Pass-through funds for nonprofits are recorded as a liability rather than revenue whenever the organization is simply holding money on behalf of a named beneficiary and has no authority to redirect it. The test is control: if your organization can decide how the money gets spent, you have a contribution that belongs on your Statement of Activities. If you are legally bound to forward the funds to a specific party, you have an agency transaction that sits on your balance sheet as “Funds Held for Others” until you disburse it. Getting this wrong inflates reported revenue, distorts the public support ratio, and can trigger IRS reclassification from public charity to private foundation.
Agency Transaction or Contribution
An agency transaction has three parties: the original donor, your nonprofit, and the ultimate beneficiary the donor named. Your organization sits in the middle and forwards the money. A contribution, by contrast, means your organization receives assets and gains economic control over them, even if the donor restricted the use to a broad program area like “education” or “disaster relief.”
The governing rules sit in FASB Accounting Standards Codification (ASC) 958-605, and the central concept is variance power: the unilateral right to redirect transferred assets to a beneficiary or purpose different from what the donor specified. Variance power typically appears, or is explicitly denied, in the gift instrument, grant agreement, or the organization’s charter. A donor who writes a check with instructions to pass it to a named school, where your governing documents give you no authority to send it elsewhere, has created a textbook agency transaction.
A second pathway to contribution treatment exists even without explicit variance power: financial interrelationship. Two entities are financially interrelated when one can influence the operating and financial decisions of the other and holds an ongoing economic interest in the other’s net assets. A university foundation that exists solely to support its affiliated university is the classic case. Transfers between financially interrelated entities are treated as contributions to the recipient because the relationship itself implies economic control.
Work the analysis in order. Check for variance power first. Then check for financial interrelationship. If neither applies and the donor has named a specific, unaffiliated beneficiary, default to agency treatment.
How to Record Agency Transactions
The journal entry on receipt is straightforward: debit Cash and credit a liability account, commonly labeled “Funds Held for Others” or “Agency Obligations.” If your organization receives $50,000 earmarked for an after-school program run by another nonprofit, you record $50,000 in Cash and $50,000 in Funds Held for Others. No revenue. No impact on net assets. When you disburse to the named beneficiary, you reverse the entry: debit Funds Held for Others and credit Cash. The full cycle lives on the balance sheet, and your Statement of Activities stays untouched.
Investment earnings while you hold the funds belong to the beneficiary unless the underlying agreement says otherwise. Record them as an increase in both the asset (Cash or Investments) and the corresponding liability. Your organization only recognizes revenue for administrative fees or expense reimbursements that the donor agreement explicitly authorizes.
Present Funds Held for Others as its own line item on the Statement of Financial Position, separate from accounts payable and other obligations. That separation lets auditors, board members, and grantors see at a glance how much of your cash balance actually belongs to someone else. Without it, your liquidity looks better than it is.
Fiscal Sponsorship: Two Models, Two Treatments
Pass-through questions come up most often in fiscal sponsorship, where an established 501(c)(3) receives and manages funds on behalf of a project or group that lacks its own exempt status. The accounting depends entirely on how the sponsorship is structured.
In a comprehensive fiscal sponsorship (sometimes called Model A), the sponsor takes full ownership of the project, which becomes one of the sponsor’s own programs. Contributions received for the project are donor-restricted revenue on the sponsor’s Statement of Activities, and the project’s expenses appear on the sponsor’s books. This is not a pass-through situation. The sponsor has variance power because it controls the project.
In a fiscal agency arrangement (a pre-approved grant relationship, sometimes called Model C), the sponsor acts as a conduit. It has no variance power, records donations as a liability, and forwards funds to the sponsored project according to the donor’s instructions. The sponsor books no revenue and no expenses for the project’s activities, except for any administrative fee it charges.
The distinction affects donors as well. Under a comprehensive fiscal sponsorship, donors get a charitable deduction because they are giving to the sponsor’s own program. Under a fiscal agency arrangement, the deductibility question is more complicated because the sponsor is not the true recipient.
Federal Sub-Awards Are Usually Not Agency Transactions
Federal grant pass-throughs work differently. When a nonprofit receives a federal award and re-grants a portion to another organization, the original recipient becomes a “pass-through entity” and the downstream recipient becomes a “subrecipient” under the Uniform Guidance (2 CFR Part 200). Because the pass-through entity typically exercises discretion over which subrecipients to fund and what terms to impose, the sub-award normally shows up as an expense on the pass-through entity’s books, not as a liability that washes out. Federal pass-throughs look like grant expenses unless the pass-through entity truly has no discretion over the distribution.
The Uniform Guidance imposes specific obligations before you issue a sub-award. You must verify in SAM.gov that the subrecipient is not suspended, debarred, or otherwise excluded from receiving federal funds. Every sub-award must identify itself as a sub-award and include the Federal Award Identification Number (FAIN), the subaward period of performance, the amount of federal funds obligated, the applicable Assistance Listings number, and the indirect cost rate, among other items.1eCFR. 2 CFR 200.332 – Requirements for Pass-Through Entities
Pass-through entities must also monitor the subrecipient’s use of funds, review financial and performance reports, and follow up on audit findings. Unlike a private-donor agency transaction, where your job ends when the check clears, federal sub-awards make you responsible for ensuring the downstream organization spends the money properly. That monitoring obligation runs the life of the sub-award.
Administrative Fees Are the One Revenue Piece
Organizations acting as pass-through entities or fiscal sponsors can usually charge an administrative fee for managing the funds. In private arrangements, the fee is whatever the parties negotiate and document: a flat percentage of the total grant, a fixed dollar amount per transaction, or reimbursement of specific documented expenses.
For federal pass-through grants, overhead recovery follows a structured framework. The Uniform Guidance allows nonprofits that lack a federally negotiated indirect cost rate to charge a de minimis rate of up to 15 percent of modified total direct costs. The rate requires no documentation to justify, and the organization can use it indefinitely until it negotiates a rate with the federal government.2eCFR. 2 CFR 200.414 – Indirect Costs
In an agency transaction, the administrative fee is the only amount that appears on your Statement of Activities. Document the fee arrangement in writing before funds are received, and disclose the fee amount or percentage to donors.
Form 990 Reporting
Form 990 treatment generally follows GAAP, but the IRS requires specific disclosures. Reporting starts at Part IV, Line 9, which asks whether the organization acted as an agent, trustee, custodian, or other intermediary for contributions or assets not included on the balance sheet.3Internal Revenue Service. Instructions for Form 990 A “Yes” answer triggers Schedule D, Part IV, where you report the details of escrow and custodial arrangements.
If you properly treat pass-through funds as agency transactions and report the liability on Part X, Schedule D, Part IV asks you to explain the arrangement in Part XIII (Supplemental Information). If you do not report the funds as an asset or liability on Part X, you must check “Yes” on Schedule D, Part IV, Line 1a and disclose the fund balances there instead.4Internal Revenue Service. Instructions for Schedule D (Form 990)
The critical revenue rule: when your organization collects funds merely as an agent for another entity, those funds are excluded from your gross receipts entirely. You do not include them in Part VIII (Statement of Revenue) or in the total revenue figure on Part I, Line 12.3Internal Revenue Service. Instructions for Form 990 If your audited financials and your Form 990 show different revenue figures because of the exclusion, Schedule D, Parts XI and XII provide the reconciliation.
Public Support Test Risk
Form 990 accuracy matters here because of the public support test. Most public charities classified under section 509(a)(1) must receive at least one-third of their total support from public sources to maintain that classification.5Internal Revenue Service. Form 990, Schedules A and B – Public Charity Support Test Organizations that fall below one-third but meet a 10 percent facts-and-circumstances test may still qualify. Below 10 percent, reclassification as a private foundation is virtually certain.
Pass-through funds incorrectly included as revenue inflate the denominator of the public support fraction, which can push the ratio in unpredictable directions depending on where the money came from. If the pass-through funds came from a single large donor, including them can actually make the ratio worse by concentrating support. Either way, the calculation becomes unreliable.
An organization that fails the public support test for a tax year and the preceding year gets reclassified as a private foundation beginning that tax year. The IRS has acknowledged that unexpected reclassification can produce harsh results, and it will not impose private foundation excise taxes for the first year of reclassification when doing so would be inequitable. That grace period is limited. Organizations that believe they failed the test due to unusual circumstances should contact the IRS promptly rather than wait for a notice.6Internal Revenue Service. Advance Ruling Process Elimination – Public Support Test
Audit Thresholds and Penalty Exposure
Federal pass-through funds can trigger a Single Audit. Any non-federal entity that expends $1,000,000 or more in federal awards during its fiscal year must undergo a Single Audit or a program-specific audit under the Uniform Guidance.7eCFR. 2 CFR 200.501 – Audit Requirements The threshold applies to fiscal years beginning on or after October 1, 2024. If your organization passes federal funds through to subrecipients, both your expenditures and theirs count toward the threshold.
Mishandling pass-through funds can also create exposure under the excess benefit transaction rules. If a disqualified person, meaning someone with substantial influence over the organization such as a board member or executive, receives an economic benefit from diverted pass-through funds, the IRS can impose an excise tax of 25 percent of the excess benefit on that person. Organization managers who knowingly participate face a separate tax of 10 percent of the excess benefit, capped at $20,000 per transaction. If the excess benefit is not corrected within the taxable period, the disqualified person owes an additional tax of 200 percent of the excess benefit.8Office of the Law Revision Counsel. 26 USC 4958 – Taxes on Excess Benefit Transactions
Keep pass-through funds in a segregated bank account, or at a minimum track them with a separate fund code in your accounting system. Maintain written agreements that spell out the beneficiary, the permitted uses, the administrative fee if any, and the disbursement timeline. When auditors or the IRS examine your books, they should be able to trace every dollar from receipt to disbursement without ambiguity. Organizations that commingle pass-through funds with operating cash and rely on spreadsheets to track the split are the ones that end up with audit findings and reclassification headaches.