Money & Business

Open-Source Projects Failing To Pass IRS Nonprofit Muster

By / Jul 22, 2014 (Photos.com/Thinkstock)

Though organizations that produce nonprofit software have long been granted tax-exempt status, the Internal Revenue Service recently denied it to two applicants. One had waited more than four years for a determination—and found the reasons for denial alarming.

The tax-status headaches that have dogged politically oriented nonprofits appear also to be giving the open-source community a migraine.

In recent weeks, the Yorba Foundation, which makes Linux productivity software, revealed that the Internal Revenue Service had denied the group 501(c)(3) tax-exempt status, despite having granted it in the past to many other organizations with open-source goals, including the Linux Foundation, the Wikimedia Foundation, and the Free Software Foundation.

The report comes a few months after OpenStack Foundation was denied a nonprofit 501(c)(6) designation. (A 501(c)(3) designation is generally set aside for groups with charitable, literary, or educational goals; a 501(c)(6) generally applies to business groups.)

Part of the problem is that the term “open-source” raised IRS flags, as did the terms “tea party,” “occupy,” and others on the agency’s Be On the Look Out (BOLO) list.

“A Substantial Nonexempt Purpose”

But the response Yorba received could be a sign of another kind of problem, and it’s drawing the concern of the open-source community.

In a blog post last month, the Yorba Foundation’s Jim Nelson explained that the organization waited four and a half years for an answer on its tax status, only to be denied in May. What particularly alarmed Nelson were statements in the IRS denial letter suggesting that the Linux software’s potential use for commercial purposes was enough to disqualify the foundation from being granted nonprofit tax status.

“You have a substantial nonexempt purpose because you develop software published under open-source-compatible licenses that authorize use by any person for any purpose, including nonexempt purposes such as commercial, recreational, or personal purposes, including campaign intervention and lobbying,” the IRS letter stated.

The agency also suggested that there was little educational value in editing or reading the open-source code and questioned the software’s status as a “public work.”

Nelson said that no matter the response from the IRS, the organization would continue, though it likely would not pursue a legal fight.

“The foundation’s existence does not hinge on 501(c)(3) status,” he wrote, adding that it would have been helpful “if the IRS hadn’t waited four and a half years to inform us of their decision.”

Questioning the Approach

Nelson’s blog post struck a chord within the open-source community, whose members largely supported the foundation and criticized the extremely long wait time for an answer from the agency.

Ars Technica writer Ryan Paul, while noting successful examples of open-source projects that thrived as for-profit enterprises, specifically took the IRS to task for discounting the educational value of open-source software.

“The educational value of open-source software is directly responsible for enabling my career—in both tech journalism and software development,” Paul wrote. “For software developers who lack the means to obtain a college education, open-source software offers an extremely valuable learning opportunity and path into the industry.”

The Electronic Frontier Foundation (EFF), meanwhile, argued that although there’s truth in the assertion that open-source values shouldn’t guarantee tax-exempt status, the IRS’s response highlighted a “fundamental misunderstanding” of how such software works.

“It may be that not every open-source project is a good fit for 501(c)(3) status,” EFF’s Kendra Albert wrote. “However, the IRS’s position that the production of software is a ‘commercial activity’ and that otherwise exempt organizations may be disqualified based on potential uses of their software by third parties is too inflexible and risks causing worthy nonprofits to lose out on 501(c)(3) status.”

Ernie Smith

Ernie Smith is the social media journalist for Associations Now, a former newspaper guy, and a man who is dangerous when armed with a good pun. More »

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