Our clients at PKHB CPA sometime inquire about fiscal sponsorship as it relates to new and aspiring charitable organizations. Some of our clients are asked to act as fiscal sponsors for these new projects while these aspiring entities engage in what can be a lengthy process of seeking 501(c)(3) status through the Internal Revenue Service. Some clients are the ones establishing these new nonprofit endeavors. Others are the potential donors who are asked to support these fledgling entities through contributions.
There’s no denying that new philanthropic efforts can fill unmet needs and provide crucial resources in our communities. But it is also essential that the parties involved in these groundbreaking projects understand the different sponsorship arrangements available—and the obligations, responsibilities, and risks attached to each of them.
To better understand how the pieces of this puzzle fit together, let’s begin with the party interested in starting this new not-for-profit organization. This “aspiring nonprofit” is seeking and is in the process of obtaining 501(c)(3) nonprofit status. The entity plans to solicit donations while completing its application or waiting to see if the IRS approves the tax-exempt 501(c)(3) status. Until the aspiring nonprofit files its application with the IRS, the newly formed entity is considered a for-profit endeavor. Until the IRS awards the new entity 501(c)(3) status, contributions received could be ultimately denied tax deductibility, increasing the risk to donors. As such, in order to move forward with its mission, this new organization may wish to find an existing charity to accept and disburse donations on its behalf.
A Fiscal Solution for New Nonprofits
There are two sponsorship options available while the new entity awaits the IRS’ all-important decision: The new entity and the existing nonprofit can engage in either a (a) “Fiscal Sponsorship” or (b) “Fiscal Agency” relationship. The distinctions involve different levels of risk and responsibilities, the bulk of which rest with the existing qualified charity. Fiscal Sponsorships allow new organizations to take advantage of an existing charity’s tax-exempt status. In exchange, the fiscal sponsor must ensure that the new organization uses its funds properly, and in a manner that supports its mission. Fiscal Agents merely collect donations on the new entity’s behalf and pass-through the funds to the aspiring entity. The organizations engaging in these relationships must determine the model that best fits their objectives and intentions.
Fiscal Sponsorship or Fiscal Agency?
Fiscal Sponsorship allows an existing charity with 501(c)(3) tax-exempt status to accept funds that are tax deductible on behalf of the new organization. This arrangement should be understood in a written agreement. To qualify for a Fiscal Sponsorship, the IRS requires that the pass through of the funds to the new entity from the sponsor meets the sponsor’s mission. This arrangement is more than simply an act of kindness by the existing nonprofit. It is a legal agreement between the two parties that comes with responsibilities and consequences. A Fiscal Sponsor retains discretion and control over how the awaiting organization’s funds are used, and is responsible for how the new organization spends its money and conducts its activities.
While the IRS reviews the awaiting organization’s application for not-for-profit status, the awaiting organization operates as a non-profit contractor for its Fiscal Sponsor. Money received is recorded as contribution revenue and expenses are recorded for the underlying cost of the project. The fiscal sponsor records individual contributions received that are restricted for the purpose of the project being carried out by the new entity. Payments by the fiscal sponsor to the new entity are recorded as contractual fees for services.
If the newly formed entity has not filed its non-profit application, the awaiting organization records payments from the Fiscal Sponsor as taxable income. The use of these funds to carry out the project objectives would be expenses of the new entity and to the extent allowable/deductible would reduce taxable income. The IRS does allow for the newly formed organization to seek refunds of any tax paid once it timely achieves its nonprofit status.
Contributions received through the fiscal sponsor for this new organization’s project or mission can be tax-deductible. The responsibility of making sure the funds are spent in accordance with the donor’s intentions lies with the fiscal sponsor. With fiscal sponsorships, the individuals donating the money can expect their donations to be tax deductible.
Fiscal Agency is an agreement between the two entities that does not require the existing charity to oversee the use of the funds by the awaiting organization. Under this agreement, a Fiscal Agent does not assume risk on behalf of the new organization for the use of the funds other than what is called for in the agreement. The fiscal agent exits to provide a service to the new organization in the form of bookkeeping and other administrative functions and typically receives a fee for this service. The Fiscal Agent holds and disburses the funds, and the Fiscal Agent simply carries out and executes the awaiting organization’s financial transactions as directed by the new entity. Throughout the term of this agreement, the fiscal agent records donations collected and payments made as assets and liabilities rather than revenues and expenses. The new awaiting entity records the donations received prior to filing its nonprofit application as taxable income and, once the application has been filed and is pending, non-taxable income. In this case, the donations made by the donor once the application is pending can be treated as a taxable donation. However, if such application is ultimately denied, the donor will need to re-evaluate that donation because it will no longer be tax deductible.
Because Fiscal Agents do not provide the oversight that is required in Fiscal Sponsorship, contributions made to the awaiting organizations through a Fiscal Agency agreement may not be tax-deductible. This is an important distinction for donors: If you want to make a contribution that is tax deductible, keep in mind that you may not be able to do so when a Fiscal Agency agreement is in place if the new organization has not filed its application, or such application is ultimately denied. That’s because the donations are not supporting an IRS-approved nonprofit. Some people—and even organizations—are willing to support these new philanthropic endeavors without the benefits of tax credits; others are not.
Create a Proper Fiscal Sponsorship
Fiscal Sponsorship and Fiscal Agent agreements are increasingly popular tools for creating and maintaining new community resources. Whether you want to launch a nonprofit startup or sponsor one of these aspiring organizations, it’s important to have a contract in place that spells out the rules, responsibilities, and risks for all of the involved parties. Donors, too, should understand the tax implications and legal liabilities associated with each of these agreements. Both your accountant and legal counsel can help you make the right decisions as you move ahead with these new initiatives. The goal is to advance the well-being of your community without compromising the financial health, integrity, and well-being of your not-for-profit, business, or personal estate.