Date: January 2013
Looking back on the year 2012, fiscal sponsorship became more of a topic of interest to government regulators — the Internal Revenue Service, the California Attorney General, and the California legislature. An advisory committee to the IRS Exempt Organizations office recommended fiscal sponsorship as an alternative to the increasing number of nonprofit corporations being formed and seeking IRS approval of their 501(c)(3) exemption. And the IRS itself, in the wake of Hurricane Sandy, as it had after Katrina, recommended use of existing organizations for community relief efforts, rather than forming new organizations. In California, the collapse of the International Humanities Center caused some members of the state Assemby to take a closer look at fiscal sponsorship, resulting in legislation to detect those charities with restricted funds and negative unrestricted funds, requiring them to report to the AG and have insurance in place. Also, fiscal sponsors need to be more aware of how their projects may fall within the definition of "donor-advised funds" under the Internal Revenue Code, depending on the donor's role in the project.
All this and more can be found in the outline of Greg Colvin's remarks to the National Network of Fiscal Sponsors meeting in Los Angeles on November 8, 2012. Download pdf now.
Doing Right by the Projects: Fiscal Sponsorship after IHC
Date: March 2012
Recent news in the nonprofit press about the reported collapse of International Humanities Center (IHC), a fiscal sponsor organization based in California, has raised real concerns in the philanthropic world. Projects sponsored by IHC received correspondence from IHC indicating that it was unable to make disbursements in response to their check requests for money to cover current project expenses. Donations made to IHC, restricted to the purposes of certain charitable projects, were not available when needed by the projects.
The most extensive coverage has appeared in a two-part article by Rick Cohen, published in Nonprofit Quarterly in February. The story also ran in the Los Angeles Times.
This is not the first time such a thing has happened. In my book, Fiscal Sponsorship: 6 Ways To Do It Right, at page 73, I cite the case of Media Network, a documentary film sponsor that collapsed in 1997 in similar fashion.
While the full story and the future of IHC may not be clear right now, many are asking: What can be done to prevent this from happening?
I suggest that sponsors take these precautions—and that projects watch to make sure they do:
1. Make it clear everywhere—in the fiscal sponsorship agreement, in writing to donors, and on Form 990—that the sponsor treats funds received for the purposes of a project as restricted under the charitable trust doctrine. The sponsor can obtain unrestricted funds by charging administrative fees, but otherwise the funds dedicated to the purposes of one project may not be used to pay the expenses of another, or to pay the sponsor's general overhead.
To be clear: a fiscal sponsor is not a bank. Each restricted fund belongs to the sponsor, not the project. However, each project fund is impressed with a trust commitment "for the charitable purposes of" the project, and the sponsor has the legal duty to honor that trust. Within the limits of those purposes, the sponsor has discretion and control over spending decisions. But if the sponsor breaches that duty, the state attorney general can intervene to enforce the charitable trust in the public interest.
2. The sponsor's board should set a reserve policy to maintain a strong minimum of general, unrestricted funds, so that the sponsor can meet its overhead expenses even if administrative fees from projects were to take a sudden drop.
3. The sponsor should have internal financial controls that would discourage any one person from invading project funds. Since many fiscal sponsors centralize check-writing authority for all projects in a few top managers, major disbursements should require a second signature or a second pair of eyes. Where required by law, the sponsor must have a board-level audit committee and an annual independent audit by a CPA firm. The accounting firm can issue a management letter to the board to address defects in internal controls.
4. The sponsor's board of directors needs to pay attention and oversee the program. Among other things, the Board should receive frequent financial statements showing the condition of the fiscal sponsor's unrestricted general fund, to make sure that reserve requirements are met and that there is no improper "borrowing" from project funds.
5. Strive for transparency. Project directors should receive frequent (or have immediate online access to) internal financial statements showing the condition of their project fund. The project's fund accounting should always show cash on hand in excess of incurred expenses. A positive balance that relies on a "receivable" from the sponsor's general fund is a danger sign; the project director should jump on that immediately.
6. The sponsor cannot afford to be too soft-hearted. General funds should not be advanced to projects. If the cash in the project fund isn't sufficient to meet payroll or other costs, employees will need to be laid off and project expenses curtailed. Reliance on grants receivable, loans, and pledges is risky business. And some sponsors may need to revisit their administrative fee structure if not enough unrestricted money is being generated to meet the costs of audits, controversies, full insurance coverage, and other elements of risk management.
7. Some fiscal sponsors, in the public health field, for instance, must rely heavily on government grants that are paid on a reimbursement basis. In those cases, projects may need to incur or pay expenses before receiving grant funding. Operating such a fiscal sponsorship system successfully requires very careful, professional planning by experienced grants managers, but it can be done.
8. The sponsor's annual IRS Form 990, accessible to the public via Guidestar, can reveal that a fiscal sponsor is in trouble. Look at Part X, the Balance Sheet, Lines 27, 28, and 33. If unrestricted net assets are negative, and total assets are less than temporarily restricted (project) assets, it can mean that the sponsor has borrowed from or misspent funds held in charitable trust for the projects' purposes. The sponsor may not have the cash to cover all the projects' check requests. The Form 990 might not be filed until almost two years after the sponsor goes in the hole to its project funds, so projects should demand more frequent balance sheets. IHC's unrestricted net assets went negative back in 2008; its projects could have transferred to another sponsor or taken other protective action in 2009.
9. The sponsor needs to be adequately insured. When I was on the board of Community Initiatives in San Francisco with Jan Masaoka and John Kreidler, our motto was "buy insurance by the truckload." Besides general liability and directors' and officers' insurance, consider employee dishonesty and theft, non-owned auto, special event coverage, discrimination, harassment, molestation, and employee claims.
10. The National Network of Fiscal Sponsors has published guidelines for best practices. These are a valuable resource for all concerned to determine whether a sponsor's program is up to the industry standard.
Are fiscal sponsors inherently weak? Not at all. By sponsoring a range of projects, the whole can be stronger than the sum of its parts. But just like any other charity—a hospital, college, museum, church, or social service group—it may fall into a deficit position for any number of reasons, pulling down all of its departments, scholarship funds, and special programs.
Does Occupy Wall Street have a 501(c)(3) fiscal sponsor? Yes it does. How about other locations?
Like other suddenly emerging social change initiatives, Occupy Wall Street presents the situation of a grass roots movement rapidly seeking to educate the public and advocate for reforms, in this case calling attention to economic inequalities in our country. Many people are eager to support the movement financially, and the New York group has found a fiscal sponsor.
Date: November 2011
I just posted a blog on www.nonprofitlawmatters.com, hosted by Adler & Colvin. There you'll find details appearing recently in the press about the charitable sponsor for Occupy Wall Street, and the options and challenges facing Occupy groups in other cities and locations.
Handouts available from COF Community Foundations Conference in San Francisco, September 20, 2011
Over 100 attended, from Delaware, Iowa, Alaska, the Outer Banks, San Diego, everywhere. Even the Ocean (Foundation).
Date: September 2011
Sorry we ran out of handouts with the large unexpected audience. Here are
(1) the basic PowerPoint on fiscal sponsorship, especially Models A and C,
(2) 6 Ways That Community Foundations Can Relate to Fiscal Sponsorship, PLUS
(3) lessons learned and posted by Jessica Janssen, executive director of Fremont Area Community Foundation.
New article discusses pros and cons of housing a fiscally sponsored project in a limited liability company (LLC)
Steven Chiodini and Greg Colvin have published an article in Taxation of Exempts this summer that explores a possible new "Model L" for fiscal sponsorship.
Date: August 2011
This article is available on the website of the law firm Adler & Colvin at http://www.adlercolvin.com/resources/public-charities.php, entitled "The Use of LLCs in Fiscal Sponsorship -- A New Model," in the Thomson Reuters journal Taxation of Exempts, May/June 2011.
Some 501(c)(3) public charities that use the Model A direct project approach have been concerned about their exposure to liabilities created by operation of the project--use of automobiles, disgruntled employees, programs involving children, outdoor sports, and the like. There is a way to contain those risks while maintaining the tax advantages of fiscal sponsorship: place the project in a limited liability company (LLC) created under state law, controlled by the sponsor as the single member of the LLC, and treated for federal tax purposes as an integral part of the sponsoring charity. But wait: that means operating the project as a separate company out of a separate bank account in the LLC's name and potential state tax law compliance issues, so this is not a solution in every case. However, if the risks and the volume of financial activity justify the additional administrative burdens, it's worth a look.
Colvin to lead workshop session on fiscal sponsorship at Fall Conference For Community Foundations
The Council on Foundations is holding its Fall Conference for Community Foundations this September in San Francisco, with a session on fiscal sponsorship that Greg Colvin will lead. The details are:
Session Date: September 20, 2011, 4 p.m.
To register: http://www.cof.org/events/conferences/2011fall/index.cfm
Location: San Francisco Marriot Marquis
Tentative Session Title: Fiscal Sponsorship: The Legal Rules
Tentative Session Description: A great idea of a donor or community group often translates into legal questions for the community foundation. Can the community foundation receive charitable contributions that it will re-grant for a community health fair if the fair is not run by a charity? Accept contributions from a golf tournament for a new charity that has not yet received recognition of its public charity status? Every community foundation has been asked such questions. What do you need to know before you respond? This session will walk through fiscal sponsorship models and legal rules you need to consider before serving as a fiscal sponsor. The speaker, Greg Colvin, author of Fiscal Sponsorship: Six Ways To Do It Right, will also touch on considerations when making a grant to a fiscal sponsor.
How should a Model C Project Apply to a Foundation for a Grant Via Its Fiscal Sponsor?
Use a Protocol That Makes Clear the 501(c)(3) Sponsor Is the Applicant
Project can prepare the application, but Sponsor must ensure its role is properly documented
On October 22nd, I gave a talk on fiscal sponsorship to the Private Foundation Summit in Seattle, convened by PESI and Clark Nuber. Here is the handout I used, entitled " How to Process a Grant from a Project with a Fiscal Sponsor (Model C Regrant)," listing the steps that a foundation could expect an applicant to take when a project proposal is submitted via its 501(c)(3) sponsor.
This situation involves a Model C "regrant" arrangement, where the project is a separate legal entity (could be an artist, an author, a 501(c)(4), a dance group -- any non-(c)(3) organization or individual) that has been "adopted" by a fiscal sponsor. The sponsor receives the outside funding and then exercises its discretion and control to regrant funds to the project with proper documentation. The grant process occurs twice -- (1) from the funder to the sponsor and (2) from the sponsor to the project.
Many times, projects, sponsors, and foundations are confused about how a sponsored project should present its application to a funder. Of course, the project director usually makes initial contact with the prospective funder and finds out if they are interested in making a grant. If so, the project prepares the grant proposal, application, budget, etc. Then what? Follow the steps on the protocol....
It is not enough just to slip a copy of the fiscal sponsor's IRS letter in the back of the package. The proposal should be presented to the funder with a cover letter from the sponsor on top. The handout includes a good example.
Click here for the handout, and good luck.
2006 Law Change May Affect Some Projects
Analysis of New Donor-Advised Fund Definition
Occasionally, a fiscal sponsor may have a project with all or almost all of its funding from one source -- and that source (a foundation or an individual) plays a continuing role in the project, advising on how funds are disbursed or even acting as the project director. The project account may come within the new Internal Revenue Code definition of a donor-advised fund (DAF), subject to new disclosures, reporting, and restrictions.
Here is a memo that begins to analyze how the new DAF rules may affect fiscal sponsors. We are waiting for IRS regulations to clarify the breadth of the new law, so stay tuned for further updates.
Looking for a Fiscal Sponsor?
New Nationwide Directory Launched
At long last, there is a place to go to find those public charities across America that are acting as fiscal sponsors for community projects, artists, filmmakers, international programs, environmental initiatives, and many other good works. The San Francisco Study Center, publisher of Fiscal Sponsorship: 6 Ways To Do It Right, has created a central repository of useful data on 140 practicing sponsors, with an online form so that others wishing to be listed can also join.
The website, fiscalsponsordirectory.org, adds to our understanding of fiscal sponsorship by including clear definitions, a chronology of pertinent legal rulings and important events and developments in the field, and Facts & Stats about the directory participants that helps put each fiscal sponsor into perspective.
Congratulations, and let's hope this will build the recognition of more and more upstanding fiscal sponsors!
Deciding Whether to Form a New Nonprofit or Use a Fiscal Sponsor
Book Page 70 (Model A, Common Uses)
At speaking events in Los Angeles, Denver and elsewhere lately, and in my law practice, people ask me whether they should create a new 501(c)(3) organization or find a fiscal sponsor. Or do both--incorporate now but "incubate" using a fiscal sponsor to receive and spend donated income until they receive their recognition letter from the IRS.
The book does not describe how to form a new tax-exempt corporation; there are many government and private "how to" guides for that. Nevertheless, I thought it would be useful to compare the pros and cons of starting an independent 501(c)(3) entity versus using a fiscal sponsor, and the chart linked below is the result.
Take a look at the chart, "Comparison of Starting a New 501(c)(3) Organization with Using a Fiscal Sponsor (Model A)," which describes the pros and cons of setting up your own tax-exempt entity versus fiscal sponsorship.
Project Intake Checklist
Book Page 71 (Transfers of Projects, In and Out)
If you are a fiscal sponsor, how much do you need to know about
a new project before you decide to take it on? Obviously, you will
want a written application stating its purpose, proposed activities,
budget, personnel and advisory committee or board. There might
be more to find out, to determine whether it will be a Model A,
B, or C project and whether it has a history with another sponsor
or a founder that you need to address in the fiscal sponsorship
agreement. Click here for a checklist of 15 questions to ask about
the new project.
IRS Promotes Disaster Relief Sponsorship
Book Page 71 (Model A, Common Uses, Sudden Needs)
In a bulletin issued on 9/6/05, the Internal
Revenue Service provided guidance to those interested in forming
new organizations for relief of Hurricand Katrina victims. IR-2005-93,
The IRS also promoted the concept of fiscal sponsorship of relief
projects through charities already in place, saying: Use of existing
charitable organizations is encouraged because such organizations,
including churches, are frequently able to administer relief programs
more efficiently than newly formed organizations, because they
already have fund-raising and distribution infrastructures in place.
Further, the IRS provided answers to 8 FAQs on use of existing