Many new nonprofits are excited to start offering their services to the community, but have not yet received 501(c)(3) designation from the IRS. The only issue you face while you wait for this designation is that you cannot fundraise without it. Tax-exemption is only qualified if moneys were contributed to an IRS designated 501(c)3 entity. This also disqualifies you from grants until approved. This is where fiscal sponsorship comes in.
What is a Fiscal Sponsor?
Any organization that has obtained 501(c)3 status can serve as a fiscal sponsor for an organization that has not yet received 501(c)3 status from the IRS. The fiscal sponsor serves as the recipient of donated funds and grant funding on behalf of the not yet 501(c)3 designated organization. They process the contributions and disburse the funds to your organization, which is now recognized as a “project” or “program” under your fiscal sponsor. Some fiscal sponsors will also take an administrative fee for providing this service.
Who do you choose for a sponsor?
Your selection depends upon the alignment that organization has with what your organization does. In order to be recognized as a project or program under the fiscal sponsor, the focus of your organization must align with their mission focus. Terms must be agreeable to all parties and a written agreement must take place to formalize the sponsorship.
The Foundation Center offers great suggestions to assist you in finding the right fiscal sponsor for your organization. The Fiscal Sponsorship Directory lists organizations that are ready and willing to serve as a sponsor. For more information on how a sponsorship works, visit the Society for Nonprofits’ resource center.
What Not To Do
You can prevent a lot of mistakes by learning more about fiscal sponsorship. One great resource is Greg Colvin’s book “Fiscal Sponsorship – Six Ways To Do It Right.“
Below are six ways you can do fiscal sponsorship wrong:
- Lack of due diligence or review of the project by the sponsoring agent. This includes review of the sponsored organization’s mission, founders, steering committee, past, present, and future activities. It is important that the sponsorship also furthers the sponsor’s charitable purposes as well.
- Lack of due diligence by the sponsored organization in choosing a sponsor without review of the sponsor: mission, reputation, previous fiscal sponsorship behavior, sponsorship policies, and fees.
- No written agreement. This is just asking for trouble. Don’t do it. All parties are open for misunderstanding, misconduct, misappropriation, legal actions, control issues, and much more.
- No clear exit provisions. The rules on whether the fiscally sponsored organization can move to another fiscal sponsor, which assets belong to which entity, and whether the sponsored organization can create additional spin-off organizations. These all need to be addressed so that departure from the contract is clear and concise.
- Lack of oversight by the sponsoring agency. This opens the sponsor up for significant liability issues. This includes debts and obligations brought by the sponsored organization.
- If the issues mentioned above are not adequately addressed, the IRS can disregard the sponsorship and declare the donations as payments to the sponsored organization, thus removing the charitable contribution factor donors and grant funders require. The sponsor can also lose their tax-exempt status for failure to demonstrate control over grant funding now deemed to be used in a non-charitable manner.