Pass-through funds for nonprofits are recorded as a liability rather than revenue whenever your organization is simply holding money on behalf of a named beneficiary and has no authority to redirect it. The test is control: if you can decide how the money gets spent, it’s a contribution and belongs on your Statement of Activities. If you’re legally bound to forward it to a specified party, it’s an agency transaction that sits on your balance sheet as “Funds Held for Others” until you disburse it. Getting this wrong inflates your reported revenue, distorts your public support ratio, and can trigger IRS reclassification from public charity to private foundation.
Contribution or Agency Transaction
An agency transaction involves three parties: the original donor, your nonprofit, and the ultimate beneficiary the donor has designated. You sit in the middle, receive the money, and forward it. You never own the funds in any meaningful sense. A contribution, by contrast, means your organization receives assets and gains economic control over them, even when the donor restricted them to a broad program area like “education” or “disaster relief.”
The governing rule comes from 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. If you have it, the transfer is a contribution. If you don’t, and you’re legally bound to send the money to a named party, the transfer is an 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 has an ongoing economic interest in the other’s net assets. A university foundation that exists solely to support its affiliated university is the classic example. Transfers between financially interrelated entities are treated as contributions to the recipient regardless of variance power.
Work the analysis in that order. Check for variance power first. Then check for financial interrelationship. If neither exists and the donor has named a specific, unaffiliated beneficiary, you have an agency arrangement.
Recording the Funds on Your Books
When you receive pass-through funds in an agency transaction, the journal entry 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 the funds to the named beneficiary, you reverse the entry: debit Funds Held for Others and credit Cash. The entire cycle lives on the balance sheet. Your Statement of Activities stays untouched.
Investment earnings on pass-through funds while you hold them belong to the ultimate 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 from any administrative fees or expense reimbursements explicitly authorized in the donor agreement.
On your Statement of Financial Position, present Funds Held for Others as a distinct liability line item, separate from accounts payable and other obligations. Without that separation, your liquidity looks better than it is, and auditors, board members, and grantors can’t see at a glance how much of your cash balance actually belongs to someone else.
Fiscal Sponsorship Changes the Answer
Fiscal sponsorship is the context where pass-through accounting questions come up most often, and the accounting treatment depends entirely on how the sponsorship is structured.
In a fiscal sponsorship arrangement (sometimes called comprehensive or Model A), the sponsor takes full ownership of the project. The sponsored activity becomes one of the sponsor’s own programs. Contributions received for the project are recorded as 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 at all, because the sponsor has variance power over the project.
In a fiscal agency arrangement (sometimes called pre-approved grant or Model C), the sponsor acts as a conduit. It has no variance power over how the funds are spent. It receives donations, records them as a liability, and passes them to the sponsored project according to the donor’s instructions. The sponsor records no revenue and no expenses for the project’s activities, except for any administrative fees it charges.
The distinction matters for donors too. Under a fiscal sponsorship arrangement, 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, since the sponsor is not the true recipient.
Federal Sub-Awards Work Differently
Federal grant pass-throughs are their own category under the Uniform Guidance (2 CFR Part 200). 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.” A federal sub-award typically shows up as an expense on the pass-through entity’s books rather than a liability that washes out, because the pass-through entity exercises discretion over which subrecipients to fund and what terms to impose. Federal pass-throughs usually look like grant expenses, not agency transactions, unless you truly have no discretion over the distribution.
The Uniform Guidance also imposes duties that don’t exist in private-donor agency transactions. Before issuing 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 clearly identify itself as such and include the Federal Award Identification Number, the 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
You must also monitor the subrecipient’s use of funds, review financial and performance reports, and follow up on audit findings. Your responsibility doesn’t end when the check clears. It runs for 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 to cover the cost of managing the funds. In private arrangements, this is whatever the parties negotiate and document. Common structures include 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 more 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 opts to negotiate a rate with the federal government.2eCFR. 2 CFR 200.414 – Indirect Costs
Regardless of source, administrative fees are the one piece of a pass-through transaction that your organization records as revenue. In an agency transaction, the fee is the only amount that appears on your Statement of Activities. Document the fee in writing before funds are received, and disclose the amount or percentage to donors.
How Pass-Through Funds Appear on Form 990
Form 990 treatment generally follows the GAAP treatment, but the IRS requires specific disclosures. The flow starts on 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 report the corresponding liability on Part X (the balance sheet), Schedule D, Part IV asks you to explain the nature of the arrangement in Part XIII (Supplemental Information). If for some reason you do not report the funds as an asset or liability on Part X, check “Yes” on Schedule D, Part IV, Line 1a and disclose the fund balances there.4Internal Revenue Service. Instructions for Schedule D (Form 990)
The critical rule for revenue reporting: 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 financial statements and your Form 990 show different revenue figures because of this exclusion, Schedule D, Parts XI and XII provide a reconciliation.4Internal Revenue Service. Instructions for Schedule D (Form 990)
What Goes Wrong When You Get It Wrong
The reason Form 990 accuracy matters so much is 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, pushing 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 could actually make the ratio worse by concentrating support. Either way, the calculation becomes unreliable. An organization that fails the test for a tax year and the preceding year gets reclassified as a private foundation beginning that tax year.6Internal Revenue Service. Advance Ruling Process Elimination – Public Support Test
Federal pass-through funds can also 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 This threshold was raised from $750,000 in the 2024 revision to the Uniform Guidance, effective for fiscal years beginning on or after October 1, 2024. If your organization passes through federal funds 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 (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
The practical takeaway: keep pass-through funds in a segregated bank account or at 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 timeline for disbursement. 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 problems.