I'm the ED of a 501(c)3 non-profit (http://localwiki.org), and when we applied for our (c)3 status we got some flack along these lines, as well. Here's my advice to the Yorba Foundation folks:
If you haven't received your final rejection, you can appeal.
Don't try and do this yourself. The post says they spoke with folks at the Software Freedom Center, which is great, but I highly recommend finding a specialized attorney who's seen lots of applications and knows the right angle. Hire an attorney who specializes in obtaining 501(c)3 status. We made this mistake early on, thinking we could work through the NOLO book and apply ourselves. It cost us. For around $1k you can find a good non-profit attorney to help.
We got flack for the open-source thing, too. Our original exemption application was basically "Hey, we're a charity! We give things away for free and release open source code, which can be used by everyone!" Depending on the IRS agent assigned to you, you might get flack for this as well. Generally speaking, they may not like that a for-profit business can use your organization's by-product to make lots of money for themselves. We spent some time explaining how OSS worked to the agent, and was able to convince him that because (most) of our OSS is copyleft, that it would be a continually-free-and-open good, not a private benefit.
Nevertheless, just releasing OSS is NOT an exempt purpose. If you read the IRS regulations, they are very specific as to what a core exempt purpose is. You'll need to pick one that fits best. Generally speaking, it's 1) Church stuff 2) Scientific advancement and research 3) Furthering of the arts 4) Education 5) "Charity," meaning helping people who are disadvantaged in some way 6) Some others that I'm not remembering.
Most OSS 501(c)3 don't get exemption by just releasing open source software-- they get exemption by being an educational institution. So you may want to go that route -- the organization's core exemption is the creation of educational materials that help education members of a particular community in XYZ ways. This is what we ended up doing -- we're classified as an educationally-exempt organization. If you look up the 501(c)3 apps of some other OSS non-profits you'll see similarly -- e.g. Plone Foundation is set up as an educational organization.
Edit: If you'd like to take a look at some of our back-and-forth with the IRS agent at the time, check out the page here: http://localwiki.net/org/Historic_501%28c%293_application_pr... You'll see his response was similar to yours, but we decided to pursue educational exemption and were granted on that basis in the end.
Also, you can call up the IRS Agent assigned to you and talk to them about the application, which can be extremely helpful.
By "we thought we could do this ourselves", philipn meant that basically I wasn't up to the task. Myself being not a lawyer and all.
Nolo's book isn't really meant for OSS/software/online projects, so it only really provides a rough outline of the process. Because of that, we got to the point where we did have to consult an attorney to get us back on track.
If you're working with an OSS community, it's important to note that giving stuff away != a charity. You need to emphasize that you are working specifically for the underprivileged. Even if you have an underprivileged community that you are serving, if you serve all comers it could easily seem as if it was self-serving to donors.
The educational exemption is generally much more appropriate for information and technology, like philipn said. When we took the time to explain that our goal was to teach people about their own communities, they were much more receptive. Other orgs like The Perl Foundation were similarly organized as educational (providing training at conferences, educational grants). Likewise with Wikimedia Foundation, which is fairly obviously educational despite major software investments.
If what you want to do is just be tax-exempt -- but not have tax deductible donations -- that's a much easier thing to do. A 501(c)6 may serve any community, so long as it gets most of its funding from donations or membership dues. That's how the Linux Foundation handles it. It's less desirable, but it will prevent you having to pay tons of back taxes.
This is a good explanation, but let me tack on one thing. The original blog post says:
>> There’s a charitable organization here in San Francisco that plants trees throughout the city for the benefit of all. If one of their tree’s shade falls on a cafe table and cools the cafe’s patrons as they enjoy their espressos, does that mean the tree-planting organization is no longer a charity?
In fact, the tree-planting group can easily show that they serve an exempt purpose, namely "lessening the burdens of government". Planting trees is something that city governments routinely do for the purposes of beautification or whatever. If a non-profit wants to do it, that's a perfectly legitimate reason to get tax exempt status. The group would also have to show that they are serving a public interest - for instance they're not just planting trees outside of one company's coffee shops but they're providing a service for the whole neighborhood.
That question shows the typical nerd-misunderstanding of law as a rule-based system with distinct outputs. They think the rule must be "no for-profit company can ever benefit from the work of the charity" and are pointing out how the rule is stupid so the rule must not exist.
IANAtaxL, in fact IANAL of any kind, but my reading is that the IRS doesn't want companies to set-up fig-leaf charities that absorb and hide their normal business functions.
And in fact, imagine a large software corporation that wishes to be able to tax-deduct the portion of its profits that go into R&D, so it sets up an open-source non-profit to do all of that, with leadership that may have a financial stake in the corporation or be otherwise leveraged, and donates its corporate profits to the non-profit for its operations. This is almost exactly the definition of a fig-leaf charity. Imagine if Google spun off an Android Foundation and sent all of its core OS developers there, or even more so if Apple spun off a Swift Foundation to make an open-source compiler - even though they would be creating open-source software that could be used by other companies, it would not be in the spirit of the law that defines 501(c)(3), and much of the benefit would be derived by the parent corporation. So as much as my knee-jerk reaction is to say "government doesn't understand software," as a taxpayer I think it's perfectly reasonable for the IRS to be wary and have the BOLO in place.
Am I the only one who doesn't have a problem with either of these Google/Apple examples?
If Apple or Google spun off a 503(c)(3) for Swift or Android how would that be a bad thing? It would ensure that the work of those developers stays open source and free to all. Even if it only applies to a particular platform it would still be open source and very useful for the world--if only to be able to see the code.
What the IRS needs is a few finer points of distinction... Let the FOSS development be tax-free as long as it's GPL or similarly licensed (the code must stay open no matter what) but deny such status for code that is BSD-like which may (easily) be used in a tax-circumvention mechanism; where some core code could be open source but to actually make it work you need the proprietary derivatives.
> If Apple or Google spun off a 503(c)(3) for Swift or Android how would that be a bad thing?
Presumably you mean a 501(c)(3) -- a not merely tax-exempt organization but one to which donations are tax-deductible as charitable donations; the problem here with one sponsored by a for-profit company, whether its developing open source software or not, is that they run the risk of being directed at the for-profit company's priorities, and being a way for money to be, in effect, funneled into the companies business in a tax-deductible manner from those with a stake in the company's returns.
> What the IRS needs is a few finer points of distinction... Let the FOSS development be tax-free as long as it's GPL or similarly licensed (the code must stay open no matter what) but deny such status for code that is BSD-like which may (easily) be used in a tax-circumvention mechanism
The copyleft vs. noncopyleft distinction really has no bearing on the central problem here. The real problem is that, to the extent that there is legitimate reason to more closely look at 501(c)(3) applications from entities focussed on OSS (perhaps because for-profit entities have been trying to set them up as ways to improve the tax status of development efforts when they have an OSS-centric business model), this particular case doesn't seem to be one that should have been problematic -- not because of license terms, but because the potential problems that such scrutiny is designed to avoid aren't present. But that may just be a poor first-level decision or a result of poor application crafting, and not any real indication of any problem with the general policy.
As a concrete example for the copyleft distinction, consider if Swift Foundation was founded to create copyleft (let's say GPL or even AGPL) compilers, but the system libraries every compiled program would need to link to were only found on Apple products. It's very clear that this would be a move that would be for the benefit of Apple's bottom line, and that it was a technology originally developed by Apple employees. So it's not like some random guy in his garage said "I will make something charitable but make the independent decision to base it on Apple hardware," as is true of (say) an iPhone app for detecting medical problems, which would indeed be 501(c)(3) eligible in my book (IANAL).
Maybe I am a little confused, but what you described sounds like how Mozilla Corp.(for profit) and Mozilla Foundation(nonprofit and tax exempt, which owns the Corp as a subsidiary) are organized.
You're definitely confused. Mozilla is the reverse of the described scenario. If Mozilla corp owned the non-profit, rather than how it currently is, then it would fit.
Right, and if the BOLO actually functions like the name implies ("be on the look out for these, give them extra attention and watch out for abuse") that's probably appropriate. If, in practice, it means "kill these so you don't have to justify your approval to your superiors", that's not okay. My understanding, second and third hand from those who have tried getting approval for various things, is that it is too much the latter.
Just out of curiosity, has any FOSS project obtained 501(c)3 status through the "scientific advancement and research" and/or "furthering of the arts" clauses? IANAL but these look like obvious matches, even more so than the education clause. Projects like SciPy make a massive contribution to scientific research, whereas collaborative tools for writers and musicians, for example, might be seen as furthering the arts.
Yup, lots have. The Apache Software Foundation has a scientific exemption, and IPython is fiscally-sponsored by NumFocus (http://numfocus.org) which has a scientific exemption as well.
Could you describe how this abuse would take place, exactly? R&D is already tax deductible.
I could see that if you funded a non profit via income like Kickstarter, that would allow you to use that money over multiple financial years without paying taxes on it in the mean time.
But that doesn't really seem egregious if the technology is to be open sourced.
> Could you describe how this abuse would take place, exactly? R&D is already tax deductible.
Here's how:
(1) Company sponsors and in-effect (though not in name) controls nonprofit doing open source development.
(2) Company provides "discounts" on its services (e.g., support or other services tied to, or closed source software license for software that depends on, but is not -- if the OSS is copyleft -- strictly derivative of the OSS developed by the non-profit) to people who donate to the non-profit. Company has now effectively restructured itself in a way that its R&D costs, or some substantial portion of them, are not merely tax deductible for it (as they would be as business expenses in any case) but also funded by tax-deductible payments from customers (which payments may not have been tax deductible expenses otherwise, particularly if the software isn't exclusively for the B2B market.)
Its not the "open source" that is the problem, its the relationship with the sponsoring company -- but I can certainly see why "open source" development is a cover for a "charity" that could be ripe for abuse, and why the IRS might want to carefully scrutinize charities of that type.
Ah, that makes total sense. I was thinking about it from the perspective of the tax the entity pays, and didn't realize "donations" to this type of entity were tax deductible. That would indeed be ripe for abuse.
If you and I both start a business, but you set yours up so all the producer surplus goes to yourself as the sole shareholder, and I set mine up so all the producer surplus goes to myself as the main employee, why should I be able to claim non-profit status?
If your non profit suddenly makes $10 million, you couldn't just pay yourself that money, could you? Surely you have to be able to justify that your spending was aligned with the stated goals of the non profit, if and when audited?
Forgive my ignorance, I'm from New Zealand, and the laws are quite different over here. For instance, corporate income tax is franked, so you aren't double taxed on profits. That alone removes a lot of incentive to eliminate the tax a company pays.
Sure, there's protections that apply after the fact of abuse, but the whole purpose of having a 501(c)(3) application and review is to try to filter inappropriate entities out before the fact.
As the founder of a 501c3 non-profit that makes FOSS (http://hypothes.is), let me strongly second the points that Philip has made here.
1) Get expert counsel. It can make the difference in the ultimate determination, and also in the number of years (!) it takes to get approved. We were lucky in that we granted our determination without question-- and it still took nearly two years to get.
2) Don't focus on the software, focus on your mission. It's not just a ruse-- it really makes sense. Become knowledgeable about the nuances of the exemption, and why it is granted when it is.
3) Proactively call your agent, once one is assigned. Not only can it dramatically shorten the time to determination, but it can also often head off questions that, once asked, require formal replies and often lead to further clarifications, which all take time.
So basically, Yorba f'd up by not getting advice from someone with deep knowledge of the proper bureaucratic bs to proffer for a successful application for tax-exempt status.
That's a little unfair. A 501(c)3 is a huge asset - not only is a 501(c)3 exempt from federal income taxes (and often state sales taxes) but people can make tax-deductible contributions to a 501(c)3. If two companies are producing a product and one is a 501(c)3, then that company has an enormous competitive advantage in the marketplace. Yorba is producing software that commercial software developers also produce. The IRS has a very good reason to make sure that Yorba is actually an exempt organization before it grants tax-exempt status - otherwise the government is effectively subsidizing one company in the marketplace.
Yes however one company builds a product to sell it or make a profit in some other way while another gives it away for free.
I would argue that the OSS company is still at a disadvantage since they have to figure out how to feed the developers (pay them a decent wage) while still giving the software away for free.
That's one option however a very annoying one for their users plus if it happens to be something non standard like a Linux terminal app where do you put the ads?
A 501(c)(3) is still subject to federal income taxes on its business income that is not directly related to its charitable purpose (aka "unrelated business income").
IOW, there is no advantage to being a non-profit unless your business is a charitable activity.
oh thanks for the link to the back and forth. I am applying for my own 501(c)(3) - details in the profile - and we are still twiddling thumbs waiting for an agent to be assigned. The IRS is backed up for nearly a year now!
idiots. the business making the money pays the taxes. what kind of clowns and political hacks run the irs? oh yeah we dont know since they conveniently destroy any evidence when it is requested, and get away with it!
If you haven't received your final rejection, you can appeal.
Don't try and do this yourself. The post says they spoke with folks at the Software Freedom Center, which is great, but I highly recommend finding a specialized attorney who's seen lots of applications and knows the right angle. Hire an attorney who specializes in obtaining 501(c)3 status. We made this mistake early on, thinking we could work through the NOLO book and apply ourselves. It cost us. For around $1k you can find a good non-profit attorney to help.
We got flack for the open-source thing, too. Our original exemption application was basically "Hey, we're a charity! We give things away for free and release open source code, which can be used by everyone!" Depending on the IRS agent assigned to you, you might get flack for this as well. Generally speaking, they may not like that a for-profit business can use your organization's by-product to make lots of money for themselves. We spent some time explaining how OSS worked to the agent, and was able to convince him that because (most) of our OSS is copyleft, that it would be a continually-free-and-open good, not a private benefit.
Nevertheless, just releasing OSS is NOT an exempt purpose. If you read the IRS regulations, they are very specific as to what a core exempt purpose is. You'll need to pick one that fits best. Generally speaking, it's 1) Church stuff 2) Scientific advancement and research 3) Furthering of the arts 4) Education 5) "Charity," meaning helping people who are disadvantaged in some way 6) Some others that I'm not remembering.
Most OSS 501(c)3 don't get exemption by just releasing open source software-- they get exemption by being an educational institution. So you may want to go that route -- the organization's core exemption is the creation of educational materials that help education members of a particular community in XYZ ways. This is what we ended up doing -- we're classified as an educationally-exempt organization. If you look up the 501(c)3 apps of some other OSS non-profits you'll see similarly -- e.g. Plone Foundation is set up as an educational organization.
Edit: If you'd like to take a look at some of our back-and-forth with the IRS agent at the time, check out the page here: http://localwiki.net/org/Historic_501%28c%293_application_pr... You'll see his response was similar to yours, but we decided to pursue educational exemption and were granted on that basis in the end. Also, you can call up the IRS Agent assigned to you and talk to them about the application, which can be extremely helpful.