Pre-approved Grant Relationship Fiscal Sponsorship
In another common form of fiscal sponsorship, the sponsor organization preapproves 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. As with comprehensive fiscal sponsorship, the sponsor in a preapproved grant relationship fiscal sponsorship must ensure that the funds it receives in support of the project will be used in furtherance of its exempt purposes and in a manner consistent with the rules applicable to organizations exempt under IRC Section 501(c)(3). Accordingly, the sponsor should (1) conduct due diligence of the potential grantee in advance of entering into a fiscal sponsorship relationship, (2) have a written fiscal sponsorship agreement that sets forth the terms of the sponsorship and the purposes of the grants, and (3) require some reporting back regarding the appropriate use of the grant funds.
Preapproved grant relationship fiscal sponsorship may be particularly appropriate where a client desires legal control over the sponsored activities and ownership of the results of such activities. It may also be appropriate where a client requires sponsorship for only a short period of time, such as between when the client submits its federal exemption application and when it receives a favorable determination letter from the IRS. This form of fiscal sponsorship is relatively pervasive in the nonprofit sector and is especially common in the arts, where individual artists may often wish not to give up ownership of the intellectual property they create. However, it is often done incorrectly, particularly when structured without the advice of legal counsel. Sponsors also often step beyond the role of mere grantmaker to provide additional services to their grantees, making the relationship more complex. The risks of entering into an improper preapproved grant relationship fiscal sponsorship are high – the IRS may view the relationship as a conduit for making tax-deductible contributions to a nonexempt entity, collapse the transactions by disregarding the sponsor’s role, and deny donors deductions for such contributions. Obviously, this is likely to anger and alienate those donors, but it could also potentially lead to a lawsuit against the sponsor and a public relations fiasco.
When setting up this, or any other, form of fiscal sponsorship, a written agreement should be used and it should contain any provisions applicable to the particular relationship. Such provisions should include ones covering (1) the purposes for which the grant may be used and the limitations on such uses pursuant to the requirements under Section 501(c)(3); (2) the fact that the sponsored project remains a separate entity and the sponsor has no responsibility or liability for the programmatic work, fundraising, contracts, insurance, or other day-to-day activities of the sponsored project; (3) the sponsor’s ultimate control and discretion over the use of the funds deposited into the restricted fund and its variance power; (4) the sponsor’s sponsorship policies and fees; and (5) provisions for termination of the sponsorship relationship.
In order to ensure that the potential grantee will appropriately use the granted funds, the fiscal sponsor should conduct due diligence regarding the individual or organization in advance of entering into the fiscal sponsorship relationship. The scope of due diligence conducted may depend on many factors, such as whether the sponsor has had a previous relationship with the potential grantee, the nature of the potential grantee’s activities, the anticipated amounts to be granted, and the size of the potential grantee. However, at a minimum, it should likely include: receiving evidence that the entity was duly formed, is validly existing, and is in good standing; a review of the entity’s financial status; an assessment of the entity’s management to ensure its ability to successfully carry out the terms of the grant; and potentially a site visit, if appropriate. Once a fiscal sponsor has made grants pursuant to a preapproved grant relationship, it should also exercise oversight over the use of such funds to ensure proper and appropriate use by the grantee. This is often done by requiring the grantee to submit reports back to the sponsor regarding how the granted funds were used.
Preapproved grant relationship fiscal sponsorship often goes wrong when the fiscal sponsor agrees to provide additional services other than grantmaking to the sponsored grantee, such as administrative services, shared office space, or assistance with filings and registrations. Providing such services can turn the relationship into one that is more than a pure grantor-grantee relationship and can increase the risk of ascending liability from the sponsored project to the fiscal sponsor. In order to avoid this, a fiscal sponsor that wishes to provide services other than grantmaking to sponsored grantees should consider doing so only pursuant to a separate written agreement and possibly in exchange for fair market value for such services.
An advantage of preapproved grant relationship fiscal sponsorship is that it may be used to support certain activities carried out by individuals, foreign organizations, or even for-profit entities, so long as the grants are limited to use for charitable or otherwise exempt activities that are consistent with the exempt purposes of the sponsor organization. Although this model of fiscal sponsorship can serve as a great tool for advancing charitable goals, it often requires the assistance of knowledgeable legal counsel to get it right.
It is worth mentioning a few recent developments that may have an increasingly significant impact on the field of fiscal sponsorship: the development of the single-member LLC form of fiscal sponsorship and the release of IRS Form 1023-EZ.
Single-Member LLC Fiscal Sponsorship
Because fiscal sponsorship is a contractual, rather than legally-prescribed relationship, it is possible for new models of fiscal sponsorship to be created and implemented, provided they comply with the provisions of the Internal Revenue Code and other federal and state laws applicable to organizations exempt under Section 501(c)(3). One such recently developed form of fiscal sponsorship involves the use of a single-member limited liability company (LLC). Extensive discussion of this model of fiscal sponsorship is beyond the scope of this article, but it is worth being aware of as an interesting emerging structure that may potentially be appropriate for some clients.
In a single-member LLC fiscal sponsorship relationship, an LLC is formed under state law with an existing Section 501(c)(3) exempt organization as its sole member and sponsor, thereby making the LLC wholly-owned by the sponsor organization, similar to a comprehensive fiscal sponsorship relationship. A single-member LLC that does not affirmatively elect to be treated as a corporation will be disregarded as a separate entity from its owner for federal income tax purposes. Accordingly, a single-member LLC with a Section 501(c)(3) exempt organization as its sole member will be treated as exempt itself and donors may deduct contributions made to the LLC directly or to the sponsor member according to the applicable rules.
Although the single-member LLC can be treated as part of the sponsor organization for federal income tax purposes, it remains a separate legal entity with its own liabilities which, assuming proper corporate formalities and separation principles are followed, should not ascend to the fiscal sponsor. This may make this model of fiscal sponsorship especially appropriate for activities with a higher risk profile than those of the sponsor or for activities that may not present a perfect cultural fit for the sponsor. However, it is important to note that the LLC will still be treated as an entity separate from its member for purposes of employment tax, certain excise taxes, and matters of state law.
In 2014, the IRS released the Form 1023-EZ, Streamlined Application for Recognition of Exemption Under Section 501(c)(3) of the Internal Revenue Code. The Form 1023-EZ is a three-page electronic application that some small organizations may use to apply for federal tax exemption in lieu of the longer standard Form 1023. The release of the Form 1023-EZ has reduced exemption application processing times significantly – some organizations that have applied for tax exemption using the Form 1023-EZ have reportedly received determination letters in a matter of weeks, as compared to the one year or longer that the IRS had previously told practitioners to expect to wait on applications made using the long Form 1023. Ultimately, the availability of the Form 1023-EZ and the ease with which a small organization may be able to obtain an exemption could decrease the demand for fiscal sponsorship, particularly comprehensive fiscal sponsorship.
Fiscal sponsorship in its many forms, a few of which are discussed in this article, can be a great tool for advancing the charitable intentions of your clients, particularly those for whom it may not be advisable to form a separate nonprofit. Attorneys can provide invaluable assistance to their clients by making them aware of the option of fiscal sponsorship, advising them as to the appropriate fiscal sponsorship structure to best achieve their goals, and helping to properly structure the chosen relationship pursuant to a written fiscal sponsorship agreement.