Bar News - February 17, 2016
Tax Law: Board Members Beware: Tax Implications for Charities Acting as Fiscal Sponsors
By: Russell Stein
Tips for Considering Fiscal Sponsorship
Here are a few tips for existing tax-exempt charities that are considering entering into a fiscal sponsorship arrangement with a separate project or organization:
1. Thoroughly vet the proposed project and the people behind the project.
2. Confirm the project is for a charitable purpose.
3. Confirm the project’s charitable purpose is in furtherance of your organization’s charitable purpose.
4. Don’t take short-cuts. Draft a fiscal sponsorship contract between the public charity and the project clearly defining each party’s responsibilities.
5. Understand that properly administering a fiscal sponsorship arrangement means more than just giving money to a project. Problems arise if the existing charity becomes nothing more than a conduit whereby money is passed to a third party with questionable charitable activities.
6. Don’t forget about state charitable registration rules. If the project is operating in states that you do not operate in, there may be registration requirements with the other state’s Secretary of State Office and Office of Attorney General, particularly if fundraising is done in the other states.
Many attorneys sit on at least one charitable organization’s board of directors. Other board members and staff at these organizations look to us for our expertise on legal and tax issues.
With an ever-increasing demand for charitable services, new charitable organizations and endeavors appear every day, despite the number of existing registered charities, of which there currently are more than 1.5 million, according to the IRS website.
What should attorneys and their fellow board members do if a champion of one of these new endeavors approaches your charity wishing to enter into a “fiscal sponsorship” arrangement, in which the new charity would take advantage of your charity’s 501(c)(3) status and ability to raise funds?
Before agreeing to do so, it would be prudent for the attorney and the organization to learn more about fiscal sponsorship arrangements and the potential benefits as well as potential risks they can bring. If done properly, acting as a fiscal sponsor can enable an organization to better fulfill its charitable purposes, but if done improperly, the arrangement could lead to problems with the IRS and a potential loss of your organization’s tax-exempt status.
For an entity to become a recognized public charity under section 501(c)(3) of the Internal Revenue Code, the entity has to be organized and operated exclusively for charitable purposes, and it generally has to apply to the IRS for recognition by filing Form 1023. The application process can be quite cumbersome – in the past it could have taken from six months to two years or more for the IRS to rule on an organization’s application. The process has been simplified in recent years for smaller charities through the government’s release of Form 1023-EZ, the “easy” application for tax-exemption.
However, for some small or start-up charitable endeavors it may not make sense to apply for charitable recognition, even using the Form 1023-EZ. A small organization with a short-term charitable goal may not want to go through the effort and expense of applying for IRS recognition, and may not have the capacity or personnel to maintain the ongoing tax-exemption and corporate administrative requirements. Such an organization, as an alternative to becoming a public charity, may look to “piggy-back” onto an existing charity’s 501(c)(3) status through a fiscal sponsorship arrangement.
Fiscal sponsorships can take a variety of forms. One common form of fiscal sponsorship results when a person or group with a charitable idea approaches an existing public charity and requests to become a project of such charity. The person or group works under the supervision of the existing charity, organizes and operates all the fundraising in coordination with the existing charity, and implements the charitable idea under the supervision of the existing charity. Donations to the existing charity are earmarked for the new project, and, accordingly, the donors may be eligible for a charitable tax deduction.
The fiscal sponsorship arrangement can benefit the existing charity by expanding its charitable activities to areas that the organization does not have the capacity to reach on its own. However, care should be taken not to take on activities that do not come within the scope of activities described in the existing charity’s Form 1023.
As simple as the process may sound for the existing charity (because the new project personnel may perform the bulk of the work), the application of a fiscal sponsorship arrangement could be quite cumbersome; particularly if the existing charity wants to make sure its tax-exemption is not put in jeopardy.
Ultimately, a public charity is responsible for assuring that its assets and the funds it raises are used in furtherance of its charitable purposes. Caution must be taken to assure that the public charity is not being used solely as a conduit for passing charitable donations to another entity.
If a public charity enters into a fiscal sponsorship arrangement with a new venture, and that venture uses the funds provided by the public charity for non-charitable purposes, the public charity could be subject to penalties under the IRS Code. Depending on the extent of the violation, the IRS could claim that the charity is no longer operated exclusively for charitable purposes and may revoke its tax-exempt status.
Additionally, in these types of arrangements, consideration must be given to a variety of business issues. Will the new charitable endeavor have any employees, and if so, how will they be paid (will they become employees of the charity)? How precisely will the public charity handle the funds that are raised for the project? Who legally owns the project and any intellectual property created by the project, the new endeavor, or the public charity? What about taxes? The new endeavor does not have tax-exempt status, so if it has any net income, it may have to pay taxes.
Accordingly, board members and charities should be sure to diligently analyze any potential fiscal sponsorship arrangements to determine if such an arrangement is a right fit for their organization.
Russell Stein is an attorney at Sheehan Phinney and a member of the firm’s Tax Group. His practice focuses on advising clients on various aspects of nonprofit formation and operations, and various tax aspects of business transactions and partnership formations and operations.