Note: alongside discussion page here and these pages, we have a legal topics email list
All these have been drafted but may not be in final form. See full list of documents here.
We have a separate page introducing the basic mechanism from a legal perspective.
We intend to operate as a non-profit, multi-stakeholder cooperative with three member classes:
- Workers: those paid to manage and develop the website
- Projects: those whose independent projects receive donations through the site
- Patrons: those who only donate
We are not stock-based but are funded by membership dues (which will be calculated as pledges to the site just as for other projects we support).
Federal 501 tax-exemption issues
Our mission absolutely fits a social purpose, not a profit or self-interested purpose. Whether that fits the particular boxes and charitable tests of the IRS is another question.
For overall info about the issue with Free/Libre/Open issues and 501, see resources at the FLOSS Entities Working Group wiki. That includes things like several records of specific past approved and rejected IRS applications. The chair of that group, Aaron Williamson, is probably the best lawyer we could work with when dealing with this side of things. He also published a summary of 501 issues for FLO software that is worth reviewing.
Do we need 501?
Forgoing tax-exemption could be feasible if we don’t have any substantial taxable income. We intend to use all revenue to serve the mission, but any holdings unspent at annual roll-over time remain a concern. According to one interpretation, all contributions are non-taxable gift income, but we’d want clarity about that.1
Whether we hold funds depends on our transaction plan: either all funding is direct donations to us with the pledge mechanism as a vote in the use of funds or we do split charges via a payment system and avoid holding funds at all.
Forgoing 501 does mean less worry about the scope of projects. We would only be limited by our own rules and Bylaws in terms of which projects to support. This would permit the most flexibility in how we interact with the users in all sorts of respects and deal with many types of legal entities for projects, including international.
501(c)(4) or maybe still (c)(3)
If we did pursue tax exemption, 501(c)(4) might be easier and more appropriate than (c)(3). Thus, we would be classed as a “social welfare” organization. We may self-determine rather than ask for IRS determination, but either way, we must be honestly confident that we qualify fully.
To qualify, we must be mission-driven for serving the public benefit. We must provide no special services to members (note: our site and services are available to anyone whether or not they are co-op members. Members only have say in governance but no other benefits generally, except that the worker-members, i.e. the Snowdrift.coop team — they get paid for their work, but no extra benefit, and they don’t get paid because they are members, but because they do work for the co-op).
Concerns about 501 classification
Do we fit simple 501 boxes enough?
We want to emphasize our cooperative structure, bringing together different stakeholder interests. We prefer not to be limited in the scope of projects (other than non-rivalrous FLO products), and we need to be flexible enough to serve our mission as effectively as we can. We have concerns about whether we fit easily enough into the predefined boxes of IRS 501 categories.
Is fundraising an exempt purpose?
Among other concerns, according to an IRS agent, fundraising for exempt purposes is not itself an exempt purpose. On the other hand, the National Taxonomy of Exempt Entities includes codes for “Fund Raising and/or Fund Distribution”. Also:
Rev. Rul. 68-489, 1968-2 C.B. 210
- An organization will not jeopardize its exemption under section 501(c)(3) of the Code, even though it distributes funds to nonexempt organizations, provided it retains control and discretion over use of the funds for section 501(c)(3) purposes.
- An organization exempt from Federal income tax under section 501(c)(3) of the Internal Revenue Code of 1954 distributed part of its funds to organizations not themselves exempt under that provision. The exempt organization ensured use of the funds for section 501(c)(3) purposes by limiting distributions to specific projects that are in furtherance of its own exempt purposes. It retains control and discretion as to the use of the funds and maintains records establishing that the funds were used for section 501(c)(3) purposes. Held, the distributions did not jeopardize the organization’s exemption under section 501(c)(3) of the Code.
How specific are our requirements for how projects use funding?
However, we are not sure if the scope of control and discretion we hold via our project requirements would be judged as adequate by the IRS. Moreover, the non-profit purposes we want to require of projects do not seem to necessarily fit the 501, especially not 501(c)(3) limitations. So, we want all project funds from our system to go toward FLO development, but not to be overly strict about the nature of the FLO products.
If we fund all sorts of FLO projects as a (c)(3), it could mean the IRS offering the (c)(3) deduction to every single FLO project in practice — not that they projects would get 501 tax exemption themselves, just that there would be a way (via Snowdrift.coop) for donors to fund them and get a deduction. In other words, the patrons to Snowdrift.coop would get a deduction, and the projects would be responsible for reporting their income per whatever tax status they have. If we were (c)(4), there would be no deductions, we wouldn’t have tax liability, and projects could (we’d hope) be able to have any range of tax statuses themselves and report their income accordingly.
Would there be limitations on which projects we could support if we were 501 of either sort? Would it bar us from supporting fully-FLO projects that were themselves not non-profit or any sort of charitable purpose? (Say, for example, FLO business accounting software or FLO video games or…)
Why not (c)(6)
If we consider (c)(6), we should know that it would mean specifically having to serve the interests of the whole scope of a field of business (in this case, producers of FLO works), and we could not have a public-benefit mission. Thus, (c)(6) probably will not be a viable option given our mission not only of promoting FLO works but of orienting their work to best serve the public interest (e.g. we want to discourage practices by FLO projects that may be financially effective for them but may be bad for the public, such as privacy-invading surveillance and ad-targeting). It seems unlikely to define a (c)(6) as serving the business interests of specifically the public-interest-focused subset of FLO projects.
Scope of projects
We prefer not to limit the site to formal non-profit projects even though we do limit the site to projects that develop public goods available to all. As with many public goods, the products we independently fund may themselves benefit businesses, citizens, and other organizations alike.
- For-profit businesses may support projects which they use
- This is sticky for software due to recent IRS scrutiny. A software project we support could be used by a for-profit business, for example. Our view is that the same could be said for an educational text. For that matter, for-profit businesses can use public libraries, and yet there is no doubt about the non-profit status of a friends-of-the-library organization. The IRS may be re-evaluating their position based on news from other FLOSS organizations.
- Put simply: a for-profit business could fund the public commons specifically because they want to use a particular work in their business. This does not have to be an issue as long as the work will also benefit and be available to everyone, not just that business.
- Some believe that we simply need the right application with help from a lawyer who understands these issues.
- We might eventually want to sponsor selected projects, fund something like a non-partisan think-tank which produces research or opinion papers, provide development services for other online cooperatives, or organize advocacy for issues pertaining to the digital commons, like net neutrality or patent reform. For reference, 501(c)(4) organizations are permitted to engage in unlimited voter education and lobbying and in limited partisan political campaigning, as long as there is a connection to the organization’s nonprofit purpose.
Ramifications of our mechanism for coordinating pledges
We have two possible implementations for handling funds. The first involves holding funds and paying out to projects as they choose to withdraw them. The second involves having a third-party system manage transactions that go directly between patrons and projects. We describe the details of each on our transactions page. We prefer the fund-holding option technically.
Not a payment processor / money transmitter
We need to be sure we are not classified as a financial institution or payment processor / money transmitter. The one thing we cannot do is touch funds ourselves but claim that the funds are still the property of the donors until given to projects. Either the funds are ours (which means we address taxes on holdings either via 501 or via accounting that somehow recognizes the funds as allotted and thus not subject to taxes at annual roll-over) or we don’t touch them, we just instruct third-parties about how to process charges and payments.
Some legal background:
- In a 2008 ruling, the Bank Secrecy Act was determined not to apply to websites like Kiva that involve credit stored in user accounts which can be transmitted at any time to international microloan companies, so long as the website remains purely a clearinghouse for coordinating transactions.
- Any transactions within the system have to be clearly tied to our mission, of course
- The primary value a payment-processor offers us is that we do not have to implement PCI compliance on our own infrastructure or have our corporate checking set up as a merchant account (as well as helping us with fraud detection).
- Gratipay is a competing FLO-project support service that used to hold funds in escrow, assigned to each user’s account until their weekly gifts use up the available funds, at which point a new charge will be made. That process turned out to be (or be too close to) an illegal money transfer service (this came to light when their payment service (Balanced Payments) shut down and they investigated alternative options). At this point, Gratipay’s escrow process still describes some of that.
- They recently worked with Aaron Williamson, a lawyer familiar with FLO issues who we might want to use and who would understand these issues.
- Flattr uses this same model (deposit to your account, funds go to projects at a rate that isn’t predetermined, then new deposit when funds run out, unused funds carry over from month to month), but they aren’t based in the U.S.
- BountySource is also playing with a version of escrow for their “salt” subscription-donation service.
- “There is a minimum billing charge of $5. If your contribution amount is less than $5, you will be charged $5 and the remaining portion will be applied as a credit to your account.” Thus they are doing some level of “credit in your account”. We don’t know how legally solid that is, although it seems reasonable on the surface.
- This old blog post at WePay describes various implementations of money transmitter and online marketplace issues. Incidentally, WePay says they are exempt from Money Transmitter licensing, but we’re not clear why (perhaps because they make recipients register in a particular manner and they then only process credit cards and do immediate transfers without any real time holding funds).
- A complex state-based issue in California has people debating whether AirBnB is a money transmitter simply because they escrow funds for a short time before paying the renters of space. In an article about the debate, it says “If a company entrusts a regulated bank with the funds it’s moving, and the bank maintains control of the funds, the department typically won’t classify it as a money transmitter.” A Business Insider article is relevant as well.
- AirBnB is now a licensed Money Transmitter. It was debated before, but now they show up in the list of licensed money transmitters for California. They do take in funds which they hold, then they pay others later. That’s similar enough to what we propose. We should make sure to avoid this status ourselves either through a partner service or through classifying our transmissions differently (not considering the funds coming in as simply being the patrons’ funds that we transmit).
- A Lawsuit against many parties for non-licensing of money transmitter status is relevant and important but may be hyperbolic and have exaggerated claims. This is from someone frustrated with the law’s burdens ruining his own startup trying to attack others who he sees as getting away with operating illegally. He certainly has at least some merit to his claims.
We want to be able to offer gift cards as funds set aside for donation to projects. In some respects, this is more like giving donations in someone’s name, although it would give that someone the chance to determine something about the direction the funds go. This is straightforward as long as we do the donation-to-us version of holding funds. Not sure how we would do this if we did the split-charges no-holding version of transactions.
Other legal concerns
- Accounting and reporting requirements
- Tax filing
- 2013 was only private actions financially. 2014 was the first year of real activity for Snowdrift.coop accounts. All 2014 income was only non-taxable contributions.
- Although we may need to consider some portion of crowdfunding rewards like shirts as being a taxable portion of the donations from the crowdfunding campaign, we still have spent basically 100% of income on expenses, i.e. none goes toward profit.
- We need to determine clarity about what tax filings we need to do for projects that use the system or to what extent the filings are strictly the responsibility of each project.
- 2013 was only private actions financially. 2014 was the first year of real activity for Snowdrift.coop accounts. All 2014 income was only non-taxable contributions.
- Anti-fraud measures
- Online charities are a favorite target as one step in the process of credit card theft: a small charge is made with a stolen card number to confirm that it is still active. Botnets will often register many fake accounts with a site for this purpose. Many failed charge attempts from a single IP or many inactive accounts with failed charges are a sign of this kind of fraud.2
- Normally the test charge amount is lost to the fraudster, but Gratipay was specifically targeted because it presented a mechanism by which the test amount could be recovered, through fake-account-to-fake-account tipping.
- Snowdrift.coop has some built-in defenses against this, such as monthly transfers (takes longer to recover anything), externally variable share price (makes the amount recovered less certain), transparent donations (can’t hide who’s donating to whom), and our project vetting process (although the Gratipay scammers also made transfers to some legitimate bystander accounts to cover their tracks).
- But we still need to be careful about credit card testing, since we allow users to withdraw sums from their accounts. The fraud prevention officers of whatever payment processors we end up using should be able to advise us on things like waiting period, maximum amount, etc.
- We may not be able to tell users “your account is suspended pending investigation into potential fraud” because, if it has to be referred to law enforcement, we don’t want the user notified that they are under investigation. Otherwise, we could be held responsible for “tipping off” the criminal and giving them a chance to escape. (This is part of the reason why PayPal has such a bad reputation.) It’s unclear how to reconcile this with the goal of a transparent organization. Is it a solution to do all we can to avoid touching credit-cards ourselves and rely on the processing services?
International legal issues for funding projects outside the U.S. and for patrons outside the U.S.
We’re not sure about the details, but this is a complex topic. Getting money from or giving money to various countries has lots of issues.
According to NOLO book on non-profit formation. The patrons get nothing besides membership in co-op which itself provides no benefits besides say in governance, and the NOLO book suggests this is unambiguously okay).↩