A recent trend in the blockchain business, and particularly among cryptocurrency companies, is to seek tax-exempt status under Section 501(c)(3) of the Internal Revenue Code (the Code). Brink Technology, Inc., a Bitcoin developer fund that provides grants to developers who work on its open-source Bitcoin protocols, is the most recent success story with its application for 501(c)(3) status being approved by the Internal Revenue Service (the IRS) on January 21, 2021.1
In response to the growing interest, this alert seeks to provide clarity on obtaining tax-exempt status based on the IRS's Private Letter Ruling (PLR) 202019028.2
Background on 501(c)(3) Status
Section 501(c) of the Code generally exempts certain corporations from paying federal corporate tax on income. For corporations that meet the requirements of Section 501(c)(3) of the Code, Section 170 of the Code offers an additional advantage, allowing donors to deduct, subject to several limitations, donations made to nonprofits with 501(c)(3) status. While 501(c)(3) status provides obvious tax benefits to nonprofits and donors, it also comes with rigid requirements that limit entity choice, forbid dividends, and restrict lobbying activities.
To obtain 501(c)(3) status, a nonprofit corporation must demonstrate to the IRS that it 1) operates exclusively for one or more exempt purposes and 2) serves an interest of the general public. Examples of exempt purposes include charitable, educational, and scientific purposes.
PLR 202019028 Denies 501(c)(3) Status
In PLR 202019028, the IRS denied an open source blockchain developer's application for 501(c)(3) status. Like most in the blockchain and cryptocurrency space, the blockchain developer asserted that it operated exclusively for educational and charitable purposes that increase the public's understanding about blockchain. To support its claim, the blockchain developer primarily relied upon the fact that its platform is open source and available to the public for free.
The IRS held that simply providing open source access to the public did not qualify as educational for 501(c)(3) purposes. Even though members of the public could have, in theory, learned about blockchain by investigating the blockchain developer's open source platform at their own risk, the blockchain developer shared no learning resources or instruction on how to advance one's understanding of blockchain or improve blockchain development skills.
The IRS explained that some sort of educational instruction must be present for a nonprofit's purpose to be deemed educational within the meaning of Section 501(c)(3) of the Code. Drawing from various other IRS authorities, the IRS clarified that such instruction can be devoted to individual skills training or public education surrounding relevant issues. Acceptable forms of instruction include workshops, clinics, lessons, seminars, panel discussions, and lectures.
To round out the IRS's analysis, free access to the blockchain platform did not inherently require a finding of charitable purpose. Simply not focusing on profit at the management level was also insufficient as a charitable purpose. And the fact that miners of cryptocurrency on the blockchain platform were able to receive fees for their work was viewed by the IRS as evidence of a private, not public, interest.
PLR 202019028 can be used by blockchain and cryptocurrency companies to better understand which activities support tax-exempt status and potentially avoid rejection of their applications for 501(c)(3) status. Examples of accepted applications and other 501(c)(3) resources for technology companies are also available online.3 Nevertheless, the IRS's inquiry into whether 501(c)(3) status is warranted is highly fact dependent, and an IRS ruling on one application for 501(c)(3) status cannot be relied upon as authority in another application. Issuing tokens or other cryptocurrencies presents additional challenges for obtaining 501(c)(3) status and raises the question of whether such tokens or cryptocurrencies should be registered as securities.