Fiscal sponsorship can be an effective and efficient alternative to starting and operating a new nonprofit organization. But there are great variations in how fiscal sponsorship relationships are established and memorialized in a written agreement. One of the first areas of confusion is who enters into the agreement with the fiscal sponsor. These are the common possibilities:
- Nonprofit organization without tax-exempt status
- Unincorporated association without tax-exempt status
- For-profit entity
- Nonprofit organization with tax-exempt status
Nonprofit corporation without tax-exempt status
Fiscal sponsors are often used as incubators allowing for leaders of a newly formed nonprofit corporation to start fundraising and operating programs prior to the corporation’s receipt of recognition of 501(c)(3) status (which can sometimes take 10 months or longer). In such case, either a Model A (comprehensive) or Model C (pre-approved grant relationship) fiscal sponsorship relationship may work. But it’s very important to understand the difference and properly construct the relationship to avoid legal troubles.
Trap: Allowing a Model A fiscally sponsored project to fundraise using the same exact name as the nonprofit corporation, particularly if the nonprofit corporation is also engaged in some fundraising separate from the fiscal sponsor. A state regulator (e.g., Attorney General) may find this to be misleading to donors and the general public and, at worst case, potential fraud.
Unincorporated association without tax-exempt status
Fiscal sponsors may also serve as an incubator for an unincorporated association without 501(c)(3) status. When a group of individuals are leading the formation and operation of the charitable project, they may enter into the fiscal sponsorship agreement as a committee. For the committee to have the legal power to enter into a contract, it needs to be an unincorporated association or legal entity. Because the committee may not want to comply with various filing and registration requirements, and is typically not covered by its own insurance, it likely wants to keep its activities limited to entering, complying with, enforcing, and terminating the fiscal sponsorship agreement.
In California, members of an unincorporated nonprofit association (UNA) have limited liability protection so an UNA is generally preferable to an unincorporated association or a partnership (both of which do not offer limited liability protection, meaning that members or partners may be personally liable for any liabilities of the association or partnership).
Generally, the same issues described for the nonprofit corporation above apply.
Tip: An unincorporated association (or UNA) is composed of two or more members, and it may have bylaws or some other form of governing document that informs how the association takes action and who is authorized to act on behalf of the association. A fiscal sponsor will want a copy of such governing documents and to be informed of the membership of the association at the time it enters into an agreement with the association and also how those items change over the term of the agreement. Otherwise, the fiscal sponsor may not know whether the committee has validly taken an action with respect to compliance, enforcement, or termination of the agreement, and an internal dispute among the committee members (which happens) can create major problems for all parties.
Individuals leading charitable projects are often the other party to fiscal sponsorship agreements, particularly in the Model C context where the project’s principal asset may be artwork or a documentary film created by the individual.
Trap: A fiscal sponsor must not mislead an individual who is the other party to the Model C fiscal sponsorship grant agreement that they will have no tax consequences or obligations as a result of grants received from the fiscal sponsor. Whether this is the case will ultimately depend on a number of factors and is the individual’s responsibility. Fiscal sponsors should not give legal or tax advice to other parties unless they have the necessary professional license.
Fiscal sponsors may enter into a Model A fiscal sponsorship agreement with a for-profit organization, but the fiscally sponsored project must be operated for charitable purposes consistent with the fiscal sponsor’s mission and cannot provide a prohibited private benefit to the for-profit or anyone involved with the for-profit. In a Model C fiscal sponsorship relationship, the fiscal sponsor must ensure that the grants to the for-profit are used exclusively for charitable purposes. The danger of providing or appearing to provide a prohibited private benefit to the for-profit or those involved with the for-profit may be relatively high. Accordingly, fiscal sponsors may want to be very careful about these arrangements if the for-profit looks like it may have its own non-charitable interests as a significant rationale for entering into a fiscal sponsorship relationship with a charity.
Trap: A fiscal sponsorship designed to expand the market served by a for-profit by subsidizing the for-profit for lower costs charged to a segment of the market may not be viewed as charitable if the for-profit is the only entity that is eligible to receive the subsidies (e.g., grants). For example, if a tech company wants to provide technology solutions to persons with lower income but wants to receive the same payment for such goods and services, a fiscal sponsor probably should not allow the tech company to create a project that solicits donations and then makes grants only to the tech company (and none of its competitors) in order to allow the tech company to charge a lower price to the targeted market segment but to keep the same profit margin as with its sales to its current market.
Nonprofit organization with tax-exempt status
Fiscal sponsors rarely enter into fiscal sponsorship agreements with nonprofits that already have tax-exempt status, but such arrangements can be legally permissible and mutually beneficial.
The other party to the agreement may be a nonprofit with tax-exempt status under 501(c)(4) or 501(c)(6). They may want to raise money from foundations and individuals who might have less incentive to give to a non-501(c)(3) organization (perhaps because such contributions may not be eligible for a charitable contribution deduction) to fund a charitable initiative of the nonprofit, such as scholarships or educational programs.
The other party to the agreement may be a 501(c)(3) organization that has been programmatically dormant due to lack of administrative capacity but not dissolved. In such case, the fiscal sponsor may allow the programs of the 501(c)(3) organization to be revived as a Model A project operated by the fiscal sponsor, whose regular staff may provide the necessary administrative support to allow the leaders of the 501(c)(3) organization to focus on fundraising and programmatic work.
Tip: Make sure the name used by the Model A project is not the same as the name used by the nonprofit party to the fiscal sponsorship agreement. This may be misleading to donors and the public and cause a regulator to examine and even penalize the parties. Even a slight variation in the name may be sufficient to differentiate the project from the separate nonprofit (e.g., Save the Gryphons Project and Save the Gryphons Foundation).
Note: There are many nuances with fiscal sponsorship. Consequently, in order to keep this post short and helpful to our readers, there are nuances, exceptions, and details not discussed. Please confer with a knowledgeable attorney who is well-versed with fiscal sponsorship for specific legal advice.
Fiscal Sponsorship: A Balanced Overview (Nonprofit Quarterly)
Fiscal Sponsorship: What You Should Know and Why You Should Know It (ABA Business Law Today)