A current trend in the blockchain business, and especially among cryptocurrency companies, is to seek tax exemption status under Section 501 (c) (3) of the Internal Revenue Code (the Code). Brink Technology, Inc., a Bitcoin developer fund that grants grants to developers working on its open source Bitcoin protocols, is the most recent success story with its application for status 501 (c) (3) by the Internal Revenue Service approved (IRS) on January 21, 2021.1
In response to the growing interest, this warning is intended to provide clarity on how to obtain tax exemption status based on the IRS ‘Private Letter Ruling (PLR) 202019028.2
Background to 501 (c) (3) status
Section 501 (c) of the Code generally exempts certain businesses from paying federal corporation tax on income. For businesses that meet the requirements of Section 501 (c) (3) of the Code, Section 170 of the Code provides an additional benefit that allows donors to deduct donations to nonprofits with 501 (c) (3) subject to several restrictions) Status. While status 501 (c) (3) offers obvious tax benefits to nonprofits and donors, there are also stringent requirements restricting company choices, prohibiting dividends, and restricting lobbying activities.
In order to be granted status 501 (c) (3), a nonprofit must provide the IRS with evidence that it is 1) operating solely for one or more exempted purposes and 2) serving a public interest. Examples of optional purposes are non-profit, educational, and scientific purposes.
PLR 202019028 Denied status 501 (c) (3)
In PLR 202019028, the IRS rejected an open source blockchain developer’s request for status 501 (c) (3). Like most in the blockchain and cryptocurrency space, the blockchain developer claimed that it was run solely for educational and charitable purposes to improve the public’s understanding of blockchain. To support its claim, the blockchain developer relied primarily on the fact that its platform is open source and available to the public for free.
The IRS held that the mere provision of open source access to the public for 501 (c) (3) purposes did not qualify as educational. Although the public could theoretically have learned about blockchain at their own risk by examining the blockchain developer’s open source platform at their own risk, the blockchain developer did not provide any learning resources or instructions on how to improve their understanding of blockchain or improve their blockchain skills. Development can improve.
The IRS stated that there must be some type of educational instruction in place for a nonprofit cause to be considered educational within the meaning of Section 501 (c) (3) of the Code. Drawing on various other IRS agencies, the IRS made it clear that such instructions could be devoted to training individual skills or public education on relevant topics. Acceptable forms of teaching are workshops, clinics, lessons, seminars, panel discussions and lectures.
To round out the IRS’s analysis, having free access to the blockchain platform did not inherently require the establishment of a charitable purpose. It was also not enough not to focus on profit at the management level. And the fact that cryptocurrency miners were able to receive fees for their work on the blockchain platform was viewed by the IRS as evidence of a private, non-public interest.
PLR 202019028 can be used by blockchain and cryptocurrency companies to better understand what activities support tax exemption status and potentially avoid rejection of their requests for 501 (c) (3) status. Examples of accepted applications and other resources under 501 (c) (3) for tech companies are also available online.3 Nonetheless, the IRS’s investigation into whether 501 (c) (3) status is warranted is highly factual and a IRS Decision on an Application for Status 501 (c) (3) cannot be used as authority on any other application. The issuance of tokens or other cryptocurrencies poses additional challenges for obtaining status 501 (c) (3) and raises the question of whether such tokens or cryptocurrencies should be registered as securities.