IRS Grossly Unqualified To Make Determinations About Software Related Exempt Applications

This post was originally published on Forbes Mar 5, 2015

Somebody in the IRS must think that open source software is even icikier than the Tea Party.  During the same period  Tea Party applications appeared on BOLO lists and were held up interminably, the same thing was happening with applications from organizations developing open source software.  Previously applications by open source organizations had sailed through.  One of the better known open source organizations is The Linux Foundation which is exempt under 501(c)(6) like the NFL.

Many of the Tea Party applications ended up being approved, including that of the flagship Tea Party Patriots Inc, but the open source groups have not been having such luck. Another denial just came out in Private Letter Ruling 201507025. Private letter rulings are redacted, but one of my sources indicated that the group involved was the LEAP Encryption Access Project. LEAP Director Elijah Sparrow confirmed that the ruling related to LEAP.

What Is Open Source Software?

I'll have to do something of an idiot's guide type of answer, with me being the idiot. Open source software isn't just free software, that you can use without paying anything. A million years ago when I learned about computer programming we would type instructions onto eighty column cards which we would hand to one of the great machine's minions who would feed the cards into a card reader to compile the program we had written. Then they could feed in our data cards which would allow for output in the form of a printed reported. It was truly extraordinary when it worked the way it was supposed to.

Here's the thing, as best I can understand it, if somebody were to print out the compiled program, he would not be able to figure out what the program was supposed to be doing unless he was as smart as Grace Hooper. If you wanted to change the program, you needed to know what I had typed on the cards and then you could add, subtract or substitute some other cards and recompile the program. My cards were the source code.

So when a program is open source you not only get to use the working program, you also have the information that allows you to see how and why it works and you are able to make modifications which you can distribute.  Open Source Initiative (a 501(c)(3)) organization) has a more detailed definition.

To the extent that I was at all aware of the open source concept, it struck me as something that would enchant hyper geeks who probably shouldn't be allowed anywhere near systems that I had to rely on to get work done.  You have to understand that I am 63 years old and witnessed the computerization of my field of work.  I had one of these visionary moments around 1983 as I was schlepping a 25 pound Kaypro around and I told one of my fellow senior accountants that in a few years there would be a machine like that on everybody's desk.  He mocked me.  The transformation of accounting was a painful process and for about fifteen years or so, the people responsible for making the machines work could be rather frustrating to deal with.  They sometimes reminded me of the kids in gas stations who did not grasp that they had a job because of people like me who are not inclined to change their own oil.

At any rate, I knew that my hit on open source was probably wildly inaccurate.  I asked software developer turned attorney Aaron Williamson, for an example of some open source software that I might have heard of.  One example jumped up and smacked me on the side of the head - WordPress There is a Wordpress Foundation - 501(c)(3).  Of course, this very tax blog is done on Wordpress.  So I have been relying on open source software for nearly four years.

The IRS And Open Source

I think it was worth getting into my mistaken impression of the open source movement, because it happens that I have the same basic education as an IRS agent.  It requires a bachelors degree with 30 hours in accounting.  On top of that their frustrations with computers are probably a lot worse than mine.  I think that they have gone down the wrong path on evaluating open source not for profit applications because of a culture difference that is even wider than that between people working in the federal bureaucracy and the Tea Party.  There is a big story there, which I have started working on, but for now I will just discuss the most recent written refusal to grant exempt status.

About LEAP

LEAP (LEAP Encryption Access Project) describes itself a a non-profit dedicated to giving all internet users access to secure communications.   It focuses on adapting encryption technology to make it easy to use and widely available.  LEAP believes that freedom of speech also means "freedom to whisper" and that freedom should be available to all internet users.  LEAP was applying for 501(c)(4) status  as a social welfare organization.

Why LEAP Did Not Qualify

 Because your software competes with other commercial products, does not serve a community within the meaning of § 501(c)(4) (analyzed infra), and benefits a narrow class of people, then you are unlike the organizations described in our favorable rulings. Accordingly, your development and distribution of open source software does not promote the social welfare and you are not operated for § 501(c)(4) exempt purposes

At lease I understand that one.  The other argument that the IRS uses is one that I find rather bizarre.  A social welfare organization is supposed to serve a community and the IRS seems to be stuck on a meatspace geographical concept of community .  As they put it the world is not a community.  What are they thinking?

 The only common connection between all of your users is that they are users of the OS operating system. They are located everywhere in the world. Everyone with an OS controlled computer and interne access may use your software without regard to citizenship or location. The world is a geographical unit but does not bear a recognizable relationship to an area ordinarily identified as a governmental subdivision or unit or district. Accordingly, the world is not a community within the meaning of § 501(c)(4) and you are not operated to promote the welfare of a community.

Monday Morning Quarterbacking

Aaron Williamson thinks LEAP's application might not have been well handled.  He wrote me:

My sense is that LEAP did not have the assistance of experienced exempt organizations counsel when it prepared its application. Assuming the IRS denial accurately characterizes the application -- and this is not a sound assumption -- it looks like the application focused too much on the general benefits of open source software and not on the particular benefit provided by LEAP.

LEAP's activities, which promote human and civil rights secured by law (including the rights to free expression and freedom of association), in my opinion should qualify for exemption even under the stricter standard applied to 501(c)(3) organizations. This is underscored by the fact that two organizations with similar purposes (one whose purposes actually included contributing to the LEAP software!) were recently recognized as exempt under 501(c)(3). The first of these is Brave New Software, which produces software (with grant funding from the State Department) to enable circumvention of internet filtering in repressive countries. The second is the Calyx Foundation, which provides privacy-preserving ISP-like services, developers privacy tools including the LEAP platform, and educates people about the need for and use of information security tools.

Any number of exempt organizations charge fees for their services, and a carefully drafted application probably could have avoided the problems LEAP ran into there. That said, absent the hostility at the IRS for open source-related applications, this one might never have been flagged.

 Maybe The Wrong People Are Looking At These Applications

I think that I agree with the analysis that Elijah Sparrow shared with me.  Essentially people educated like me should not be the ones making these decisions.

The logic of the IRS is deeply flawed. The IRS is grossly unqualified to determine if the security offered by our free software is a difference of kind or degree from existing expensive solutions that are vaguely similar on the surface. The idea that the existence of some security software somewhere precludes any other security software from ever having a social benefit is deeply troubling, since most existing software is complete crap and is not up to the task of ensuring the right to privacy online as affirmed by the UN as an essential human right.

Also, many foundations that fund non-profits have started to structure their giving in the form of a contract, in order to be able to more closely monitor the work of the non-profit. This is the case with our funders. The IRS would like to classify these grants as simple normal business activities, but LEAP entirely conceived of the projects and entirely directed the development and the funders received no product from us. The only thing it has in common with a normal business activity is the word "contract" at the top of the funding agreements.
We were advised that we could probably be successful in an appeal, but that it would be very expensive and time consuming. We are a small non-profit on a limited budget and we had no means by which we could mount an effective appeal.

What Is So Great About 501 Status?

I think that some organizations might want to think about whether the game is worth the candle when it comes to applying to the IRS for exempt status.  If you are not expecting to get much in the way of charitable contributions and you don't intend to accumulate a large reserve, there is not a lot gained from a federal tax perspective.  In certain circles 501 status will give you an entirely undeserved dose of credibility and certain grant making organizations will only make grants to organization with exempt status.  There are also a variety of state and local benefits that can hinge on exempt status.  Still many organizations, particularly the 501(c)(4)s could probably be what they want to be without IRS recognition.

What Does The IRS Have Against Open Source Anyway?

The dark money and Tea Party groups, of course, were looking to avoid donor disclosure in some cases.  That appears to be why Lois Lerner's minions thought they were icky.   They have a lot more friends in Congress than the open source geeks, which accounts for deeper inquiry into what happened with them.  It might well be that a closer look at what caused the open source applications to bog down might shed some light on the other scandal. I plan on looking further into the open source issue, but what with tax season and Kent Hovind, it may take a while.