Fiscal Sponsorships: Flexible Philanthropic Tools or Problematic Compliance Risks?

Fiscal sponsorships are a nearly ubiquitous concept in the philanthropic community.  When done correctly, they foster collaboration, innovation, and efficiency.  They permit the incubation of new charitable concepts, support nascent charities, and remove often-prohibitive barriers to start-up and grassroots programming.  When done incorrectly, they risk the desired tax results for donors, trigger costly penalty taxes for foundation funders, and could even jeopardize the 501(c)(3) status of the fiscal sponsor.  Getting a fiscal sponsorship right, from the very beginning and all the way through to its conclusion, should be a top priority for all involved.

In its most basic form, a fiscal sponsorship is an arrangement pursuant to which an established 501(c)(3) organization (usually a public charity) “sponsors” a charitable project or organization that does not have its own 501(c)(3) status.  The sponsor’s board approves the sponsorship because (a) the sponsored project furthers 501(c)(3) purposes, and (b) the sponsored project furthers the sponsor’s specific 501(c)(3) purposes.  Both generally must be true in order for the organization to step into the sponsor role.  The sponsor then can raise money from donors and funders to support the sponsored project.  Funds go into a restricted fund at the sponsor, which the sponsor draws from for direct project expenses, to make grants to the sponsored organization, or some combination of the two.  

With appropriate structures in place, funds coming into the 501(c)(3) sponsor are treated as donations and grants to the 501(c)(3) sponsor and are reported as such by the sponsor on its annual Form 990 (and, if relevant, as part of its public support calculation). The 501(c)(3) sponsor issues a contribution acknowledgment letter to the donor and is responsible for any reporting to foundation funders, individual donors can claim an income tax deduction for their donations to the sponsor, and foundation funders treat the grants to the 501(c)(3) sponsor as qualifying distributions.  The sponsor then separately can enter into a grant agreement with the sponsored project or perhaps even conduct the project itself.  The fiscal sponsorship works as intended, and the philanthropic goals of all involved are fulfilled.  

Appropriate form and substance are needed to achieve this desired outcome.  Terms and phrases like “pass-through”, “fiscal agent”, “using the sponsor’s 501(c)(3) status”, “earmarked”, and others are red flags indicating that the sponsor’s role may not be structured correctly or understood properly.  Using those words in program descriptions or donor communications or agreements may not necessarily doom the success of the fiscal sponsorship, but they are lightning rods for regulators and auditors and certainly signify that the sponsorship warrants further review.  

Good practices and procedures are critical.  This generally requires a comprehensive written agreement reflecting the key points of the arrangement and highlighting the sponsor’s primary role.  It also means appropriate oversight by the 501(c)(3) sponsor, including initial review and approval of the sponsorship by the sponsor’s board or, in some cases, a committee or staff, and regular reviews of the use of funds for their intended purposes.  The sponsor’s tax reporting should be consistent with its role in the sponsorship: donations and grants for the sponsored project should be reported on the sponsor’s Form 990 and factored into its public support test (if applicable), the sponsor’s Form 990 should reflect any grants to or expenses for the sponsored project, and the sponsor should provide requisite contribution acknowledgments to donors.  

Significant risks abound if those structures are not in place.  The donors will be treated as having made earmarked grants to non-501(c)(3) organizations, thus eliminating any charitable deduction that may have been sought.  Foundation funders similarly will be treated as having made earmarked grants to non-501(c)(3) organizations without appropriate controls in place, thus triggering costly penalty taxes and the possible failure to meet the minimum distribution requirement.  The 501(c)(3) sponsor will have difficult questions regarding the use of its bank accounts and infrastructure to facilitate potentially non-charitable activities.  All involved will face reputational risk vis-à-vis their donor base, the broader public, and regulators.  Even more, other risks can accrue to the inattentive sponsor if the sponsored project has staff, facilities and vendor agreements, and public programming.

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Fiscal sponsorships offer incredible opportunities to further philanthropic goals but must be structured and implemented appropriately.  The C3 Legal team would be pleased to assist your organization as it considers how to best incorporate fiscal sponsorship into your operations.