Why more nonprofit startups are choosing fiscal sponsorships

Filing for tax exemption is no easy feat, but through fiscal sponsorship, your organization can receive tax-deductible donations from supporters, even if you haven't yet received your 501(c)(3) status.

In this blog, we’ll cover everything you need to know about nonprofit fiscal sponsorship, so your organization can take advantage of all the benefits that come from charity status.

What is a fiscal sponsor?

Usually, fiscal sponsorship entails a larger, more established nonprofit (i.e., the fiscal sponsor) assuming the financial and legal responsibility of a smaller organization—essentially taking them on as a project or program in exchange for a percentage of their income.

How does nonprofit fiscal sponsorship work?

To understand how a fiscal sponsorship program works, you first need to understand the basics behind nonprofit tax laws.

To be fully recognized as a public charity in the United States, your nonprofit organization needs to obtain 501(c)(3) status from the IRS. Doing so comes with a number of advantages for both you and your supporters, including:

• Tax exemption 💸 Charitable projects are exempt from paying federal income and unemployment taxes, state income tax, and even sales tax.
• Tax-exempt financing 🏦 If you ever need to borrow funds for a capital project or other necessity, 501(c)(3) organizations can apply for a tax-exempt bond.
• Tax-deductible contributions 🎁 Charitable contributions can reduce the taxable income of your supporters—but only if you've received your tax-exempt status.

 To officially gain 501(c)(3) status, organizations have two options: file with the IRS or get fiscally sponsored by an existing nonprofit. Though a nonprofit can obtain this status itself, fiscal sponsorship is an alternative route that some (typically new) organizations take to get the benefits of 501(c)(3) nonprofit status. We’ll walk you through the steps of each option.

How to secure tax-exempt status: Filing for your own nonprofit status

Going the traditional route of applying for your own 501(c)(3) status may require more time and money. Here’s a basic overview of the process:

Step 1: Get prepared 💪

Filing for nonprofit status typically requires a few specific pieces of information. So, before you jump into the process, be sure to: 

• File for an EIN (employer identification number)
• Open a bank account
• Submit your articles of incorporation to your secretary of state
• Draft nonprofit bylaws

Step 2: File and pay upfront fees 💰

To apply for tax-exempt status, you'll need to file either a Form 1023 or Form 1023-EZ, which cost $600 and $275, respectively. Coupled with attorney fees, you should expect to accrue roughly $3,000 in start-up costs.

Step 3: Sit back and wait 🕝

Receiving nonprofit status isn’t a given. Expect to wait 2–12 months for the IRS to review submitted paperwork and either approve or deny the request.

Step 4: Abide by ongoing requirements and costs 🔁

To maintain your nonprofit status, expect to spend $2,500 annually and have bookkeepers, accountants, and even attorneys on retainer. If your nonprofit status gets revoked or you shut down your organization, expect to spend $5,000 in closing costs.

But for nonprofits that continue to operate, be sure to adhere to IRS requirements, like filing an annual 990 form.

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How to secure tax-exempt status: Establishing a fiscal sponsorship arrangement

Securing tax-exempt status for a project through a fiscal sponsorship arrangement involves careful planning, compliance with legal requirements, and adherence to the guidelines set by tax authorities. Here are general steps to consider:

Step 1: Select a qualified fiscal sponsor 🧐

Choose a fiscal sponsor that is a tax-exempt organization with 501(c)(3) status and aligns with the activities of the sponsored project.

Step 2: Establish a written agreement 🤝

Draft a comprehensive fiscal sponsorship agreement that outlines the terms of the arrangement. The fiscal sponsorship guidelines should Include details about:

• Financial responsibilities
• Reporting requirements
• Decision-making processes
• Level of control the fiscal sponsor will have over the project
• Communication requirements

Step 3: Define project activities ✍️

Clearly define the charitable purpose and activities of the project, including:

• Goals and outcomes
• Mission alignment
• Compliance with tax regulations
• Methods of implementation
• Budget

What are the benefits of nonprofit fiscal sponsorship?

A nonprofit fiscal sponsorship comes with some great perks, like:

• Expert bookkeeping and administrative support 📚 Don't feel like wading through mounds of paperwork? Have confidence that the bookkeeping paperwork and taxes will be taken care of by the nonprofit sponsor.
• Predictable administrative fees 🤓 Typically, the sponsoring organization will have a fixed fee structure, preventing you from paying ad hoc legal operating costs.
• Built-in HR, benefits, and board 💛 Fiscally sponsored organizations do not need to have their own board of directors or a legal requirement of 501(c)(3)s. Plus, many can also get their staff on the healthcare plan of their sponsoring organization in addition to other benefits.
• No commitment 🙅 At any time, you can terminate your fiscal sponsorship agreement and file for a separate tax-exempt status.
  

Fiscal sponsorship is a great avenue for small start-up projects, student-led organizations, and anyone looking to avoid a headache with the IRS while still getting the benefits of nonprofit status.

Who can be a fiscal sponsor?

A fiscal sponsor can be any established nonprofit organization with tax-exempt status under section 501(c)(3) of the IRS code in the United States.

Fiscal sponsor vs. fiscal agent

Typically, there are two kinds of fiscal entities: a fiscal agent and a fiscal sponsor. While similar, they’re a bit different in terms of legal and tax status.

💰Fiscal sponsor: In essence, fiscal sponsorship allows an organization to gain tax-exempt status through a sponsor, who often has financial control. 

💰Fiscal agent: A fiscal agent takes on the financial oversight and management of a project or organization. However, it does not provide tax-exempt status to that project or organization.

What are the different types of fiscal sponsorship? 

Fiscal sponsorship models are different approaches that organizations can use for a fiscal sponsorship arrangement. The specific model chosen depends on the type of nonprofit of both the fiscal sponsor and the sponsored project. 

Common fiscal sponsorship models include:

• Pre-approved grant relationship: In this model, the sponsor is a separate entity from the organization. Funds that the sponsor collects are then funneled to the sponsored project or organization.
• Direct project: The project or organization legally belongs to the sponsor, and activities are carried out by its volunteers and staff. 
• Group exemption: In this model, the fiscal sponsor is typically an umbrella organization that sponsors multiple affiliated projects or chapters and grants group tax exemption.
• Independent contractor project: The fiscal sponsor hires contractors to work on specific projects under the fiscal sponsor's guidance and oversight.
• Technical assistance: The fiscal sponsor provides specific services to the sponsored project like program development or grant writing.
  

What does signing a fiscal sponsorship agreement typically involve?

These arrangements can take many forms, but to qualify from the outset, organizations or sponsored projects must fulfill these three IRS requirements:

• Be committed to the nonprofit sector 🌎 Your organization must remain fully committed to being not-for-profit and charitable in nature, meaning all expenses must go towards running your nonprofit.
• Have no political affiliation 🙈 Your organization must remain nonpolitical—political nonprofits are a completely different category within the IRS.
• Follow expense reporting requirements 📊 Your team must submit receipts for every purchase so that your fiscal sponsor can file taxes on behalf of your tax-exempt organization.

While some organizations will only seek a fiscal sponsorship for a short period of time, more and more nonprofits are opting for a longer-term, mutually beneficial partnership.

Lay the groundwork for a strong fiscal sponsorship

Building a new organization comes with plenty of upfront hurdles, particularly surrounding filing for tax-exempt status. As an alternative, many nonprofits choose fiscal sponsorship to gain instant tax-exempt status, avoid hidden fees, and get ongoing financial management for their organization.

Whichever path you take toward growing your nonprofit, Givebutter is here to help you reach your fundraising goals. Givebutter is a free fundraising platform that brings together everything changemakers need to successfully raise funds for good causes—and all of our tools are always completely free to use.

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