Fiscal sponsorship and donor advised funds for charitable endeavors
Creating a new charity can be an exciting prospect. There is an urgent need, or a long-term purpose, and the instinct is to build an organization to carry it. For most founders, that instinct typically leads straight to incorporating a nonprofit corporation and filing for tax exemption.
Forming a charitable organization is not a quick process. While incorporating the entity is relatively straightforward, obtaining IRS recognition as a tax-exempt charity under Section 501(c)(3) is not, and the application can take many months to clear. Tax-exempt status then brings regular obligations, including filing an annual public Form 990 with the IRS, maintaining accounting practices consistent with FASB guidance for nonprofit entities, insurance, charitable solicitation registrations in every state where the organization fundraises, and in many states, an independent audit. For founders who want to move quickly, that timeline and overhead are often the deciding factor.
However, there are alternatives to establishing a new nonprofit corporation that may be attractive for those publicly fundraising. Even when an individual, a family, or a corporation is going to fund a charity, considering options other than a private foundation is a valuable exercise.
Specifically, a Fiscally Sponsored Project or a Donor Advised Fund (DAF) allow a project to start more quickly and place the compliance burden on an existing organization. Both are worth evaluating before forming a new nonprofit corporation.
Fiscally Sponsored Project
Under this model, a founder designs a charitable project and operates it within an existing public charity’s 501(c)(3) exemption rather than forming and qualifying a new entity. The project can begin work — and accept tax-deductible contributions — without waiting for IRS recognition of its own.
By leveraging an established public charity as its fiscal sponsor, the project founder is able to focus on such mission-related work as:
- Testing and improving on charitable aims
- Operating project activities
- Building alliances
- Identifying grant recipients
- Focusing on any needed public fundraising
Meanwhile, the fiscal sponsor takes on the functions that might otherwise consume a new organization’s first year:
- Maintaining accounts for sound financial management
- Drafting legally sound vendor contracts
- Conducting due diligence on grantees to ensure qualifications under law
- Complying with IRS and state legal and tax requirements for charities
Fiscal sponsors frequently offer employment and benefits to the project’s staff, carry commercial liability insurance, and handle other regulatory obligations such as lobbying registration.
What This Means in Practice
A Fiscal Sponsorship Agreement
Fiscal sponsorships require a written agreement between the project’s leaders and the fiscal sponsor, and its terms carry real consequences. Counsel can help structure an agreement that delivers the services the project needs while protecting the fiscal sponsor’s exempt status and required oversight. Fiscal sponsors typically retain a percentage of a project’s revenue to cover administration and compliance.
Who Controls What
The project generally has no board, corporate governance, or legal compliance to manage, though it may have an advisory committee offering support. It typically maintains its own brand, manages a domain associated with that brand, and selects its charitable activities, but the fiscal sponsor must retain ultimate control and discretion to ensure legal compliance and fiscal integrity.
Donor Advised Funds
Donor Advised Funds are a popular alternative for taxpayers who want to guide their charitable giving over time to a charity, or set of charities, whose activities they value. The donor makes a qualifying charitable contribution to a public charity that administers DAFs (the so-called DAF sponsor) — and takes the deduction in the year of the contribution, then recommends grants to operating charities from the DAF over time. The contribution is irrevocable; the donor’s continuing role is to recommend grants, not to direct them. While DAFs are frequently used in tax planning, they are also an effective vehicle for advancing charitable aims. DAF sponsors include community foundations and large national charity funds affiliated with financial services firms.
A DAF may be a good alternative to forming a public charity for a specific need, particularly where one or more of these circumstances exist:
- Existing charities are capable of managing the activities and need funding to scale in alignment with the donor’s charitable objectives
- A collection of individuals and/or companies is interested in consolidating efforts to coordinate contributions for effective use of charitable funds
- Private foundations are interested in specified charitable objectives and trust the DAF charity administrator with restricted giving
What This Means in Practice
An Alternative to a Private Foundation
A DAF enables donors to support causes they care about without having to set up a separate charitable organization. For a donor whose goal is directed giving rather than managing the operation of charitable activities or giving immediately to a specific organization, a DAF delivers much of the benefit at a fraction of the complexity.
Collaborative Giving
Community foundations have long used this model to enable individuals and companies to plan their giving while accumulating funds in an account. Some also permit an “advisory committee” for a particular charitable purpose, which creates a way to attract contributions toward a defined objective rather than a particular charitable entity, such as supporting summer programs for children’s organizations in low-income communities, or granting funds to charities working on health access. Where those collaborative options exist, a donor can invite others to contribute to the fund and recommend grants toward a shared purpose and specified charities. That is a meaningful alternative to founding an organization for the purpose of convening other funders.
Who Controls What
As with a fiscal sponsorship, the donor gives up formal control over where the funds are used, retaining an advisory role through the account agreement with the DAF sponsor. More specifically:
- Charitable activities are not managed by the donor or the DAF sponsor
- The donor’s role in grantmaking is advisory only
- The DAF sponsor maintains control and discretion over grants from the fund to qualified charities
- Account agreements may carry restrictions worth reviewing, such as prohibitions on lobbying or on grants to foreign entities
The Bottom Line
Using a fiscal sponsorship or DAF can be an effective option for projects or donors who want to avail themselves of existing charitable structures and can provide an opportunity to pursue a mission without having to invest money, time, and other resources into a new nonprofit corporation infrastructure.
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The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
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