By Andras Kosaras, Associate, Arnold and Porter LLP
Private foundations frequently receive grant applications from groups that are under the fiscal sponsorship of a section 501(c)(3) public charity. But sometimes the request is for the private foundation itself to serve as a group’s fiscal sponsor. Is a private foundation legally permitted to serve as a fiscal sponsor? Why would a private foundation serve as a fiscal sponsor and what issues should the foundation’s Board consider before approving such a role?
Although fiscal sponsorship is common in the nonprofit sector, it is not a concept that is specifically defined in the tax rules and regulations. The most common reason for entering into a fiscal sponsorship is tax related. Section 501(c)(3) public charities are typically asked to serve as fiscal sponsors to facilitate charitable contributions to a project or group that does not have its own tax-exempt status. As long as the fiscal sponsor is exercising sufficient oversight and control over the project and its funding — and is not acting as a mere conduit for earmarked contributions to the project — the contributions should be tax deductible to the donors. Appropriate control is the key element of a fiscal sponsorship arrangement.
Benefits of Fiscal Sponsorship
Providing tax benefits to donors is not the only advantage of fiscal sponsorships. Other benefits may include the following:
- Fundraising/credibility. Many donors prefer to give charitable contributions to organizations that have their section 501(c)(3) tax-exempt status, whether or not the donor receives any tax deductions from doing so. Thus, a group or project without exempt status is unlikely to be able to fundraise.
- Temporary projects. A project or group may be established for only a temporary period to undertake an activity within a specific timeframe. It would be too costly and take too long for the group or project to obtain its own tax-exempt status.
- Tipping. A fiscal sponsorship arrangement may exist between two organizations that both have their tax-exempt status. A smaller public charity (the “grantee”) may ask a, larger public charity to serve as a fiscal sponsor because the grantee is undertaking a project for which it is anticipating receiving significant amounts of support from a few key donors (individual donors and private foundations). As a result, the grantee may be concerned that the contributions from such donors would affect its public support test calculation, and, in turn, cause the grantee to lose its public charity status and “tip” it into a private foundation. Because the fiscal sponsor is deemed to be the donor when calculating the public support test and grants from public charities are treated favorably when calculating the public support test (unlike grants from individual and corporate donors and private foundations), using a public charity fiscal sponsor would eliminate the concern over “tipping.” (The grantee may try to exclude the contributions from its public support test calculation by classifying the grants as “unusual grants,” but it may not be able to do so based on the specific facts and circumstances.)
- Capacity building. The group may not have the administrative and fiscal expertise to implement the project. In this case, the fiscal sponsor would rely on its administrative capacity to exercise proper oversight of the project. If the project or group eventually obtains its own tax-exempt status, there is the added benefit of administrative capacity building for the group from its earliest founding.
Private Foundations as Fiscal Sponsors
When a private foundation acts as a fiscal sponsor, the foundation, like a public charity fiscal sponsor, may also provide important capacity building functions and credibility for the group.
However, some of the other benefits discussed above may be eliminated and new issues may arise, as follows:
- Limits on tax deductions. The limits on tax deductions for contributions (including contributions of other than cash and public securities) to private foundations are less favorable than contributions to public charities. If tax considerations are important to donors of a project looking for a fiscal sponsor, then a private foundation fiscal sponsor would not be a good fit.
- “Tipping.” The benefit of using a public charity as a fiscal sponsor when facing the problem of “tipping” is eliminated when the fiscal sponsor is a private foundation. As discussed above, the concern regarding the public support test remains when using a private foundation fiscal sponsor.
- Expenditure responsibility. If a private foundation is serving as a fiscal sponsor for a group that does not have its section 501(c)(3) tax-exempt status (or perhaps even for an individual grantee), then the private foundation will have to exercise expenditure responsibility over the payments made to the group (or individual grantee). Expenditure responsibility is required in order to avoid causing the grants to be treated as taxable expenditures (and potentially subjecting the foundation and foundation managers to penalty taxes). The foundation would also have to exercise expenditure responsibility in order to treat the grants as part of the foundation’s qualifying distributions in satisfying its annual payout requirement.
- Capacity building. Serving as a fiscal sponsor is just one small way that a foundation can provide capacity building support to a grantee. For example, the foundation could give a grant specifically for capacity building, offer its own staff or board expertise. or retain a third-party consultant to work with the grantee on capacity building and technical assistance.
There are additional issues that a private foundation should consider before entering into a fiscal sponsorship arrangement, including:
- Review organizing documents and policies. The foundation should review its organizing documents (Articles of Incorporation, Bylaws, trust instrument, gift agreements, policies) to confirm that its mission is consistent with serving as a fiscal sponsor. For example, a foundation that is prohibited from making grants internationally pursuant to its Articles of Incorporation may not serve as a fiscal sponsor for a group that is undertaking international relief work.
- Liability. Because the fiscal sponsor must exercise appropriate control and oversight over the project and funding, a private foundation that is acting as a fiscal sponsor should consider what liabilities it may incur as a result of its role as a fiscal sponsor. In addition, the foundation should review its insurance policies to determine its coverage.
- Unrelated business income tax. If a private foundation is asked to serve as a fiscal sponsor only in order to provide basic back office and administrative functions for a group — and the foundation receives payment for those services — the foundation should review whether those payments may be subject to unrelated business income tax.
- State charitable solicitation registration. Because a fiscal sponsor receives contributions from donors for a project, a private foundation that serves as a fiscal sponsor should determine if receiving charitable contributions pursuant to a fiscal sponsorship would require the foundation to register under, and be subject to, state charitable solicitation rules.
- Written agreement. A fiscal sponsorship arrangement raises too many issues to be done on a handshake. Terms and conditions should be set forth in a written agreement that discusses the roles and responsibilities of each party.
For additional information on fiscal sponsorship arrangements for nonprofits, please see the following articles and resources:
- Fiscal Sponsorships: 6 Ways To Do It Right by Gregory L. Colvin
- Fiscal Agency Versus Fiscal Sponsorship, by Jane C. Nober (formerly with the Council on Foundations)
- Legal FAQs on Grantmaking, by the Minnesota Council on Foundations
- What You Need to Know About Fiscal Sponsorships, by Michael Wells of grantsnorthwest.com
Editor’s Note: The information in this article should not be taken as qualified legal advice. Please consult your legal advisor for questions about specific legal issues discussed here. The information presented is subject to change, and is not a substitute for expert legal, tax, or other professional advice. This information may not be relied upon for the purposes of avoiding penalties that may be imposed under the Internal Revenue Service.