How Does a Nonprofit Fiscal Agency Work?

Fiscal agency involving nonprofit organizations is an agreement for a tax-exempt charitable organization to accept donations on behalf of an organization that has not been granted tax-exempt status by the IRS or one that does not meet the criteria a foundation sets for receiving a grant. Some foundations allow a tax-exempt organization to act as fiscal agent for another organization for various reasons. The fiscal agent agreement is more than an act of kindness from a big nonprofit to a startup. It is a legal action that has consequences.

The agent in the fiscal agency relationship acts on behalf of the principal -- the organization that receives the pass-through grant -- and has no control over the donation or the project the funds are intended to support. The fiscal agent merely acts a pass-through organization to allow another organization to receive the donation. The principal controls the agent's activities and has no obligation to provide information to the fiscal agent or allow involvement beyond acceptance of the donation.

Many foundations cannot legally make donations to organizations that are not tax-exempt under section 501(c)(3) of the IRS tax code. Some organizations don't have tax-exempt status because they are waiting for a decision from the IRS or they are foreign organizations that have not applied for exemption. Some foundations restrict their financial support to established organizations. Fiscal agents sometimes accept funds for organizations that are tax-exempt, but don't have the infrastructure to manage funds and provide the required record-keeping. Foundations cannot make grants to individuals. The use of fiscal agents by some foundations, like the National Endowment for the Arts, solves the problem of the grants being taxed as personal income for the individual recipients.

An organization that is not tax-exempt finds a foundation that is a good match and that allows fiscal agency. The organization identifies and meets with a 501(c)(3) organization, preferably one with a similar mission, to discuss the project or need and ask about fiscal agency. Fiscal agents usually charge administrative fees for the service. Foundations that allow fiscal agency have guidelines for acceptable fiscal agents and procedures for applying for and receiving the donation. A formal agreement will prevent problems down the road and ensure that all parties behave as expected.

The IRS allows charitable deductions on income tax returns only for donations made to 501(c)(3) organizations. The IRS may determine that the donation passed through a fiscal agent is not a charitable donation made to a tax-exempt organization and eligible for a tax deduction. The IRS considers the donation a gift to the tax-exempt charity only if it retains some control over the funds it passed along to the other organizations. Because the donation is earmarked for a specific organization or use, the IRS may ignore the involvement of the fiscal agent and determine that the donation was made directly to an organization that is not tax-exempt.

Many people in the nonprofit world use the words "fiscal agency" and "fiscal sponsorship" interchangeably, but attorneys distinguish between the two, explaining the difference in terms of agency laws and control over the funds. Fiscal sponsorship requires the fiscal sponsor to accept responsibility for proper use of the funds and the operation of the project the funds support. The fiscal sponsor may exercise control over the recipient organization and is liable for reimbursing the foundation for funds used improperly.