In Part 1, we covered how to set up your non-profit organization as a legal entity, and in Part 2, we looked at applying for tax-exempt status with IRS Form 1023-EZ. But chances are that if your organization qualifies for the EZ application for tax-exempt status, then you might want to consider fiscal sponsorship.
Just what is fiscal sponsorship, and how can it help your new non-profit organization or project?
What is fiscal sponsorship?
Fiscal sponsorship is the use of another non-profit organization’s tax-exempt status and often administrative resources to “sponsor” your project or new non-profit organization. As a sponsored project, you will still be pursuing your mission (and will typically maintain quite a bit of programmatic autonomy), and you should still have a board of directors or advisory board making strategic decisions. But the sponsoring organization will receive funds on your behalf and disburse those funds as needed for project expenses, all while maintaining appropriate books and records.
Fiscal sponsorship allows you to start seeking donors and apply for grants that might not otherwise consider you without your own tax-exempt determination. It’s also a great way to “test the waters” and determine to what extent donors are willing to support your project or whether grants exist that you not only qualify for but can actually be awarded.
In addition to financial oversight, some fiscal sponsors also provide additional back office services such as access to their human resources professionals, office or meeting space, and consulting/coaching.
Fiscal sponsorship can be a great option for smaller non-profit organizations and even charitable projects that, for one reason or another, don’t want to take on the financial expense and administrative burden of forming their own organization and applying for tax-exempt status. For example, I still meet too many entrepreneurs who want to start a non-profit and believe that they will “own” the organization and its assets. The truth is, no one “owns” a non-profit organization. These entities exist for charitable or other tax-exempt purposes and do not “belong” to anyone, even their founders. If the founder moves on or the organization ceases to operate, the assets of the non-profit must remain with a tax-exempt non-profit.
On the other hand, I meet entrepreneurs who are so focused on the mission that they overlook administrative issues like board meetings and minutes, annual charitable registrations, regular Secretary of State filings, bookkeeping, charitable donation letters, and annual information returns to the IRS. If you aren’t ready to take on these compliance matters, then having a fiscal sponsor who can take on this administrative burden frees up your time to focus on the mission.
Neither of these types of entrepreneurs is “bad.” But if administration isn’t your strong suit, a fiscal sponsorship arrangement can fill in the gap.
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What's in it for the sponsor?
Fiscal sponsors usually charge an administrative fee for their services, usually as a percentage of the funds raised by the project. I commonly see 5-10% as the fiscal sponsor’s fee, but I have seen reports of sponsors charging as much as 15%, particularly if complicated government grants are involved. Obviously, if your organization or project grows enough in terms of annual revenue, then it will eventually make sense to become a completely independent tax-exempt organization, and a good fiscal sponsorship agreement will address the process for doing so. But if you qualify to apply for your tax-exempt status with IRS Form 1023-EZ, then there’s a pretty good chance that fiscal sponsorship is a more economical way to handle the administrative tasks that come with running a non-profit.
Fiscal Sponsorship Doesn’t Always Replace Forming a Legal Entity
Some entrepreneurs who seek out a fiscal sponsor choose not to create a separate legal entity for their project. But depending on the terms of your fiscal sponsorship arrangement, you might still want to form a legal entity just for the limited liability protection. You should always consider whether your activities could potentially expose you to any legal liabilities and whether the terms of the sponsorship agreement address those potential liabilities.
There has to be a good working relationship between a fiscal sponsor and a sponsored-project. The sponsor is still responsible for the activities that occur under the guise of its tax-exempt status. So any projects the sponsoring organization takes on should fit with the mission and tax-exempt purposes of the sponsoring organization. Similarly, the sponsored project should feel comfortable working with the sponsor, both in terms of day-to-day administration but also in terms of mission alignment.
Like any business partnership, there is absolutely no excuse for not having a compressive written agreement addressing who is responsible for what. When will funds be disbursed? How will expenses be approved? How often will financial reports be provided to the project?
As the sponsoring organization, what activities will the project engage in? Is the project carrying liability insurance for those activities? How will your organization be protected if a claim arises out of the project’s activities? Will the project create intellectual property (i.e., artwork or content)? Who owns the IP?
If the relationship doesn’t work out, or the project simply outgrows the need for sponsorship, how will the parties separate? How will funds be transferred to a different tax-exempt organization (whether that’s the project itself or a new sponsor for the project)?
Considering fiscal sponsorship, whether as the sponsoring organization or as a project?