Any organization established for the purpose of carrying out charitable work can technically call themselves a nonprofit. But, to meet the strictest legal definition of a nonprofit, organizations must comply with nonprofit registration requirements at both the state and federal levels.
Going through the nonprofit registration process at the state level is simple and affordable. Usually, the entire application can be completed online through your relevant Secretary of State’s webpage. Once registered, the organization is considered a nonprofit corporation.
Nonprofit corporations receive an Employer Identification Number (EIN) and must file taxes on their income. Nonprofits without the federal 501(c)(3) status usually collect their funding through membership fees, corporate donors, and individuals. However, donors cannot write-off contributions on their own tax returns.
Drawbacks of Nonprofit Corporations
Without completing the 501(c)(3) registration process, a nonprofit is not exempt from federal taxes.
Additionally, grantmakers and foundations will not consider funding nonprofit corporations, as their own mandates prohibit them from doing so. Organizations that are not 501(c)(3)s also cannot qualify for state or federal government grants.
Not taking the next step in the nonprofit registration process can leave a lot of money on the table.
Downsides of 501(c)3s
On the other hand, applying for (and maintaining) 501(c)(3) status is a complex process that can create extra paperwork and tracking requirements.
501(c)3 organizations are regulated by the Internal Revenue Service (IRS). The IRS requires all 501(c)(3) nonprofits to file the 990 tax form annually. This can add accounting costs on top of an organization’s operating expenses.
If your organization has a very small amount of revenue and rarely seeks out donations, going the 501(c)(3) route may have more pros than cons.
But what do you do if your nonprofit corporation finds the perfect grant opportunity? This is an ideal scenario for an alternative to 501(c)(3) registration: working with a fiscal sponsor.
What is a Fiscal Sponsor?
Essentially, a fiscal sponsor is a nonprofit organization with 501(c)(3) status that commits to partnering with an unregistered nonprofit corporation.
Fiscal sponsorship agreements can vary, but generally, the 501(c)(3) organization will oversee the financial aspects of grant management, including receiving and distributing funds and reporting expenses.
Collaborating with a fiscal sponsor enables a nonprofit corporation to apply for funding opportunities they otherwise would not be eligible for. These arrangements can also help nonprofit staff learn the ropes of grant management from more experienced leaders before taking on the 501(c)(3) status.
Types of Fiscal Sponsorship Models
Before working with a fiscal sponsor, nonprofit corporations should determine which relationship model best suits their mission, vision, and program delivery methods.
The three most common types of fiscal sponsor partnerships include:
Direct Project
In this relationship model, the sponsor has complete liability and responsibility for the project. While the individuals who carry out the programming can help shape the program or projects design and delivery, the sponsor will have the final say.
Any grant awards or donations for the project will be given directly to the sponsor, which then distributes the money as stipulated in the grant or funding agreement.
Pre-approved Grant Relationship
Under this model, the nonprofit corporation takes on the majority of the responsibility for completing the project and obtaining the stated outcomes. The fiscal sponsor’s main responsibilities are receiving and distributing the funds.
Independent Contractor
Nonprofits with 501(c)(3) status may need the support of unregistered or for-profit entities to advance their mission. For example, a literacy organization may need to hire trained phonics tutors to administer a reading program. In this case, the registered nonprofit will act as a fiscal sponsor for the independent contractor. As in the direct project model, the fiscal sponsor is still responsible for the project’s outcomes and conducting fiscal oversight.
When to Consider a Fiscal Sponsor
Working with a fiscal sponsor may be a good fit for your nonprofit corporation in the following scenarios:
- A grantmaker has shown interest in funding your organization, but you are not 501(c)(3) registered
- You want to scale your fundraising efforts, but lack technical experience or the people power to take on the extra workload
- Your organization can’t afford the legal, financial, and administrative requirements that come with creating and maintaining a nonprofit (state and federal registrations, tax filings, and financial audits)
- Your programming/services are most effective when under the umbrella of a larger organization with a broader mission
- You are an artist, musician, or writer seeking grant funding.
Pros and Cons of Fiscal Sponsorship
Advantages
You can apply to more grant opportunities
While being a nonprofit corporation won’t preclude you from applying to all grants, you will have difficulty qualifying for the majority of funding opportunities. Grantmakers are more likely to accept applications from nonprofit corporations partnering with fiscal sponsors than those without any 501(c)(3) status.
You can get technical assistance and support
Nonprofit organizations that offer fiscal sponsorship as part of their programming models often include administrative and technical support alongside their partnership. Your organization may have to pay a small fee, but the skills your staff will gain will be more than worth it.
Disadvantages
A good fiscal sponsor can be difficult to find
Having a 501(c)(3) status is the only real criteria a nonprofit organization needs to have to serve as a fiscal sponsor. Unfortunately, this does not ensure that an organization has the capacity or knowledge to execute an effective partnership. Working with a poorly-managed fiscal sponsor can cause disruptions to your program delivery.
Additionally, the best fiscal sponsorships occur between organizations with very similar missions and visions. It can be difficult to find a sponsoring organization that aligns not only with your goals, but also your methods.
There will be grants you cannot qualify for
Fiscal sponsors add an additional layer between the grantor and the grantee. This can create communication barriers between the funding organization and the recipient. For this reason, some grantmakers and foundations exclude applicants with fiscal sponsorships.
A nonprofit can outgrow a fiscal sponsorship
The fiscal sponsorship model can restrain the types of activities or programs that a sponsored nonprofit corporation can pursue. A nonprofit that needs to scale rapidly to meet the demand for their services may be better off registering as a 501(c)(3) tax-exempt entity and securing funding on their own.
How to get a 501(c)(3) for free
Filing for 501(c)(3) status can be time consuming, but it’s something anyone in your organization can do for free. Be wary of online services that offer to file for your 501(c)(3) status for a fee.
You can find the IRS’s registration instructions through a quick Google search. Type “Nonprofit registration + IRS”, and you will find all the requirements and application processes applicable to your nonprofit.
If you’re ready to take the next step, check out the Ultimate Guide to Grant Writing. This course will help you get grant ready, find the perfect grants, write incredible grants, and do strategic planning for your nonprofit.
