounts in the restricted fund and the fiscal sponsor's ability to utilize the funds for other charitable purposes on termination of the project. If these control mechanisms are not implemented, the IRS may disregard the fiscal sponsor's role and determine that the initial funding source has made a grant directly to the fiscal sponsor, a non-501(c)(3) organization. In that event, individual donors would not be able to take a charitable deduction, and private foundations would have to comply with the strict procedures of "expenditure responsibility."

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Fiscal sponsorships can be a very economical way for new or smaller charitable projects to attract funding and manage their administrative costs and operations. With a well-crafted agreement, under which both parties are comfortable with the intended purposes for the funds and the required allocation of control, a fiscal sponsorship may be the right short-term or long-term solution for a charitable start-up.



[1] See Treas. Reg. § 301.7701-3(b)(1)(ii).