Disclaimer: I am neither a lawyer nor a tax advisor. This article is not legal advice. This article is not tax advice. This is a series of articles on research into regulations and information for Non-Profit Decentralized Autonomous Organizations (DAOs). For those unfamiliar with DAOs, we recommend starting with our previous article titled DAOs 101. If you still need to read parts 1 and 2, please find them below.
You know nothing, John.
In the popular HBO series Game of Thrones, a saying is repeated to one of the main characters, Jon Snow. Ygritte, his romantic wildling partner, repeats, “You know nothing, Jon Snow.” After writing parts one and two on Non-Profit DAO Research, this is the sentiment I have. You know nothing, John.
While my superficial understanding of the regulations is helpful, when the rubber hits the road, one question exists. Will my DAO get approved to be a Non-Profit?
A harsh reality is that a DAO could do all of this work, and the Internal Revenue Service (IRS) does not recognize them as a public charity. This creates uncertainty in the Web3 space. However, some great resources and people are trying to help get legal clarity for DAOs, and I genuinely appreciate those tools and organizations. One of those resources (the Lex Clinic) opened my eyes to another type of Non-Profit designation, the 501(c)(6).
Wait, Wait, Wait!
What happened to the 501(c)(3)? Please don’t fret, friends. The 501(c)(3) research was not all for naught. In fact, I have found a DAO that claims to be “The first non-profit led philanthropic DAO.” It is called Big Green.
Big Green is a USA 501c3 non-profit that believes growing food changes lives. We created a DAO (Decentralized Autonomous Organization) to democratize and decentralize grantmaking for food and gardening organizations in the US.
So there seems to be some precedence out there. Additionally, other DAOs like the Nouns DAO are looking into DAO Entity Structures & the UNA. Specifically, they allude to the possibility of a UNA having “a shot” at becoming a 501(c)(3) or 501(c)(4).
The UNA is a model limited to DAOs who serve a nonprofit purpose (meaning members are not entitled to profits of the organization, with some limited exceptions). Provided this requirement (which also helps alleviate securities risk) is met, UNAs provide almost all of the benefits we are seeking. They: 1) provide limited liability protection; 2) support anonymous membership; 3) are cheap and simple to set up (they do not even require a formal filing to exist); 4) are flexible — standards and agreements between members can be governed by contract through the membership agreement; 5) if established in a state like Wyoming, allow the DAO to own physical property and engage in other real world activity; 6) support direct onchain and decentralized governance; 7) allow for taxation as C-corps, protecting members from individual liability; and 8) as nonprofits, have a shot to qualify for tax exempt status as 501(c)(3)s or 501(c)(4)s (though this may require member doxxing and sacrificing some decentralization). On the flip side, they are subject to US tax and information collection obligations, and are a relatively new organizational model that has not been tested in courts as applied to DAOs.
So hope is not lost for the 501(c)(3); in my opinion, certain DAOs may meet the IRS-defined exempt purposes. It all leads us back to questions, though. Will my DAO get approved? How hard would it be to obtain this designation? How much money would it cost, etc.? Those questions equate to money in terms of the necessity for legal and tax clarification.
Exhausting all options
Therefore, if a resource recommends another option, I research it. Can you switch like that? I had the same pause. I was going down the rabbit hole of 501(c)(3)s, and now the pivot to 501(c)(6)s? Shouldn’t it just be black or white, and I meet one or the other? I wish, but we live in the grey, and many examples overlap. This overlap isn’t just a DAO thing, though.
In 2003, John Francis Reilly, Carter C. Hull, and Barbara A. Braig Allen wrote a Technical Instruction Program for IRC 501(c)(6) Organizations. Within that instruction was a section that describes “overlap.” It gives examples of organizations and their activities which meet both IRC 501(c)(3) and IRC 501(c)(6) applications.
What does this mean? It means that there can be some similarity between 501(c)(3) and 501(c)(6) because organizations can overlap in their business activities. The extent to which side those activities fall likely determines the best fit. So here we go (again)!
So what is 501(c)(6)? As we mentioned in our first article, 501(c) is a section of regulations (26 CFR). In this case, 501(c)(6) provides specific exemptions for Business Leagues, Chambers of Commerce, Real Estate Boards, Boards of Trade, and Professional Football Leagues. Yes, that’s right, I said Professional Football Leagues. Non-Profit Football League DAO, anyone?
For this article, I will focus on the Professional Football League exemption. Just kidding, I meant the Business Leagues.
What is a Business League?
The IRS defines a Business League as the following.
A business league is an association of persons having some common business interest, the purpose of which is to promote such common interest and not to engage in a regular business of a kind ordinarily carried on for profit.
To be exempt as a business league, an organization’s activities must be devoted to improving business conditions of one or more lines of business (as distinguished from performing particular services for individual persons). It must be shown that the conditions of a particular trade or the interests of the community will be advanced.
This was a lot, so I will break it down and use ELI5 DAO as a thought experiment.
- A business league can be a group with a common business interest. Examples of common Business interests can be found here. Two examples I liked included:
Promoting higher business standards and better business methods and encouraging uniformity and cooperation by a retail merchants association,
Educating the public in the use of credit.
A proposed common business interest for ELI5 DAO could be “Educating the public on the use of DAO Tools.”
2. Next, the purpose of the business league (in our case, the DAO) must promote a common interest and can’t be for profit.
ELI5 DAO is testing out DAO tools and writing reviews for the benefit of the ecosystem. A sort of Web3 equivalent to Consumer Reports, but for DAOs. Side Note:
Consumer Reports is a not-for-profit organization under Section 501(c)(3) of the Internal Revenue Code.
So ELI5 DAO promotes a common interest and is not engaged in a regular business ordinarily carried out for profit.
3. The business league must be devoted to improving business conditions. Here, the IRS gives examples of what this is not. More broadly, my understanding is that it must show that it “…is improving business conditions of one or more lines of business”. Once again, the Technical Instruction provides some examples.
A simple rule: If you eat to meet, you may qualify as an IRC 501(c)(6) organization, but if you meet to eat, exemption may be denied.
Since the ELI5 bounties are for writing reviews on DAO Tools, are open to the public, and help understand and improve business conditions (DAOs operating more efficiently, effectively, etc.) The DAO is devoted to improving business conditions. Likewise, the highest bounty for a three-month epoch is $75. No one is using this to replace their income.
4. You mentioned “improving business conditions of one or more lines of business” What is a line of business? The IRS states the following about the “Line of Business.”
This term generally refers either to an entire industry or to all components of an industry. For exemption purposes, a line of business is a trade or occupation, entry into which is not restricted by a patent, trademark, or other means that allow private parties to restrict the right to engage in the business. It does not include a group composed of businesses that market a particular brand within an industry. Thus, for example, an organization that served the needs of users of a specific brand of computer or assisted franchise owners of a particular brand of products promoted only a segment of a line of business and so was not exempt under section 501(c)(6).
ELI5 DAO remains agnostic to brands (i.e., DAO members are not beholden to one brand or tool and democratically vote to use different ones)and is testing all tools in the space; they are not marketing a particular brand.
Furthermore, a DAO contributor is not restricted by a “patent, trademark, or other means that allow private parties to restrict the right to engage in the business.”
No Inurement and Meaningful Membership Fees
Lastly, nothing can benefit the individual member, and a 501(c)(6) must receive meaningful support from membership dues.
First, the dues. Membership dues are required. However, there is some leeway here.
Although an organization may receive a substantial portion or even the primary part of its income from non-member sources, membership support, either in the form of dues paid to or involvement in the organization’s activities, must be meaningful.”
Next is inurement. For this explanation, I will once again give it to you straight from the IRS website.
An organization does not qualify for exemption under Code section 501(c)(6) if any of its net earnings inures to the benefit of any member. Members may nevertheless receive some kinds of benefits from the organization, such as newsletters and similar material. In addition, return of dues or contributions members paid to support the organization, in proportion to amounts paid, is not inurement. Moreover, the profitability of the members’ individual enterprises may be enhanced by the successful promotion of the common business interest.
I read this as no net earning can specifically benefit a member. However, in this case, the DAO can return contributions from dues or contributions back to the member, which is not considered inurement. Additionally, suppose a member is a founder of a DAO Tool, a founder of a DAO, or operates in a specific DAO. They can participate and get a membership because a rising tide lifts all ships. This would be particularly useful, especially if a DAO creates a DAO tool and wants to get it tested.
If you have made it here, you, my friend, are something spectacular. Am I done? No, but am I done for tonight? Yes.
To sum this up. There are a few potential options for Non-Profit designations. Some DAOs are operating or looking into 501(c)(3) status, but this article pivoted to research the 501(c)(6). A 501(c)(6) provides tax exemptions for Non-Profits operating under conditions where they promote common business interests and do not seek individual profit. With this classification, there are specific requirements that must be met. Examples include meaningful membership, no inurements, and improving overall business conditions. In Part 4, I want to look into the tax forms for 501(c)(6) and any additional items.
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