Op-ed: IRS denied tax-exempt status to nonprofit organization on dubious grounds.

The IRS denied a proposal to grant 501(c)(3) status to Yorba, a nonprofit organization that develops open source software for the Linux desktop. In a blog post yesterday, Yorba spokesperson Jim Nelson disclosed the full text of the IRS rejection letter. He fears that IRS policy has evolved to broadly preclude nonprofit open source software developers from obtaining 501(c)(3) tax exemptions.

In the United States, the 501(c)(3) classification is typically granted to a certain class of nonprofit organizations that are engaged in activity that can be considered charitable, religious, scientific, literary, or educational. Many prominent open source software organizations hold 501(c)(3) status, including the Apache Foundation, the GNOME Foundation, the Mozilla Foundation, the Free Software Foundation, and the Wikimedia Foundation.

IRS scandal

The IRS was at the center of a major controversy last year following the release of internal memos revealing that the agency systematically applied a disproportionately aggressive standard of review to organizations that matched certain keywords. Targeted organizations faced greater difficulty obtaining 501(c)(3) status. Interest in the scandal has largely centered on the question of whether prominent political groups were unfairly treated, but the same internal IRS memos that defined the policy also oddly singled out open source software.

IRS personnel responsible for reviewing 501(c)(3) applications were instructed to elevate cases involving open source software to their supervisors, resulting in extensive delays in the review process and frequent rejections. In the wake of the controversy, a New York Times report highlighted how nonprofit organizations that develop open source software may, in fact, receive harsher treatment than many of the other targeted categories.

Luis Villa, a lawyer and well-known open source community member who currently serves as deputy general counsel at the Wikimedia Foundation, told the Times about two nonprofit open source software organizations that were denied tax-exempt status because their use of a targeted keyword triggered a harsh response from the agency.

“As soon as you say the words ‘open source,’ like other organizations that use ‘Tea Party’ or ‘Occupy,’ it gets you red-flagged,” he told the Times. “None of the groups have been able to find the magic words to get over the hurdle.”

Yorba’s rejection

In theory, it might make sense for the IRS to closely review applications from organizations that develop open source software in order to make sure that they aren’t actually for-profit companies that sell commercial support or monetize their software with other services. If that were the standard of review, there would be no cause for concern. Unfortunately, it looks like the IRS is applying a much more dubious standard.

The Yorba Foundation was originally founded by former Google employees who wanted to give back to the open source software community. The organization makes open source software applications for the Linux desktop, including a photo management application called Shotwell and a mail client called Geary.

Yorba develops its applications completely in the open, with community participation. The software is distributed under the terms of the relatively permissive LGPL. Yorba doesn’t sell any services or monetize its software; it relies largely on donations in order to fund its operations.

In the rejection notice to Yorba, the IRS flatly denied that Yorba’s unambiguously nonprofit open source development qualifies for 501(c)(3) status. One of the main points raised by the agency is the possibility that some third party could potentially use Yorba’s software for commercial purposes.

“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,” the letter says.

One of the key facets of open source software licensing is that there are no restrictions imposed on specific fields of endeavor—open source software can be used by anyone for any reason. As such, a software license that prohibits commercial use is, by definition, not an open source license. However, the question of whether a piece of open source software is developed for commercial purposes is distinct from whether it is ultimately used commercially by some of its users.

It isn’t impossible to understand where the IRS is coming from. Consider a company like Canonical, a commercial software vendor that includes one of Yorba’s applications in its own product. If Canonical makes a donation to Yorba that funds development of that software and consequently benefits Canonical’s business, it isn’t unreasonable to question whether it's really fair for that donation to be tax-deductible.

But the reality is that very little charitable work happens in a vacuum. There are always peripheral effects that benefit a range of other parties and interests. If a nonprofit organization uses donated funds to purchase resources that support its cause, you don’t dismiss the effort as non-charitable simply because somebody else profits.

The fact remains that the nonprofit organization in question is motivated by the goal of advancing its cause and not the peripheral commercial benefits. Linux desktop applications like the ones made by Yorba play a role in making Linux a viable option for underprivileged schools and other environments that might not otherwise be able to provide access to computers.

As Nelson points out in his blog post, the widespread use of the Apache server software in the enterprise doesn’t invalidate the fact that the purpose of the Apache Foundation, as the steward of software that can be used by anyone, is distinctly noncommercial. The Apache Foundation routinely receives donations from major commercial software vendors, ranging from Microsoft to Red Hat, and nobody questions the validity.

Education

In addition to contending that the possibility of commercial usage makes open source software fall outside the boundaries of 501(c)(3) status, the IRS also shockingly asserts that open source software has no intrinsic educational value. In its rejection notice to Yorba, the agency claims that “anything learned by people studying the source code is incidental.” While I may have been able to see at least a hint of logical basis for the agency’s concerns about commercial usage, its opinion about the educational value of open source software defies all reason.

I gravitated toward the Linux desktop as a teenager specifically because access to source code, and the ability to participate while receiving mentorship and support from the community, provided me with a great opportunity to learn. The educational value of open source software is directly responsible for enabling my career—in both tech journalism and software development. 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.

Considering Yorba’s situation specifically, I’d make the case that there’s clear and obvious educational value in much of the software that it has written. Its photo management application, called Shotwell, is arguably among the largest and most widely used pieces of real-world software written in the Vala programming language. Someone who wants to learn Vala and see how a large, complex Vala application is structured would benefit significantly from studying the Shotwell source code.

If you still have doubts, I encourage you to read a blog post by Valentin Barros, a computer science student who was mentored by Yorba employees while he implemented face detection in Shotwell as part of the Google Summer of Code program. He specifically credits Yorba’s high quality standards and code review process as things that helped him grow as a professional programmer.

Long-term implications

It’s not yet clear how broadly the policy will be applied or what it means for existing 501(c)(3) nonprofits that clearly don't pass the new standard, but the position expressed by the IRS in its rejection notice to Yorba doesn’t bode well at all for new organizations that want to follow in the footsteps of the Apache Foundation or the Free Software Foundation.

Some open source software nonprofits that launch to support software development are able to later expand and formalize their existing commitments to broader, more obviously charitable goals. For example, the GNOME Foundation is increasingly focused on its Women’s Outreach program, a laudable initiative that aims to help an under-represented group participate in open source software development and thus enter the software industry.

But newer organizations, such as Yorba, may not have the opportunity to grow to the size where they can really maximize the social good of their pursuits if they are denied access to 501(c)(3) status and the incentives that it creates for donors to contribute funding.

Granted, not all nonprofit organizations need 501(c)(3) status. The Fedora project, for example, opted against forming an official charitable foundation, because it didn’t want to constrain the manner in which its patron Red Hat could financially support the project. The existing protections that are already in place naturally discourage abuse and understandably make it impractical for nonprofit open source organizations that have strong ties to commercial software vendors to operate under the 501(c)(3) umbrella. Is it really necessary for the IRS to push further?

Yorba will certainly be able to continue operating without the 501(c)(3) designation. The organization can receive money from supporters, but it is treated as income rather than a donation—Yorba will pay income tax, and the donor will not be able to get a tax deduction. This makes it a lot harder for the organization to collect large donations. The end result is that IRS policies could discourage the formation of new open source nonprofits that are devoted to public service and vendor-neutral industry-advancing collaboration, instead forcing such organizations to adopt business models and focus on monetization to the detriment of the community.

It took the IRS four years to issue Yorba’s rejection, consistent with the poor treatment and delays seen by other organizations that were targeted by the IRS keyword watch list. Beyond the problems with the reasoning that the IRS provides for rejecting Yorba, the manner in which it has singled out prospective charitable organizations by blind keyword matching rather than the merits of the individual case seems deeply discriminatory.

I’d like to see the IRS adopt a more nuanced policy that will properly award 501(c)(3) status to community-driven nonprofit open source development. In light of the positive social impact that such organizations have to offer, excluding them from 501(c)(3) status seems unreasonable and misguided. Surely, existing policies that mandate strict accounting for nonprofits are sufficient to prevent any possible abuse.