So You Need 501(c)(3) status? You May Not Need It After Reading This.

“I want to start a non-profit.” It is a phrase that I hear over and over again—and it’s noble cause. “For profit” businesses want to give back to society and, in their mind, the way to do this is through forming a non-profit organization complete with tax exempt status from the Internal Revenue Service (IRS). Well…not so fast! There are requirements that come with starting a non-profit (accounting, legal, fiduciary) that many would be non-profits are not aware need to be followed or your status could be revoked or worse. Now—-let me tell you about the concept of “fiscal sponsorship” that serves as an alternative to starting a non-profit from scratch and having to consistently fulfill the compliance requirements of a non-profit organization.

Fiscal sponsorship is a contractual relationship that allows a person or organization that is NOT tax-exempt to advance charitable or otherwise exempt activities with the benefit of the tax-exempt status of a sponsor organization that IS tax exemption from federal incomes tax under the IRS. In essence, it’s a strategic partnership between a non-exempt organization and an exempt organization to carry out a charitable objective. This can save time, money and headache, especially for persons or organizations who already have a “for profit” organization to run.

A few definitions…

  • “Sponsored Project”/”Charitable Project”- The particular initiative that has a charitable cause that an organization or person would like to see;
  • “Fiscal Sponsor”- The entity that has the IRS 501(c)(3) tax exempt status;
  • “Grantee”- Person who receives benefits of sponsored project who is often the non-exempt status organization;

There are 3 forms of fiscal sponsorship (the mechanics of which should be discussed with your legal counsel):

  1. Comprehensive Fiscal Sponsorship (most common form)- The sponsored project becomes an internal program of the fiscal sponsor. In other words, if you want to conduct a fundraiser for “Back to School” supplies, you would find a fiscal sponsor and contract with them to make your charitable project one of their charitable projects. The fiscal sponsor may charge a percentage of funds raised for a particular project as an administrative fee. But it’s important to select the RIGHT fiscal sponsor however, not just the one with the lowest fees, because they are essentially spearheading and branding your charitable initiative. The importance of securing a WRITTEN contract cannot be overstated since this is essentially a partnership and all parties need to know their rights and responsibilities before the sponsored project is underway.
  2. Pre-Approved Grant Relationship Fiscal Sponsorship– The fiscal sponsor pre-approves another individual or entity as a grantee, agrees to establish a restricted fund to receive contributions for the purpose of supporting the grantee’s charitable project, and makes grants to the grantee from the restricted fund. In this form of sponsorship, three things are key: due diligence, a written agreement and follow up reporting; your legal counsel should be able to handle this for you. This is attractive if you want legal control over the sponsored project and ownership of the results of sponsored activities. It must be done correctly so there is not the appearance that your organization is trying to bypass the tax exemption process.
  3. Single Member LLC Fiscal Sponsorship (newest development)- An LLC is formed under state law with an existing Section 501(c)(3) exempt organization as its sole member and sponsor so that the LLC is fully owned by the tax exempt organization (much like the comprehensive fiscal sponsorship). A single member LLC with an exempt 501(c)(3) organization as its sole member will be treated as exempt itself and donors may deduct contributions made to the LLC directly according to applicable rules.There are still reporting and compliance requirements and rules with maintaining the LLC but they are far less than would be required to retain tax exempt status.

NOTE: In 2014, the IRS realized Form 1023-EZ which streamlined the application process for recognition of tax exempt organizations. It’s a 3 page electronic application and has reduced processing time significantly.

So as you see, if done CORRECTLY, fiscal sponsorship can be a great way for organizations to fulfill a charitable goal without requiring the formation a new non-profit entity and the ongoing compliance requirements. If done INCORRECTLY, the IRS could see view the relationship merely as a way for a non-exempt entity to get around the requirements for being a tax exempt entity. Therefore, as always, make sure you have great legal counsel that can show you the right way and the wrong way to set up one of these sponsorship models. Then go and do a lot of good in the world!

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Filed under business advice, business consulting, business law, business legal services, business owner, Georgia, Georgia legal, non-profit, small business

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