Nonprofit accounting: How to Account for Fiscal Sponsorship

Nonprofit accounting: How to Account for Fiscal Sponsorship

In recent years fiscal sponsorship relationships have soared exponentially. Ever since the pandemic when so many nonprofit organizations have been struggling to obtain funding and so many had to close their doors – a new type of financial and legal relationship has emerged. Well, it is not new per se. The first known fiscal sponsorship dates back to 1959, when a Boston based nonprofit organization (today known as TSNE MissionWorks) started sharing support to semi-autonomous missions.

Forty-five years since the first fiscal sponsorship the official trade association was founded the National Network of Fiscal Sponsors (NNFS) in 2004. There has been a tremendous surge in fiscal sponsorship over the past half a century.

So what is exactly a fiscal sponsorship is a type of legal relationship between a nonprofit organization and another association, entity, a person or a project that lack a 501 (c) 3 nonprofit status. In this type of relationship, a nonprofit organization can lend its nonprofit status to another entity that lacks the exempt status for activities that align with the parent’s organization mission.

While it sounds pretty complex (and in fact can get complex) – the main idea is that the parent nonprofit (the fiscal sponsor) provides nonprofit status to the sponsoree (or a project).

Models of fiscal sponsorship relationships

Based on the legal agreement between he two parties, the fiscal sponsorship relationship can fall under one of the following models :

1. Direct project – model A
2. Independent contractor project – model B
3. Preapproved grant relationship – model C
4. Group exemption – model D
5. Supporting organization – model E
6. Technical assistance – model F
7. Payments “for the use of” sponsor – model X

The most commonly used model is a model A – direct project. As such, I will focus on reviewing this model in more detail in this article.

In a model A type of fiscal sponsorship, the sponsor takes the project in-house. The project is not a separate legal entity. Hence the sponsor takes legal ownership of the project and takes on all the risks associated with running the project. The revenue and assets associated with the project belong to the sponsor and reported on the sponsor’s financial statements and tax return (form 990). Legally the project is no different than any other activity that is carried out by the sponsor directly.

Model A also referred to as “incubator”, because this model is often used by nonprofits to teach the project the ropes of running a nonprofit organization. The financial relationship between the parent nonprofit and the project are as follows:

1. The people running the project become employees of the sponsor. Sponsor is responsible for payroll tax withholding, workers’ compensation insurance, unemployment benefits etc.
2. The expenses are paid by the sponsor and flow through the sponsor’s statement of activities (even if a separate bank account is established for the project and project staff and the signatories on the account – the bank account belongs to the sponsor).
3. The sponsor’s board of directors carried the ultimate responsibility for overseeing the project’s activity (sponsoree’s activity).
4. The project personnel may write their own grants and solicit donations, however the ultimate responsibility to the donor and grantors carries the sponsor. The sponsor should review all the fundraising materials and grant proposals before they are issued or submitted.
5. Typically, in this type of relationship the funds raised for the project are restricted and are required to be reported as such on financial statements and tax return (form 990).
6. The sponsor may decide that a certain portion of the funds raised be kept for sponsor’s management and administrative expenses and overhead (as long as it does not contravene with any grant or donor agreements).
7. The sponsor carries all the liabilities in case of unpaid bills by the project or in case of injuries or damages caused by the project employees.
8. If in the course of running the project there were acquired or created some assets (furniture and equipment, buildings, land or work of art, other tangible and intangible assets) – they belong to the sponsor.

Fiscal Sponsorship – model A

Below is a visual presentation of what model A looks like:

Here is an example of a model A fiscal sponsorship: A local artists want to provide art lessons to children in the north suburbs of Chicago. An established Arts’ nonprofit helps this group of local artists to obtain funding and set up classes in their respective neighborhoods. All the funding raised by the artists would be recorded in the Arts’ nonprofit’s books. Moreover, the nonprofit can charge a fiscal sponsorship fee to help fund its general and administrative operations. Below we detail out the journal entry would be made record funds received by the nonprofit for the purposes of the local arts project.

Fiscal Sponsorship Journal Entries

Dr.	Cash	$100,000
Cr.	Restricted contribution revenue	$100,000

The contribution revenue is recorded as restricted. If nothing is spent at year end, the entire amount would be recorded in the restricted net assets and the revenue would be classified as revenue with donor restrictions on the statement of activities.

Then when expenses are incurred on this project (let’s next fiscal year) the following journal entry would be recorded:

Dr.	Program expense	$50,000
Cr.	Cash	$50,000

Then the release of net assets would need to be recorded as well with the following journal entry:

Dr.	Net assets with donor restriction – released	$50,000
Cr.	Net assets without donor restriction - released	$50,000

As stated above, all the transactions are recorded in the sponsor’s books and treated as restricted. Keeping track of the restrictions and all of the ins and outs of the cash can get pretty complex, so hiring a nonprofit accountant or nonprofit CPA with experience in nonprofit accounting is best to keep your nonprofit organization on the right track.

And finally, I would like to talk about the importance of the exit strategy determined for these types of relationships. In his book “Fiscal Sponsorship: 6 ways to do it right” Gregory L. Colvin called it the “leaving the nest” phenomenon. In his book he described the most important aspects that should be put into writing in order to ensure smooth separation from the nonprofit organization. The following items should be set forth by a resolution:

1. Tangible assets associated with the project should be identified (including cash, equipment, supplies etc.)
2. Intangible assets should be identified as well (things like logo, mailing lists, copy rights etc.)
3. Liabilities associated with the project should be clearly defined (borrowed funds, unpaid bills etc.)
4. Determine the preconditions for the project to be released by the sponsor (i.e. should the project obtain its own 501 c 3 status or should it find another fiscal sponsor etc.)
5. Define ultimate authority – assuming all the preconditions have been met, who has the ultimate decision-making authority. (Would it be the sponsor’s executive director, or the board or some other committee?)
6. Determine the methods of transferring the assets and liabilities.
7. Provide for the enforceability of the terms of separation.

In conclusion, accounting for fiscal sponsorship agreements is very complex and hiring a specialized nonprofit accountant or nonprofit CPA as well as engaging an attorney to draw up a fiscal sponsorship agreement is of paramount importance. If you need help with accounting for fiscal sponsorship from a nonprofit accountant or nonprofit CPA – do not hesitate to contact us directly. At WCC we specialize in not-for-profit accounting, and it is our mission to help mission-based organizations to achieve their mission.