Fiscal sponsorships.

Board members of fledgling nonprofit groups typically have one question on their minds: how can my organization qualify to receive grant funding and other tax-exempt donations?

First, your group must incorporate in your state. Second, your group must apply to receive recognition of 501(c)(3) tax exemption from the federal Internal Revenue Service (IRS).

This process can take a long time and cost a lot of money. The Form 1023 and its required attachments are long and complex; once you’ve submitted your complete application, some organizations have waited up to a year to hear back from the IRS. The IRS charges a $400 Form 1023 application fee for small organizations.

Are there any other options?

In a fiscal sponsorship relationship, a nonprofit group that does not have 501(c)(3) status (nonexempt group) finds a similarly-minded 501(c)(3) nonprofit organization that is willing to be a sponsor. The sponsoring organization charges an administrative fee in exchange for agreeing to accept donations on the nonexempt group’s behalf. In this way, the nonexempt group can apply for grants through their sponsor that would normally only be open to exempt organizations.

Sounds great, right? Here are a few issues to consider as you think about forming a fiscal sponsorship.

1. Does my group qualify, as a nonexempt organization, to enter into a fiscal sponsorship?

If you are the nonexempt group: by forming a fiscal sponsorship, you are essentially saying to the IRS: “if our currently-nonexempt group went through the 501(c)(3) application process, we would qualify for tax exemption, too.” You can’t form a legal fiscal sponsorship relationship between a sponsoring 501(c)(3) nonprofit and a for-profit business. If you do so, you’re endangering the tax exempt status of the sponsoring organization.

2. What terms should the fiscal sponsorship document include?

Both groups should come up with a written document, signed by representatives from both organizations, that lays out all of the terms of the fiscal sponsorship agreement. Please consult legal advice when you set up this relationship! Ideally, each side of the agreement (both the nonexempt and the sponsoring organization) would be represented by legal counsel.

3. Is this an improper conduit relationship?

The fiscal sponsorship is not allowed to be merely a “conduit” through which funds are automatically passed through to the nonexempt organization.

“In order to be deductible, the IRS requires that the … sponsor have complete discretion and control over the funds and holds [the sponsor] legally responsible to see that its payments to [the nonexempt organization] are made to further [the sponsor’s] tax exempt purposes.” Fiscal Sponsorship — Doing it Right!p4.

To illustrate this crucial point, I’ll use an example.

Let’s say a group of neighbors starts a garden project called the Sunny Valley Garden. The group incorporates as a nonprofit corporation in their state, and they start running educational gardening programs for their community. After a growing season, the group decides that they want to hire a staff member, but they don’t have the resources to do all the administrative tasks that come with hiring an employee. They also can’t afford to hire the staff person until they get a grant to cover the costs of paying the employee. Luckily, there’s a foundation that offers a grant that will cover the employee costs; however, the grant is only available to 501(c)(3) tax exempt nonprofit groups.

Sunny Valley Garden contacts its local community association, Bright Futures Community Association, Inc. (BFCA) about a fiscal sponsorship relationship. BFCA is incorporated and has already received recognition of 501(c)(3) tax exemption. BFCA sees the great nonprofit educational work that the Garden is doing and agrees to be the Garden’s fiscal sponsor. As part of that agreement, BFCA agrees to let the Garden use some office space and agrees to take care of the payroll and other issues for the employee. BFCA would also receive any grant funds that the Garden applied for and then disburse those funds to the Garden. For all of these great benefits, BFCA will take a small percentage of any grant funds the Garden receives in order to cover BFCA’s administrative costs.

Any issues? No, provided that BFCA retains complete control over where the Garden’s money is being spent. Remember, BFCA is responsible to the IRS, as the fiscal sponsor, for any choices that the Garden makes.

Would you like assistance in drafting a fiscal sponsorship agreement? If your organization is in Maryland, Community Law Center can help! 

Posted on by Becky Witt

One Response to Fiscal sponsorships.

  1. Cherie June says:

    Do projects sponsored by fiscal sponsors have to pay tax on the project’s income (distributed grants and donations through the fiscal sponsor)? The project functions in Africa by a US citizen, the sponsor org, in the US.

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