How to create social change without becoming a 501(c)(3)

Disclaimer: I am not an attorney. The following post cannot and should not be taken as legal advice (it isn’t). It’s just meant to give you references to consider your legal options as you are deciding what is the best course of action for you to pursue in order to get your not-for-profit idea off the ground and to make it sustainable.


When you want to create social change there are several ways to accomplish it. You can do it by being part of a larger organization (a for-profit with a deeply engrained social credo and a track record of socially responsible behavior or an established nonprofit that you feel identified with), you can start your own nonprofit organization or you can go at it alone. Right? Well, sort of.

There are options “between” those options that enable you to surround yourself with the appropriate corporate structure to let your mission spread its wings without the burden or barriers that come with some of the most commonly chosen options. You can think of the following few paragraphs as one of the things I wish I had known when we first formed our nonprofit: I will be discussing the concept of Fiscal Sponsorship, an option that falls somewhere between “going at it alone” and “starting your own nonprofit.”

The difference between being a nonprofit and being tax-exempt
There is a concept that is often misunderstood: the difference between being a nonprofit and being a tax-exempt organization. To become a nonprofit, you create articles of incorporation and bylaws and file them with your state’s attorney general. You also set up a board of directors and paying a filing fee, give or take (different states will have different requirements). Even if you get legal help, before you embark on the trip of forming a nonprofit, I highly recommend you read the Nolo book about forming a nonprofit (there is one specific to California, if you need it).

Once you have incorporated and registered your organization as a nonprofit with your state, you still are not a tax-exempt organization. This means, if you do nothing else, your income will be taxed as any other for-profit entity and any donations you may receive are not tax deductible (to the donor).

There may be good reasons to do nothing else and continue as a nonprofit without having tax exempt status, but because of the extra work it entails, I am not sure this would be in your organization’s best interest. Some of the things you need to do as a nonprofit are:
• Act as a nonprofit, i.e. work towards your mission as a nonprofit public charitable corporation, not organized for the private gain of any person.
• Hold board meetings, keep minutes of the meetings.
• Set up bank accounts and maintain books for the nonprofit.

Though this may not sound as much, if you are a small nonprofit, keeping up with these administrative tasks may feel to you like you are not focusing all your time and energy doing what your nonprofit mission calls for.

At this point, one natural path you may want to pursue is to apply for 501(c)(3) tax-exempt status. There are other types of 501(c) organizations you can apply for: most do not give you tax-exempt status –neither the corporation is exempt from paying income tax nor are the donations they receive tax exempt to the donor. In this post I am only dealing with organizations that qualify for 501(c)(3) status.

I won’t lie to you: the application process (from filing an IRS 1023 application to obtaining your 501(c)(3) status) can become lengthy, costly and even a bit exhausting (you may also find it to be straightforward, but I can’t say that from my own experience).

Only once you receive your letter of approval from IRS stating you have been granted 501(c)(3) status are you exempt from paying taxes on business-related income. Also, at that point all donations you receive become tax deductible, you become eligible for many more foundation and government grants and you can take full advantage of benefits such as the ones offered by TechSoup, Google Grants and YouTube’s Nonprofit Program.

Fiscal Sponsorship: an alternative route
You may be wondering if there is an alternative to pursuing the 501(c)(3) route, at least initially. There is no other way to have ALL the benefits that a 501(c)(3) has access to, but if you are willing to sacrifice some things, you can apply for a fiscal sponsorship.

First off, you can think of a fiscal sponsorship as a way to “incubate” your social change project under an existing nonprofit.

To help explain the concept of fiscal sponsorship better, I interviewed M. Melanie Beene, President and CEO of Bay Area-based fiscal sponsor Community Initiatives. The Diabetes Hands Foundation, the nonprofit I lead, recently became a fiscally sponsored project of Community Initiatives.

What is a Fiscal Sponsor?
Melanie Beene:
When a nonprofit, 501(c)(3) corporation agrees to oversee other nonprofit activity (a fiscally sponsored project) in order to allow that project to be able to solicit grants from foundations and corporations and to provide its individual donors with tax-exemption for their contributions, the relationship is called fiscal sponsorship. There are six ways to structure this relationship and they are outlined in the only book on the topic, “Fiscal Sponsorship, 6 Ways To Do It Right,” by Gregory L. Colvin, available from Study Center Press.

Different fiscal sponsors provide different services in addition to fiscal sponsorship itself. For example, Community Initiative provides its full-service projects (Model A in Colvin’s system) with financial accounting, reporting, auditing, full human resources services such as payroll and benefits administration (health, dental, vision, disability, 401(k), flexible spending accounts), grants management, and comprehensive insurance at no cost. We also provide problem solving and risk management consultation and discounted legal referrals as needed. (For more detail see: www.communityin.org.)

Other fiscal sponsors may provide shared office space and bulk purchases of supplies as well as other services.

What are the main advantages of becoming a fiscally sponsored project?
MB: The main advantages are:
• Timing: you get the benefits of tax exemption quickly while waiting to submit and have the IRS process your application. Or if you need to respond quickly to a critical situation (e.g., natural disaster) a fiscal sponsor can be a way to receive donations quickly.
• Incubation: you may not want to invest the time and money to incorporate and develop organizational infrastructure until you have tested your idea and are convinced it is viable and has attracted funding.
• Ability to concentrate on your programmatic work: some of our projects don’t want to evolve into their own organizations because they are happy to have the back office functions handled by a fiscal sponsor who has qualified staff dedicated to Finance, HR, and Grants management.
• Economies of scale: most small nonprofits don’t have the staff or expertise to negotiate for lower costs that a larger organization can, particularly in the area of payroll, benefits administration, insurance and risk management services.
• If your project is one of limited duration it doesn’t make sense to create a corporation. Many collaborative partners (e.g., multi-funder or multi-agency) often prefer to use a neutral third party home for their activities. Fiscal sponsorship gives you a way to easily set up a professional infrastructure.

What are the disadvantages of becoming a fiscally sponsored project?
MB: Initially, I don’t think there are many disadvantages. Here are some:
• Some funders may not accept proposals from fiscal sponsors.
• Depending upon an organization’s budget size (and the corresponding fee it pays its fiscal sponsor), there may come a time when the project can get the same services by spinning off to become its own nonprofit and hiring staff to do what the fiscal sponsor has been doing.
• All the project revenues must be housed with the fiscal sponsor who takes financial and programmatic responsibility for them. For some, this may initially feel like a loss of control, but operationally at Communitiy Initiatives, it’s never been an issue.
• Projects with a lot of individual donors sometimes feel that it’s harder to assert their brand identity using a fiscal sponsor, although we use their logo on our website and accept donations in their own names.

How does a person/group apply for fiscal sponsorship? What are the requirements?
MB: The requirements vary by fiscal sponsor. A directory of fiscal sponsors is available at www.fiscalsponsordirectory.org. At Community Initiatives we vet the nonprofit purpose and we need to see a minimum of $24,000 per year in revenues. Other fiscal sponsors have higher floors and some have none.

If you have already formed a nonprofit, can you still apply for fiscal sponsorship?
MB: The response to this will vary by fiscal sponsor. At Community Initiatives we have several groups that already have their nonprofit status, but while they are with CI all their revenues go through us.


It is my hope that this post helps you find alternative ways to develop the necessary structure to develop and support your social change project. Perhaps the best option for you is creating your own nonprofit and applying for tax-exempt status. Perhaps it will be best for you to apply for fiscal sponsorship. At least, if you know the options, you can make a better-informed decision.