Arweave TX
Following the inception of GoFundMe and similar crowdfunding apps, individuals were able to raise capital for projects and causes they believed in. Through the power of the internet, I could give 100 dollars to a friend in need and receive the tax-deductible benefits provided by the IRS for gifts to charities. Fundraising through the internet represented a revolution in using technology and social media to solicit donations. Just as GoFundMe signaled a radical transformation in philanthropy, so too do DAOs have the potential to be the next iteration of fundraising innovation.
While there are many complex and revolutionary applications for DAOs, one practical use case is a DAO dedicated to fundraising for a charitable purpose. Essentially all DAOs fundraise, but today we’ll discuss those that do so for the sole purpose of philanthropy. A relevant example would be Ukraine DAO, which raised 8 million dollars during the start of the Ukraine-Russia conflict and is backed by the Ukrainian Ministry of Digital Transformation. Today, the DAO continues spreading awareness and raising money for its cause.
Types of DAOs, from Alchemy
Suppose a DAO is being used as a vehicle to help fundraise; will it be eligible for tax-deductibility status for United States citizens? To be a tax-deductible organization in the US, you need to apply for 501(c)(3) status with the IRS. This status allows the IRS to affirm your charitable purpose and prevent bad actors from receiving tax-deductibility. Unfortunately, 501(c)(3) tax status is difficult to obtain. The IRS scrutinizes each application carefully, and the process can take as little as a month to as long as a year.
The reality is that philanthropic DAOs cannot remain disconnected from the regulatory world to compete with the current fundraising options available to US donors. If philanthropic DAOs want to represent the next paradigm in philanthropy, like GoFundMe, they need to follow the regulations to obtain the difficult 501(c)(3) status. First, DAOs must form a legal entity to be considered for 501(c)(3) status. Many global DAOs form an entity by incorporating in the Cayman Islands, Switzerland, the Marshall Islands, or other non-US jurisdictions. Unfortunately, obtaining 501(c)(3) status is even more difficult for non-US-incorporated charities than US-incorporated charities. However, there are still many ways a DAO incorporated offshore can provide tax-deductibility to attract US donors.
The following options are considered more traditional Web 2 options offered to international charities and may be less effective for internationally incorporated philanthropic DAOs than some new opportunities emerging.
If you can find a US-based 501(c)(3) charity that aligns with your DAO’s mission, they may be willing to enter into a joint fundraising project with your entity. Your US donors will donate to the partnered 501(c)(3) charity via a joint fundraising project, which will then pass the money to your DAO. Since most charities in the US currently don’t accept crypto, these donations most likely wouldn’t be on-chain, and the DAO would receive US dollars from the joint fundraising project. This structure could be very effective, as it is most likely the cheapest available option. Furthermore, it is typically the quickest option and requires the least amount of scrutiny from the IRS (depending on the partnering organization). Read more here.
You can incorporate your own friends organization in the US, for example, as a Delaware corporation, which can then apply for 501(c)(3) status. Your US donors will donate to “ x DAO friends organization” 501(c)(3) charity, which will then donate money on behalf of the DAO. In a friends organization, the foreign charity (in this case an internationally incorporated DAO) retains control over this new entity by appointing the friends organization’s board. Since the DAO is technically “creating” the friends organization, it can set any parameters for the charity it wants, such as accepting crypto, so long as it follows 501(c)(3) guidelines. It is a highly effective structure once granted 501(c)(3) status, yet it requires a lot of time and fees for legal work to gain this status. A friends organization may require additional filing and record-keeping. To read more about these organizations, click here.
The incorporated DAO directly becomes a 501(c)(3) in the US. Per the IRS, “Foreign organizations may apply for tax-exempt status on income earned in the United States in the same way that domestic organizations apply for exempt status. If you’re a foreign organization applying for exempt status, you must complete all required parts of Form 1023. Contributions by US residents to foreign organizations generally aren’t deductible.” -Internal Revenue Service. If successful this is the most irreversible option, but there is no guarantee that contributions from US residents are deductible. For that reason, this is probably the most ineffective option for internationally incorporated DAOs as it doesn’t guarantee tax-deductibility. For more info, read here.
These options are considered more innovative and are likely more effective for internationally incorporated philanthropic DAOs than the previous options discussed above. They require less legal structuring than the options discussed above, and are easier for DAOs to manage since there is no additional entity creation or partnership required.
With this approach, a DAO would create a US-based DAO-controlled fund for all donors to donate their tax-deductible gifts. The DAO could also directly contribute crypto to this fund from their treasury. However, this option is unique not because the DAO can control the community fund, but because it is inherently crypto-native. Firms like Endaoment are pioneering this option. Take, for example, the Rari Capital Foundation; the foundation stood up their DAO’s community fund at Endaoment with an anchoring gift from their treasury and allowed anyone to make donations to the fund. Anyone who donated crypto to the Endaoment site would get a tax receipt, and a Snapshot vote of Rari Governance Token holders determined the grants sent out to charity.
As of today, Endaoment has donated $48.97m
Two more solutions would be to apply to a fiscal sponsorship organization or a friends fund. These organizations support internationally incorporated philanthropic DAOs by acting as a third party between the donors and the DAO. Essentially, anyone would be allowed to donate to these third parties and receive the necessary tax benefits from their jurisdiction. Both options are 501(c)(3) organizations that hold many international-based charities under their umbrella. These options are helpful because many firms operate these funds and organizations, so DAOs can do their own diligence in determining which best suits their philanthropic mission. These solutions are not crypto native yet, and currently do not take crypto donations. For more info, read about a prominent friends fund here, and a fiscal sponsorship organization here.
While it may seem difficult for foreign philanthropic DAOs to gain 501(c)(3) status, thankfully there are many solutions available to solicit US-based donations. Special thanks to Endaoment and Hurwit Associates for their excellent support and for providing resources for this research. I’m excited to see philanthropic DAOs continue to thrive, and I can’t wait to see the positive impact they make in the Web 3 community and beyond. Philanthropic DAOs have the potential to be one of the most transformative, yet, wholesome aspects of crypto, and obtaining 501(c)(3) status hopefully propels them into the US market. According to CAF World Giving Index 10th edition, "The United States of America is the world’s most generous country over the last 10 years.” While it is a long shot, maybe Philanthropic DAOs are the way Web 3 sees mainstream adoption in the United States.
As a reminder, this is not legal or financial advice; it is always important to consult a CPA or lawyer for tax or legal advice. This article’s assertions have been generalized to apply to a broad audience. Every situation is unique, and you should seek professional advice for your specific situation.
Leo
