Nonprofit Fiscal Sponsorship: How It Works, Tax-Deductible Donations Without 501(c)(3) Status, and the Two Models

A group of community organizers wants to accept tax-deductible donations for a neighborhood park renovation. They have no nonprofit corporation, no 501(c)(3) determination letter, and the IRS application (Form 1023 or 1023-EZ) takes 3-12 months. In the meantime, donors who write checks to the organizers cannot deduct the donation because the organizers are not a qualified charitable organization. Fiscal sponsorship solves this problem: a 501(c)(3) organization (the “fiscal sponsor”) accepts the donations on behalf of the project, provides the tax-deductible receipt, and disburses the funds to the project subject to the sponsor’s oversight. The donors get their deduction immediately, the project gets its funding, and the IRS treats the donation as a contribution to the sponsor (which is a qualified organization).

What is fiscal sponsorship and why is it used?

Fiscal sponsorship is a formal arrangement between a 501(c)(3) organization (the sponsor) and a project that lacks its own tax-exempt status. The sponsor provides the project with access to its tax-exempt status, allowing donors to the project to claim a charitable deduction under IRC 170.

Common reasons projects use fiscal sponsorship:

Startup projects. A new charitable initiative that needs to raise funds before (or instead of) incorporating and applying for 501(c)(3) status. The Form 1023 application can take 3-12 months, and the project needs money now.

Time-limited projects. A project with a defined scope and timeline (a documentary film, a community event, a research project) that does not justify the cost and ongoing compliance burden of maintaining a separate 501(c)(3).

Projects testing viability. A group that wants to test whether a charitable concept is viable before committing to the infrastructure of a separate nonprofit (board, bylaws, annual filings, state registrations).

International projects. A project operating outside the US that cannot obtain 501(c)(3) status (which requires a US nexus) but wants to solicit US donors. The fiscal sponsor accepts the US donations and grants the funds to the international project, subject to the sponsor’s expenditure responsibility under IRC 4945(h).

How does Model A (comprehensive/direct project) work?

In Model A, the project becomes a program of the fiscal sponsor. The sponsor has complete legal control over the project: the project’s staff are employees (or contractors) of the sponsor, the project’s contracts are in the sponsor’s name, the project’s assets belong to the sponsor, and the sponsor’s board has ultimate authority over the project’s activities.

Donor perspective: The donor makes a donation to the sponsor, earmarked for the project. The sponsor issues the donor acknowledgment letter on its own letterhead with its own EIN. The donation is a contribution to the sponsor, and the deduction is straightforward.

Variance power. The sponsor must retain “variance power,” which means the sponsor has the discretion to redirect the funds to another purpose if the earmarked project is not feasible, or if the sponsor determines that the funds would be better used elsewhere within its charitable mission. Without variance power, the donation is not a contribution to the sponsor (it is a pass-through to the project), and the deduction may be disallowed. In practice, the sponsor almost never exercises variance power, but the legal authority must exist and be documented in the fiscal sponsorship agreement.

Sponsor’s obligations: The sponsor is responsible for: accounting for the project’s revenue and expenses (included in the sponsor’s books and Form 990), providing payroll services for the project’s staff (if any), maintaining insurance coverage, ensuring that the project’s activities further the sponsor’s exempt purpose, and exercising oversight to prevent misuse of funds.

Fiscal sponsorship fee: The sponsor typically charges 5-10% of the funds received for the project. The fee covers the sponsor’s administrative costs (accounting, compliance, insurance, oversight). The fee is not tax-deductible to the donor (it is a cost borne by the project out of the donated funds, not an additional donation).

How does Model C (pre-approved grant) work?

In Model C, the sponsor does not absorb the project. Instead, the sponsor receives the donation, exercises its judgment that the project’s activities further the sponsor’s exempt purpose, and makes a grant to the project. The project operates independently: it has its own legal entity (or is an unincorporated association), its own bank account, its own staff, and its own governance.

Donor perspective: The donor makes a donation to the sponsor, earmarked for the project. The sponsor issues the acknowledgment letter. The donation is a contribution to the sponsor, subject to the sponsor’s variance power.

Grant-making process: After receiving the donation, the sponsor evaluates whether the project’s proposed use of the funds is consistent with the sponsor’s exempt purpose. If so, the sponsor makes a grant to the project. The grant agreement specifies: the purpose of the grant, the restrictions on use, the reporting requirements (the project must report how the funds were used), and the right of the sponsor to redirect or reclaim unused funds.

Expenditure responsibility. If the project is not itself a 501(c)(3) public charity, the sponsor must exercise “expenditure responsibility” under IRC 4945(h): the sponsor must ensure that the grant funds are used exclusively for charitable purposes, require the project to report on the use of the funds, and report the grant on its own Form 990 (Schedule I). Failure to exercise expenditure responsibility can result in excise taxes on the sponsor under IRC 4945.

Key difference from Model A: In Model C, the project is not a program of the sponsor. The project’s staff are not the sponsor’s employees. The project’s contracts are in the project’s name. The sponsor has less control (and less liability) than in Model A, but the sponsor still has the obligation to ensure that the funds are used for charitable purposes.

What does the IRS require?

The IRS does not have specific regulations on fiscal sponsorship. The arrangement is governed by general principles:

Tax deductibility of the donation. The donation is deductible under IRC 170 because it is made to a 501(c)(3) organization (the sponsor). The earmarking (designation for a specific project) does not disqualify the deduction as long as the sponsor retains variance power. Rev. Rul. 68-489 established this principle: a contribution to a charity for a specific project is deductible if the charity has full control and discretion over the use of the funds.

The sponsor must further its own exempt purpose. The project’s activities must be consistent with the sponsor’s exempt purpose. A 501(c)(3) educational organization cannot fiscally sponsor a political campaign committee. The sponsor must evaluate the project’s activities and determine that they further the sponsor’s mission.

Reporting on Form 990. In Model A, the project’s revenue and expenses are included in the sponsor’s Form 990 as part of the sponsor’s own activities. In Model C, the grant to the project is reported on Schedule I (Grants and Other Assistance to Organizations). The sponsor must also report the total amount of fees charged for fiscal sponsorship.

No private benefit. The fiscal sponsorship arrangement must not result in private benefit (benefit to individuals or non-charitable entities that is more than incidental to the charitable purpose). If the project is a for-profit venture using fiscal sponsorship to obtain tax-deductible donations, the arrangement violates the private benefit doctrine, and the sponsor’s exempt status is at risk.

What happens when the project gets its own 501(c)(3)?

Many projects use fiscal sponsorship as a temporary arrangement while they incorporate and apply for their own 501(c)(3) determination letter. When the project receives its own determination letter, the transition involves:

Asset transfer. In Model A, the project’s assets (cash, equipment, intellectual property) are transferred from the sponsor to the new 501(c)(3). The transfer is a grant from the sponsor to the new organization, reported on the sponsor’s Form 990 Schedule I. The transfer is not taxable to either party.

In Model C, the transition is simpler because the project already has its own assets and operations. The fiscal sponsorship agreement terminates, and future donations go directly to the new 501(c)(3).

Donor notification. Donors who set up recurring donations through the sponsor must be notified to redirect their donations to the new organization. The sponsor’s acknowledgment letters for past donations remain valid (the donation was to the sponsor, and the sponsor’s 501(c)(3) status at the time of the donation is what matters).

Ongoing obligations. The sponsor should obtain a final report from the project on the use of all funds received during the fiscal sponsorship period, retain the records for at least seven years, and ensure that any remaining funds held for the project are transferred or returned.

What should I do next?

If you are a project considering fiscal sponsorship, identify a sponsor whose exempt purpose aligns with your project’s mission. If you are a 501(c)(3) considering offering fiscal sponsorship, establish a written fiscal sponsorship policy that specifies: the due diligence process for evaluating projects, the fee structure, the oversight and reporting requirements, and the termination procedures. If you are currently in a fiscal sponsorship arrangement, verify that the sponsor is issuing correct donor acknowledgment letters and reporting the arrangement properly on its Form 990.

• Nonprofit Form 990 filing guide, where the sponsor reports fiscally sponsored project revenue and grants
• Nonprofit donor acknowledgment, the acknowledgment letter the sponsor must issue to donors under IRC 170(f)(8)
• Nonprofit governance, the board oversight that should review fiscal sponsorship arrangements for conflict of interest
• Nonprofit UBIT, the tax exposure if a fiscally sponsored project generates unrelated business income
• Starting a nonprofit: 501(c)(3) application, the full startup sequence for transitioning from fiscal sponsorship to your own tax-exempt entity
• Church bookkeeping, the parallel fund accounting structure that churches use to segregate designated funds

This guide is general information, not tax advice for your specific situation. Which points apply, and how, depends on your facts.