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

A project that has no 501(c)(3) determination can still raise tax-deductible money by working under a fiscal sponsor, an existing charity that receives the gifts, issues the acknowledgments and controls how the funds are spent. The gift is a contribution to the sponsor, which is an organization described in IRC 170(c)(2), so the donor’s deduction is ordinary. What makes it hold up is control: Rev. Rul. 68-489 protects a charity’s exemption when it funds non-exempt groups only where it “retains control and discretion as to the use of the funds,” and the donor’s deduction rests on the same control. There are two structures most sponsors use, Model A (the project becomes a program of the sponsor) and Model C (the sponsor makes a grant to an independent project), and the choice sets who employs the staff, whose books the money sits in, and what shows on the sponsor’s Form 990.

What’s fiscal sponsorship, and why does the sponsor have to control the money?

A written arrangement under which a 501(c)(3) accepts contributions for a charitable project that has no exemption of its own. A deduction under IRC 170 requires a gift “to or for the use of” an organization “organized and operated exclusively for religious, charitable, scientific, literary, or educational purposes,” which the sponsor is and the project isn’t. So the sponsor has to be the real recipient. Rev. Rul. 68-489 lets an exempt organization distribute funds to non-exempt groups “provided it retains control and discretion over use of the funds for section 501(c)(3) purposes.”

• The ruling describes the discipline: the exempt organization limited “distributions to specific projects that are in furtherance of its own exempt purposes,” and it “maintains records establishing that the funds were used for section 501(c)(3) purposes.”
• Projects use sponsorship when they need deductible fundraising before a Form 1023 determination arrives, when the work is time-limited (a film, a study, a festival), when the founders want to test the idea before building a board and bylaws, or when a foreign project wants US donors.
• Foreign projects carry extra rules. Rev. Rul. 68-489 points to Rev. Ruls. 63-252 and 66-79 “for requirements with respect to deductibility under section 170 of the Code of contributions by individuals to a charity organized in the United States that thereafter transmits some or all of its funds to a foreign charitable organization.” Those rulings treat a domestic charity that only forwards the money as
• The project’s activities have to fit the sponsor’s exempt purpose. An arts organization can sponsor a mural project; it can’t sponsor a candidate’s campaign, and it shouldn’t sponsor a food bank unless its purposes are drafted that broadly.

How does Model A (the project as a program of the sponsor) work?

The project becomes part of the sponsor. There’s no separate legal entity doing the work: the project’s staff are the sponsor’s employees, its contracts are signed by the sponsor, its bank account is the sponsor’s, and the sponsor’s board has final say. The project keeps its own name, its advisory committee and its fundraising identity, and the sponsor keeps a percentage of what comes in to cover payroll, accounting, insurance and oversight.

• The donor writes the check to the sponsor with the project’s name in the memo line. The sponsor issues the acknowledgment letter under IRC 170(f)(8) on its own letterhead, with its own EIN, because it’s the donee organization.
• Payroll is the sponsor’s. Withholding, W-2s, unemployment insurance and workers’ compensation all run under the sponsor’s accounts, and employment claims land on the sponsor.
• The project’s revenue and expenses sit inside the sponsor’s books and inside its Form 990 as one of the sponsor’s program services. The project files nothing of its own because it isn’t a taxpayer.
• Model A gives the cleanest answer on donor deductibility, because the sponsor’s control is total. It’s also the most work for the sponsor, and the sponsor carries the liability.

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

The sponsor takes the donations, decides the project’s work furthers its exempt purpose, and makes a grant to a project that runs itself. The project has its own entity or unincorporated association, its own bank account, its own staff and its own contracts. From the donor’s chair nothing changes: the gift goes to the sponsor, the sponsor sends the acknowledgment. Behind that, a grant agreement sets the charitable purpose, the restrictions, the reporting the project owes, and the sponsor’s right to take back unused funds.

• A common claim is that the sponsor “must exercise expenditure responsibility under IRC 4945(h).” That’s a private foundation rule. IRC 4945(d)(4) makes a grant to a non-public-charity a taxable expenditure “unless … the private foundation exercises expenditure responsibility,” and 4945(h) defines that as “all reasonable efforts and … adequate procedures (1) to see that the grant is spent solely for the purpose for which made, (2) to obtain full and complete reports from the grantee on how the funds are spent, and (3) to make full and detailed reports with respect to such expenditures to the Secretary.”
• A public charity sponsor isn’t subject to 4945. It still needs the same three things, because a pre-grant inquiry, a written agreement and grantee reports are how it shows the control Rev. Rul. 68-489 requires. If the sponsor is a private foundation, the procedures stop being good practice and become the law.
• The sponsor has less liability in Model C, since the project signs its own leases and employs its own people, and less control, which is the trade. A sponsor that never reads the reports and never turns a request down is drifting toward conduit status.
• Private benefit is the exposure for both models. Treas. Reg. 1.501(c)(3)-1(d)(1)(ii) requires that an exempt organization “serves a public rather than a private interest” and is “not organized or operated for the benefit of private interests such as designated individuals, the creator or his family.” A for-profit venture wearing a sponsor’s exemption to collect deductible gifts puts the sponsor’s status at risk.

What’s variance power, and what should the agreement say?

Variance power is the sponsor’s written right to redirect the donated funds away from the project if the project can’t or shouldn’t use them. It’s the contractual form of the “control and discretion” in Rev. Rul. 68-489. Sponsors almost never use it, and that’s fine; what matters is that the right exists, the project can’t override it, and the donor understands the designation is a preference the sponsor honors as long as it can.

Point	Model A (program of the sponsor)	Model C (pre-approved grant)
Legal home of the project	Inside the sponsor	Separate entity or association
Who employs the staff	The sponsor	The project
Whose name is on contracts and leases	The sponsor	The project
Where the money sits	The sponsor’s accounts	Granted out to the project’s account
Sponsor’s control	Total; the board runs the program	Grant agreement, reports, right to reclaim unused funds
Sponsor’s liability	Full	Limited to its own conduct and grant oversight
Form 990 treatment	Project revenue and expenses inside the sponsor’s return as a program service	Grant reported as an expense; Schedule I once grants to any one domestic organization pass $5,000
Who issues the donor acknowledgment	The sponsor, as donee under 170(f)(8)	The sponsor, as donee under 170(f)(8)
Exit	Assets transferred to the new 501(c)(3) as a grant	Agreement ends; remaining grant funds released or returned

• Put the variance clause in plain words: the sponsor may, in its sole discretion, apply the funds to any purpose within its exempt mission if the project becomes impossible, impractical or inconsistent with that mission.
• Set the fee, what it covers, and what costs (payroll processing, benefits, legal review) are extra. The donor’s deduction is the full gift; the fee is a cost the project bears out of the funds.
• Write the reporting the project owes and the records the sponsor keeps, since Rev. Rul. 68-489 turns on the sponsor being able to show the funds were used for exempt purposes.
• Write the exit before the entry: what happens to remaining funds, equipment, the mailing list and the name when the project gets its own determination or the relationship ends.
• Decline a gift that comes with a hard condition that the money go only to the project no matter what. That condition contradicts variance power, and taking it invites the conduit argument.

How does the sponsor report it on Form 990?

As its own activity. In Model A the project’s contributions are the sponsor’s contributions, its expenses are the sponsor’s program expenses, and a sizable project appears as a program service with its expenses and revenue. In Model C the sponsor reports the gifts as revenue and the grant as an expense, and the Form 990 instructions send it to Schedule I once it reported “more than $5,000 of grants and other assistance to any domestic organization.” The Form 990 guide covers the return itself.

• Part IV, line 21 is the trigger: “Answer ‘Yes’ if the organization reported in column (A) of Part IX, line 1, more than $5,000 of grants and other assistance to any domestic organization, or to any domestic government.” The instructions give the counter-example of two $4,000 grants, which doesn’t trigger it.
• Grants to a foreign project go through Schedule F instead once they pass $5,000 to any one foreign organization (Part IV, line 15), with the added deductibility rules noted above.
• The acknowledgment the donor receives should describe the gift as a contribution to the sponsor for the named project, with the three elements the substantiation rules require. Any premium or benefit the project gives donors is the sponsor’s quid pro quo disclosure problem.
• If a fiscally sponsored project sells things or runs a business, the unrelated business income is the sponsor’s too.

When should the project get its own 501(c)(3), and how does the transition work?

When the fee costs more than running a small charity would, when the project plans to exist indefinitely, when a funder insists on an independent determination letter, or when the mission has drifted from the sponsor’s. The mechanics reward planning: under the Form 1023 instructions, “if you file Form 1023 within 27 months after the end of the month in which you were legally formed, and we approve your application, the effective date of your exempt status will be your legal date of formation.” File later and exemption generally starts on the filing date instead.

• Keep the sponsorship running while the application is pending, so donors keep getting deductible acknowledgments from the sponsor. The gifts made during that period were gifts to the sponsor, and those letters stay valid after the project leaves.
• In Model A the sponsor transfers the project’s remaining cash, equipment and other assets to the new organization as a grant, reported like any other grant on its return. In Model C the sponsor releases whatever grant funds remain under the agreement and the agreement ends.
• Recurring donors need a note telling them where the next gift goes. The project’s first independent return is due for its first year as a separate filer; the sponsor keeps its records of the sponsored period with the rest of its Form 990 records.
• A project that leaves its sponsor and then files late for its own exemption has a gap, from its formation date to its filing date, when gifts made directly to it were not deductible. The 27-month rule is the reason to file early, or to stay sponsored until the determination arrives.

What should I do next?

If you’re a project, find a sponsor whose stated exempt purpose covers your work, read its variance clause, and ask what the fee includes. If you’re a charity thinking of sponsoring, write the policy first: how you vet a project, what you charge, what reports you require, how you exit, and who on the board signs off. If you’re already in an arrangement, check that the acknowledgments name the sponsor, that the sponsor’s Form 990 reflects the project, and, for Model C, that the grant reports actually exist.

• Nonprofit Form 990 filing guide, where the sponsor reports the project
• Donor acknowledgment letters, the three elements the sponsor has to put in every letter
• Grant management and restricted funds, the grant agreement and reporting discipline Model C depends on
• Starting a 501(c)(3), the application the project files when it’s time to leave
• Governance and conflict of interest, the board review a sponsorship should get
• Nonprofit UBIT, if the sponsored project earns business income

Related guides:

• Choosing a Tax Year: Calendar Year vs. Fiscal Year for Small Businesses

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