Tax-Deductible Deductions to DAOs

Tax Deductions for DAOs

Following the inception of GoFundMe and similar 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 campaign I felt especially touched by and receive the tax-deductible benefits provided by the IRS for gifts to charities. Fundraising through the internet represented a revolution in using technology to solicit tax-deductible donations. Just as GoFundMe represents a radical transformation in philanthropy, so too, do DAOs have the potential to be the next iteration of fundraising innovation.

DAOs as Fundraising Vehicles

While there are many complex and revolutionary applications for DAOs, one practical use case is a DAO dedicated to fundraising for a charitable purpose. In essence, all DAOs fundraise, but some do it for the sole purpose of philanthropy. A good example would be Ukraine DAO, which raised 8 million dollars during the start of the Ukraine-Russia conflict and was backed by the Ukrainian Ministry of Digital Transformation. Today, the DAO continues to spread awareness and donate money to the cause.

Tax-Deductibility Issues for International DAOs

Suppose a DAO is being used as a vehicle to help fundraise. A concern these DAOs face is: Will our entity be treated as a 501(c)(3) and be eligible to receive tax deductibility status for United States citizens? Unfortunately, 501(c)(3) tax status is difficult to obtain. Each application is carefully scrutinized, and the process can take as little as a month to as much as a year.

As for DAOs, you must be incorporated to be considered for 501(c)(3) status. Many global DAOs form an entity by incorporating in the Marshall Islands or other non-US jurisdictions. The problem is that for non-US incorporated charities, obtaining 501(c)(3) status is even more difficult. However, there are still many ways a DAO incorporated offshore can provide tax deductibility to attract US donors.

How an Internationally Incorporated Philanthropic DAO Can Allow for 501(c)(3) Tax Deductible Donations

Traditional Options

These options are considered more traditional and may be less effective for incorporated DAOs than some new opportunities emerging.

1. Partnering With an Existing Charity: 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 LLC. Your US donors will donate to the partnered 501(c)(3) charity, which will then pass the funds to your DAO. 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, depending on the partnering organization. Read more here.
2. Create Your Own Friends Organization: You can incorporate a friends organization in the US, for example, as a Delaware corporation, then it can apply for 501(c)(3) status. Your US donors will donate to this 501(c)(3) charity, and the DAO can decide where these funds are allocated. You can give your DAO control over this new friends organization by appointing its board, but the DAO can never receive the funds from the friends organization. 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.
3. Apply as 501(c)(3): The incorporated DAO directly becomes a 501(c)(3) in the US. Per the IRS, our best understanding is that these donations are not generally tax deductible, but please ask your financial or tax advisor if you want to dig into it further. “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 U.S. residents to foreign organizations generally aren’t deductible.” -Internal Revenue Service. For more info, read here.

Innovative Options

These options are considered more innovative and may be more effective for some incorporated DAOs than some of the previous options discussed above.

1. Create a Collective Fund: In this option, a DAO would create a US-based fund for US donors to donate their tax-deductible gifts. The DAO could also contribute to this fund from their treasury. However, this option is unique because the DAO can control the community fund. Firms like Endaoment make this option possible. Take, for example, the Rare Capital Foundation; the foundation stood up their DAO’s community fund at Endaoment and allowed anyone to make donations (with an anchoring gift from their treasury). Anyone who donated to the Endaoment site would get a tax receipt, and a Snapshot vote of RGT holders determined the grants sent out to charity.
2. Join a Fiscal Sponsorships Organization or a Friends Fund: Two more solutions for MIDAO non-profit LLCs 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 the DAO and receive the necessary tax benefits from their jurisdiction. Both of these 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. As far as MIDAO is aware, these solutions are not crypto native yet, and currently do not take crypto donations. A prominent friends fund can be found here, and a fiscal sponsorship organization can be found here.

Conclusions

While it may seem difficult for foreign non-profits 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 providing resources for this post.

MIDAO is happy to be able to refer philanthropic DAOs to Endaoment following your incorporation with us. We believe Endaoment is solving a significant issue for philanthropic DAOs, and we can’t wait to see the positive impact they make in the Web 3 community. If you are considering incorporating as a philanthropic DAO, don't hesitate to get in touch with MIDAO. We are happy to assist you in all your incorporating needs and refer you to organizations that will help increase the positive impact you have in the world.

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. Assertions made in the article have been generalized to apply to a broad audience. Every situation is unique, and you should seek professional advice for your specific situation.

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