The Yorba Foundation, a non-profit group that produces open source Linux desktop software, reported last week that it was denied tax-exempt 501(c)(3) status by the IRS. The group had waited nearly five years for a decision. The IRS stated that, because the software Yorba develops can be used commercially, the organization has a substantial non-exempt purpose and is disqualified from tax-exempt status. We think the IRS’ decision rests on a fundamental misunderstanding of open source software.
This decision comes against the backdrop of previous “be on the look out” (BOLO) orders for open source software organizations’ applications for 501(c)(3) status. BOLOs were at the heart of the controversy over increased scrutiny of progressive and Tea Party organizations. A Mother Jones reader theorized that the IRS’s concerns might stem from debates during the 1970s and 1980s about whether computer user groups should count as non-profits. Perhaps so, but that’s no excuse for a five-year delay.
As Bradley Kuhn from the Software Freedom Conservancy noted in a 2013 Wired article, some open source projects that primarily work on commercial products aren’t actually a good fit for 501(c)(3) status and “[the IRS] has trouble making the distinction.” In fact, in its June 23rd 2010 letter to Yorba, the IRS asked directly: “Please explain how the activities of this organization differ from a commercial software development company beside distributing the software for free.”
Open source software organizations applying for tax-exempt 501(c)(3) status have to show that they are organized and operated exclusively for charitable, scientific or educational purposes. Unfortunately, these narrow buckets don’t necessarily correspond to the important work that some free and open source software (FOSS) organizations do.
Many FOSS projects have direct educational impacts. The Raspberry Pi Foundation, out of the United Kingdom, was formed directly to address the declining number of students interested in computer science. The GNOME Foundation, which is a 501(c)(3) organization, funds an outreach program for women interested in free software. But organizations like Yorba directly fund software production as opposed to educational programming, and that makes them a harder fit for 501(c)(3) status.
Just as a project might reject code that doesn’t conform to its standards, even if the code is well written, the IRS is bound by a narrow set of restrictions that it has previous interpreted. Journalism start-ups have faced similar problems – while clearly their work benefits the public, it may not fully be charitable or educational, and thus may not be eligible for 501(c)(3) status.
Still, the IRS’s denial demonstrates a lack of understanding of the open source movement:
[The Yorba Foundation has] a substantial nonexempt purpose because [it] develop[s] 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.
As Jim Nelson said in his post about the denial, these objections clash with three of the Four Software Freedoms: the freedom to run the program as you wish, the freedom to redistribute copies, and the freedom to distribute copies of your modified versions. That’s the benefit of permissive licensing. Although the IRS’s concerns about laundering money through non-profits to avoid taxes are reasonable, those should not stand in the way of legitimate open source software organizations.
Additionally, five years is a ridiculous length of time to sit on an application. The Yorba Foundation heard nothing from the IRS between October 2011 and July 2014. Although efforts are being made to streamline this process via providing a new, easier form, the IRS still has 60,000 pending applications. 501(c)(3) status is often vital for organizations that are looking to use grant money or have larger donors. Although individual small donors may not be worried about the tax deduction, foundations and large donors often won’t work with non-501(c)(3)s. We hope that the new simplified form will help cut down the number of organizations stuck in limbo.
It may be that not every open source project is a good fit for 501(c)(3) status. However, the IRS’ 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 non-profits to lose out on 501(c)(3) status.