Fiscal sponsorship is the term used to describe a set of relationships between (1) an individual or group desiring to run a project that advances a tax-exempt purpose; and (2) a tax-exempt organization that is willing to serve as the project’s fiscal sponsor by conferring upon the project the benefit of its tax-exempt status. It’s important to note that fiscal sponsorship is not defined under state or federal law and there are several possible models that may be used to accomplish the parties’ goals. But it’s more common than not to see fiscal sponsorship agreements drafted in a way that fails to accomplish the parties’ goals, is inconsistent with applicable laws, creates exposure to liability for one or both parties, and jeopardizes the donors’ ability to take a charitable deduction.
Greg Colvin’s book “Fiscal Sponsorship – Six Ways To Do It Right” (available here) is an indispensable resource for an individual or group considering fiscal sponsorship as an alternative to forming a nonprofit and existing organizations that either serve or are considering serving as a fiscal sponsor. The most common way to do it right is referred to by Colvin as a Model A (or comprehensive) fiscal sponsorship, where the sponsor takes the project in-house, and the project has no separate legal existence. Another popular form of sponsorship is referred to as a Model C (or pre-approved grant relationship) fiscal sponsorship, where the sponsor and the project have a grantor-grantee relationship that enables the project to obtain proceeds of a grant and donations through the sponsor (i.e., the sponsor essentially regrants the initial gifts to the project).
Because it’s sometimes easier to learn from others’ mistakes, here’s our list of six ways to do fiscal sponsorship wrong:
1. Sponsor organization fiscally sponsors a project without adequate due diligence/review of the project; its mission; its founders and steering committee; and their past, present and planned activities. The Model A sponsorship is akin to a merger and acquisition. The sponsor must treat such a transaction with appropriate care and ensure that the sponsorship furthers the sponsor’s own charitable purposes.
2. Project gets fiscally sponsored by a sponsor without adequate due diligence/review of the sponsor; its mission; its reputation; its previous experience with fiscal sponsorship; its sponsorship policies; and its charges to the project’s fund.
3. The fiscal sponsorship arrangement is created without a written agreement. All sorts of room for misunderstandings, harsh feelings, and disputes. The sponsor is likely to have ultimate control and discretion over all terms where there was no mutual assent if a Model A structure was contemplated.
4. The fiscal sponsorship agreement does not include clear exit provisions. Can the project spin off? Can it be moved to another fiscal sponsor, and if it can, what are the qualifications of the successor sponsor? What assets (including intellectual property assets) follow the project and what assets stay with the sponsor?
5. The sponsor does not provide sufficient oversight over the project. In a Model A structure, the sponsor may be entirely liable for any and all debts and obligations incurred by the project.
6. A Model C-like fiscal sponsorship is structured in a manner that has the sponsor serving as a conduit for donations to go to the project. As Colvin states in this article: “If there is a “trap for the unwary” among fiscal sponsorship arrangements, Model C is it. If the control mechanisms are not administered properly, Model C can collapse into a “conduit” or “step transaction” in which the IRS will disregard the role of the sponsor and declare that the funding source has, in effect, made a payment directly to a non-501(c)(3) project. For funding sources, the result will be that the donor cannot take a charitable deduction, or the the private foundation must now observe the strictures of “expenditure responsibility.” The project will find that funding has disappeared. The sponsor may lose its tax exemption for failure to exercise sufficient control over its grants, allowing those funds to be used in a noncharitable manner.”