IV. Old Wineskins: Existing Law and the New Assets
Two related bodies of law have particular relevance for charitable assets. The first is federal tax law, primarily the rules relating to the charitable contribution deduction, but also potentially rules regulating tax exempt organizations. The second is state law, both fiduciary duty law generally and the specific laws that impose duties on charities and their leaders relating to investments. As will been seen, the issues that arise under federal tax law are more complicated and difficult to resolve and so will be addressed separately for each type of new asset. In contrast, the issues that arise under state law are relatively simple to resolve and so all three types of new assets can be considered together when addressing them.
A. Federal Tax Laws
Federal tax law governs the tax consequences for donors who contribute property to or for the use of charities. It generally allows an income tax deduction in an amount equal to either the donor’s adjusted basis in the contributed property or its fair market value, depending on the type of property contributed and the type of charity receiving the contribution, with certain limitations and substantiation requirements. For contributions of new types of assets, the relevant questions are therefore whether existing law provides a relatively clear answer regarding the deduction amount and the requirements for claiming that amount. And, if it does, whether that amount and those requirements are appropriate given Congress’ twin policy goals of encouraging charitable giving to support the charitable sector while preventing abuses such as overvaluation.
Ownership of property may also have other tax consequences, including potential exposure to the unrelated business income tax (UBIT) and, for private foundations, to excise taxes on excess business holdings and on investments which jeopardize the recipient’s charitable purpose. It is also unclear whether having a purpose directly relating to the new assets, such as developing a new cryptocurrency or operating a DAO for philanthropic purposes, might itself either qualify an entity for tax exemption as a charity under section 501(c)(3) or be considered a significant non-exempt purpose. And even if the answers to these questions are relatively clear, one must then ask whether those answers are appropriate given Congress’ policy goals for these provisions. Those goals include (i) only providing exemption under section 501(c)(3) to organizations organized and operated to further the (broadly defined) charitable, educational, religious, etc. purposes of that section, (ii) taxing commercial activities not sufficiently related to exempt purposes that may compete unfairly with taxable businesses (including income from businesses and other investments purchased using debt), and (iii) limiting the permissible investments of private foundations to preserve assets for charitable purposes and to curb the use of private foundations to maintain control of businesses.
The most significant federal tax issue for the new assets is what category of “property” they fall into under existing law for various federal tax purposes, including the specific laws relating to charitable contributions. The other significant federal tax issue is whether organizations either formed to promote digital assets or that use blockchain technology to further charitable purposes can qualify as tax exempt charities under section 501(c)(3).
1. Cryptocurrency
The Service’s first step in considering the federal tax treatment of cryptocurrency was a 2014 Notice holding that convertible virtual currency is treated as property but not as foreign currency. The Service defined “virtual currency” as “a digital representation of value that functions as a medium of exchange, a unit of account, and/or a store of value” and “convertible virtual currency” as “[v]irtual currency that has an equivalent value in real currency, or that acts as a substitute for real currency.” The Service also stated that virtual currency “operates like ‘real’ currency—i.e., the coin and paper money of the United States or of any other country that is designated as legal tender, circulates, and is customarily used and accepted as a medium of exchange in the country of issuance—but it does not have legal tender status in any jurisdiction.” In a 2019 Revenue Ruling, the Service distinguished virtual currencies from digital representations of either the United States dollar or a foreign currency, defining foreign currency as “the coin and paper money of a country other than the United States that is designated as legal tender, circulates, and is customarily used and accepted as a medium of exchange in the country of issuance.” And in a 2023 Notice, the Service modified the last phrase quoted above from the 2014 Notice in light of the fact that two countries (the Central African Republic and El Salvador) had enacted laws recognizing Bitcoin as legal tender to read: “in certain contexts, virtual currency may serve one or more of the functions of ‘real’ currency—i.e., the coin and paper money of the United States or of any other country that is designated as legal tender, circulates, and is customarily used and accepted as a medium of exchange in the country of issuance—but the use of virtual currency to perform ‘real’ currency functions is limited.”
The Service therefore appears to now rest its conclusion that virtual currency is not foreign currency for federal tax purposes on the fact virtual currency is not “customarily used and accepted as a medium of exchange” even in the few countries that have adopted a specific cryptocurrency as legal tender. And that position has consequences because foreign currency is subject to certain special rules. These rules include the facts that gains and losses are classified as ordinary, not capital, that there is a personal-use exemption for transactions resulting in $200 or less in gain or loss, and that taxpayers are free to use any reasonable basis accounting regime, including first-in- first-out or last-in-first-out as opposed to having to track specific units.
This conclusion has not been accepted by all commentators. For example, Reuven Avi-Yonah and Mohanad Salaimi argue that cryptocurrency’s high volatility and anonymity create administrative difficulty for the Service, such that gains and losses should only be recognized when cryptocurrency is exchanged for non-cryptocurrency items, whether fiat currency, goods, or services. They also argue that when cryptocurrency is held for less than a year it functions as a currency and so should be treated as foreign currency, with treatment as other property only appropriate when cryptocurrency is held for more than a year and, thus, seems more like an investment.
In contrast, commentators have generally agreed that cryptocurrencies are not securities, as that term is defined for purposes of federal tax laws, because they do not represent an interest—equity or debt—in a corporation. (The one exception is the result of a recent legislative change and limited to certain reporting rules.) That said, they have identified some ways that this conclusion may lead to incorrect results from a policy perspective. The most obvious is the non-applicability of the wash-sale rules, which means that cryptocurrency owners are free to sell cryptocurrency units to realize and recognize losses while at the same time buying an identical number of units to continue to maintain the same level of cryptocurrency ownership.
Commentators are less sure whether or not cryptocurrencies are commodities, as that term is defined for purposes of the federal tax laws, because while historical definitions of commodity would appear to be limited to either items traditionally traded on a commodities exchange or tangible property and so would not include cryptocurrencies, the Commodity Futures Trading Commission (CFTC) has asserted that cryptocurrencies are commodities under a broad definition of that term. The Treasury Department has proposed that, at least for reporting purposes under section 6045, digital assets should be considered commodities if classified as such under the CFTC’s self-certification procedures. But Treasury has further proposed that, to avoid unnecessary duplication, a sale of a digital asset that qualifies also as a commodity will only be subject to the digital asset reporting requirements, not the commodity reporting requirements. Treasury and the Service have yet to issue guidance on whether cryptocurrency should be considered a commodity for purposes of other Code sections.
As detailed in the 2014 Notice, in an expanded FAQ section on the Service website, and in several other documents (primarily Chief Counsel Advice), the Service and the Office of Chief Counsel have concluded that virtual currency is property but not foreign currency and have applied that conclusion to a series of common situations relating to cryptocurrency. These include gain or loss from virtual currency transactions (amount realized less adjusted basis, included acquisition costs such as fees), receiving virtual currency in return for services (ordinary taxable income), exchanging one type of virtual currency for another type (not qualifying as a like kind exchange under pre-2018 law), and deducting losses (only permitted when the cryptocurrency has been abandoned or becomes worthless). The first, second, and fourth conclusions flow from the categorization of virtual currency as property; the third turns on the differences between different types of cryptocurrency.
The federal government has also addressed the tax consequences of two unique circumstances relating to cryptocurrency. One such circumstance is a “hard fork,” which occurs when new blockchain software is developed—usually because of a disagreement among developers—resulting in two different versions of a blockchain emerging (one tied to the old or “legacy” software and one tied to the new software). The most notable hard fork related to Bitcoin and resulted in all Bitcoin owners receiving, in addition to their existing Bitcoin holdings, units of a new cryptocurrency identified as Bitcoin Cash. The Service initially issued a Revenue Ruling concluding that a hard fork only results in gross income if the taxpayer actually receives units of the new cryptocurrency. In a later document, Chief Counsel concluded that the Bitcoin Cash hard fork resulted in an accession of wealth under section 61 and so constituted gross income to the recipients of the Bitcoin Cash because they in fact received and controlled the new units of Bitcoin Cash, whether or not they had immediate access to it through an exchange. The other unique circumstance is a protocol upgrade of a distributed ledger, which occurs when there is a change in how future transactions are validated and blocks are added to a blockchain that do not alter past transactions or validations. This is sometimes referred to as a “soft fork.” Chief Counsel concluded that a protocol change by itself does not cause the realization of gain or loss or result in gross income.
Congress’ only enacted cryptocurrency tax legislation to date is an expansion of the reporting rules for brokers and for anyone engaged in a trade or business who receives more than $10,000 in cash by providing that those rules apply to digital assets, effective after December 31, 2023. For purposes of these changes and as noted previously, Congress defined the term “digital asset” to mean “any digital representation of value which is recorded on a cryptographically secured distributed ledger or any similar technology as specified by the Secretary.” These amendments have already been the subject of a court challenge, but the court dismissed that challenge without prejudice, principally because the claims the plaintiffs raised were not yet ripe for consideration. The Treasury Department recently issued proposed regulations to start implementing these changes, which provide that exchanges for cryptocurrency and other digital assets are required to file certain information returns, among other provisions.
Four instances of cryptocurrency guidance or rulings are specifically applicable to charities, two involving the charitable contribution deduction under section 170 and the other two involving tax exemption under section 501(c)(3). The first instance is Q&As relating to donations of cryptocurrency to charities found on the Service’s digital assets FAQs webpage. They contain several conclusions that flow from the Service classification of virtual currency as property, but not foreign currency, including that the donation does not result in the recognition of gain (or loss) to the donor, that if the virtual currency was held by the donor as a capital asset then the donor may be able to deduct its fair market value (as opposed to the lesser of basis or fair market value), and that recipient charities should treat such donations as non-cash donations for reporting and substantiation purposes, including reporting sales of donated cryptocurrency if completed within three years of the donation.
The second instance is Chief Counsel-issued advice relating to the documentation a taxpayer is required to obtain to claim a charitable contribution deduction of more than $5,000 for a donation of cryptocurrency. Relying on the general categorization of cryptocurrency as property, Chief Counsel concluded that if a donor claims a charitable contribution deduction of more than $5,000 for a donation of cryptocurrency then the taxpayer must obtain a qualified appraisal of the cryptocurrency, as would be required with a donation of any other property, except for certain readily valued property (such as a cash and publicly traded securities). Chief Counsel specifically considered and rejected the argument that cryptocurrency could qualify as a publicly traded security, and thus readily valued for these purposes, because Chief Counsel concluded it did not fall within the statutory definition of that term.
One issue raised by this conclusion, as Sanford J. Schlesinger and Andrew S. Auchincloss have noted, is that identifying a qualified appraiser for cryptocurrencies may be difficult. That is because, to be qualified, an appraiser must be “an individual with verifiable education and experience in valuing the type of property for which the appraisal is performed.” The relevant regulations further state that this standard is met by either (i) successfully completing relevant professional or college-level coursework and having two or more years of experience valuing the property or (ii) earning a “recognized appraiser designation . . . for the type of property.” The relatively recent emergence of cryptocurrency may render appraisers with either the required education and experience or the required designation relatively rare and hard to find. That said, there are at least some appraisers who claim to be qualified to appraise cryptocurrencies for this purpose. And a related issue is that charities that choose to retain donated cryptocurrencies or purchase cryptocurrencies themselves could have difficulty valuing them for various tax purposes, such as reporting on their annual information returns and, for private foundations, calculating the required payout under section 4942, although this is (admittedly) an issue present for any hard-to-value asset.
The fact that there are cryptocurrency exchanges that publish values for at least the most traded cryptocurrencies raises a question regarding whether Chief Counsel is correct that all cryptocurrencies should be considered not readily valued and that, consequently, qualified appraisals are required for charitable contribution deduction purposes. The possible lack of qualified appraisers provides a further reason to carefully consider this issue, since if the value of donated cryptocurrency is readily apparent because of these exchanges but a donor cannot claim a deduction because of the inability to identify a qualified appraiser, that would unnecessarily inhibit donations of cryptocurrencies and so would frustrate Congress’ purpose of incentivizing charitable contributions. A related issue is whether regularly traded cryptocurrencies are sufficiently like publicly traded stock that donors to private foundations should be able to claim a deduction equal to their fair market value (so not limited to their adjusted basis in the donated cryptocurrency) assuming they held the cryptocurrency as a capital asset and for more than a year, which presumably would incentivize such donations. I will explore these issues further in Part IV.
As for exemption, in 2020 the Service issued an adverse determination letter to an organization that was formed to support a specific cryptocurrency and that had applied for recognition of exemption under section 501(c)(3). More specifically, the letter summarized the organization’s activities as:
You are formed to advance T. T is open source and is a cryptocurrency which is defined as a digital asset designed to work as a medium of exchange that uses strong cryptography to secure financial transactions, control the creation of additional units, and verify the transfer of assets. Your software is free to download, inspect and edit. All your software and research are public and open source allowing anyone to take advantage of or contribute to your work. You work to build technology and software to support the T blockchain.
The Service considered whether the organization qualified either as educational or charitable in its operations given these activities. The Service concluded it was not educational because it did not conduct any programs that educated the public or trained individuals, such as public discussion groups, forums, panels, or lectures, but was instead “best described as providing a product with product information and are analogous to a product manual,” which was not sufficient. The Service further concluded it was not charitable because “[m]erely providing open source webs applications to the public for free is not a charitable activity” and, furthermore, “the public who may use your programs is not a recognized charitable class.” Finally, the Service concluded the organization was unduly benefiting private interests because both block creators and developers received fees.
Paul Streckfus, longtime reporter on tax exempt organization issues and founding editor of the EO Tax Journal, has criticized the Service approach to purported charities involved in open source software, including this denial, stating that “[t]he IRS’ approach . . . is basically throw every possible rationale [for denial] at a wall and see if anything sticks.” His criticisms echo similar concerns raised by others, including that the Service approach reflects an overly narrow interpretation of “educational” and that the general public itself can be a “charitable class.” These criticisms have some merit, given the broad regulatory definition of educational and the traditional understanding of charitable class as including the public as a whole. I will therefore address these concerns further in Part IV.
In contrast, it appears that the Service has recognized the exemption under section 501(c)(3) of organizations with a more traditional charitable or educational purpose but that use blockchain technology as a means to accomplish that purpose. For example, the Service has recognized the exemption under section 501(c)(3) of an organization created to receive and dispose of cryptocurrency donations on behalf of other charities, specifically web platform Every.org, which allows charities to benefit from cryptocurrency donations without having to directly receive and dispose of cryptocurrency themselves. That said, Every.org, which applied under the name ECO Foundation, did not limit its planned activities to this specific task in its exemption application but instead said more generally that it “seeks to serve the general public by undertaking activities to explore and create foundational technologies that connect funders to charitable beneficiaries, including research and development of electronic platforms and related technology for the transmission of fiat and/or cryptocurrencies to indigent populations worldwide.” While the Service has not published any guidance supporting this decision, it presumably based it on the longstanding Service position that facilitating contributions to tax exempt, section 501(c)(3) charities is itself a qualifying charitable purpose and activity under section 501(c)(3) unless the facilitation method is unduly commercial in nature.
As for charities that receive or hold cryptocurrencies but rely on other activities for their tax exempt status under section 501(c)(3), there do not appear to be any areas of major concern. Income generated from selling or otherwise disposing of cryptocurrencies as investments should be exempt from UBIT, unless the acquisition of the cryptocurrency was financed with debt, in which case the debt-financed income rules should apply in the same manner as they would for any other investment. While several commentators have questioned whether the debt-financed income rules further Congress’ stated purposes for UBIT, there is nothing unique to cryptocurrencies that suggests they should be exempted from those rules.
For the subset of charities known as private foundations, there is the possibility that holding cryptocurrency as a significant investment could subject them to the jeopardizing investment excise tax, assuming the private foundation did not receive the cryptocurrency as a donation. But the Service rarely invokes that tax, and the standard for its application is essentially the same standard as state law imposes on charity leaders when it comes to investments, which is relatively forgiving (as will be discussed below). To the extent a private foundation violates that prudence standard because it unwisely invests, or over-invests, in cryptocurrency, application of the jeopardizing investment excise tax seems appropriate.
In summary, while the available Service guidance is limited, it generally appears sufficient to allow both donors to determine what amount they can claim as a charitable contribution (and subject to what substantiation requirements), and purported charities to determine whether involvement with cryptocurrencies could affect overall exemption, albeit based on a few examples of denials and approvals, or have other negative tax consequences. But these conclusions may not be consistent with Congress’ policy goals in two respects. First, treating all cryptocurrencies as not readily valued may, for exchanged-traded cryptocurrencies, unnecessarily inhibit donations of those cryptocurrencies. Second, denying exemption under section 501(c)(3) to organizations with the purpose of developing specific cryptocurrencies may not be justified under existing law, which Congress has structured to define charitable and educational broadly. Both of these areas of possible tension between the answers provided by the Service and the goals of the relevant federal tax laws will therefore be discussed in Part IV.
2. Non-Fungible Tokens
There is almost no guidance relating to the federal tax treatment of NFTs, with only three exceptions. The first exception is that the digital asset reporting legislation mentioned above also applies to NFTs, as the now statutory definition of digital asset for reporting purposes is broad enough to encompass them. Under the recently issued proposed regulations implementing this legislation, this means that exchanges and other intermediaries that facilitate trading of NFTs will be subject to certain reporting requirements.
The second exception is a 2023 Service Notice stating that Treasury and the Service intend to issue guidance classifying certain NFTs as collectibles under section 408(m), which defines collectibles as including works of art, rugs, antiques, metals, gems, stamps, coins, alcoholic beverages, and “any other tangible personal property specified by the Secretary.” The tax consequences of this classification include a higher-than-normal long-term capital gains tax rate applicable to gains recognized on such property (and related special netting rules) and deemed distribution treatment if an individual retirement account (IRA) or a section 401(a) qualified plan acquires such property.
The Notice states that “[p]ending the issuance of that guidance, the Service intends to determine whether an NFT constitutes a section 408(m) collectible by analyzing whether the NFT’s associated right or asset is a section 408(m) collectible (referred to in this notice as the ‘look-through analysis’).” That said, the Notice leaves open the question of whether the associated right or asset is a digital file that renders the NFT a collectible because the file is a “work of art.” It also raises a series of questions relating to the look-through analysis approach and to this categorization issue more generally. Treasury received more than 30 comments in response to the Notice addressing these and related issues.
The issue of whether some NFTs are collectibles for federal tax purposes may have an indirect ramification for charitable contribution deduction purposes. If the Service also applies its proposed look-through analysis approach to such deductions, then donations of NFTs with an associated asset that is tangible personal property will be subject the statutory rule that contributions of such property are only deductible at fair market value (if greater than adjusted basis) if that property is used by the recipient charity to further its exempt purposes. However, it appears that most if not almost all of the subset of NFTs associated with a particular asset are associated with intangible assets in the form of digital images. If that is accurate, then resolution of the collectibles issue will not be relevant for almost all contributions of NFTs to charities.
That said, there is another possible ramification of the proposed look-through analysis. If a donated NFT is associated with copyright or other intellectual property rights, this analysis would presumably lead to the application of the special rules limiting the permitted deduction for donations of such property. But as mentioned earlier many, perhaps most, NFTs are not associated with any intellectual property rights. And to the extent they are, it seems appropriate to make them subject to the special rules Congress created for donations of intellectual property to prevent incorrect—and often overstated—valuations.
The third exception is an extension of the Chief Counsel Advice requiring a qualified appraisal for cryptocurrency donations of more than $5,000 to donations of NFTs. Perhaps to an even greater extent than with cryptocurrencies, such donors could have difficulty finding a qualified appraiser for these purposes, although it may be possible for traditional art appraisers to be considered qualified with respect to NFTs. In addition, the non-fungible nature of NFTs may make it particularly tempting for donors—with the help of a willing qualified appraiser—to claim relatively high valuations that the Service would have difficulty challenging, even with NFT exchanges.
While the treatment of NFTs for charitable contribution purposes is the same as for cryptocurrencies, in contrast to the situation with cryptocurrencies, there does not appear to be any significant tension between that treatment and the goals underlying the existing federal tax laws for charitable contributions. That is because, unlike at least some cryptocurrencies, there is no mechanism that could render NFTs readily valued or similar to publicly traded securities. Indeed, the non-fungible nature of NFTs makes them instead particularly vulnerable to overvaluation and so strongly supports their current treatment, including the requirement of qualified appraisals—however difficult to obtain—if the donor wishes to deduct more than $5,000. This conclusion is further supported by the much smaller overall market cap for NFTs as compared to cryptocurrencies, thereby resulting in limited potential for increasing overall charitable contributions significantly if it were easier to claim a deduction for donating NFTs, not to mention the lack of any evidence of a significant volume of NFT donations.
As for exemption, there also do not appear to be any significant areas of uncertainty with respect to NFTs for two reasons. First, and unlike cryptocurrencies, there do not appear to have been attempts to claim tax exempt status under section 501(c)(3) (or any paragraph of section 501(c)) for organizations solely promoting NFTs. While it appears at least two of the charitable DAOs identified plan to distribute or sell NFTs to help fund their operations, the NFT images are substantially related to their exempt purposes and so would not appear to raise UBIT issues. Second, and for the same reasons as detailed with respect to cryptocurrencies, other applications of UBIT and the private foundation jeopardizing investment excise tax rules appear to be the same as for any other possible investment, and that sameness does not conflict with the goals underlying those tax rules.
3. Decentralized Autonomous Organizations
No published federal tax guidance relates specifically to DAOs. It is not clear if this is because they are a relatively new and, to date, small scale phenomenon, or instead because Treasury and the Service view the treatment of DAO ownership interests as not requiring specific, new guidance. Support for the latter position can be found in the parallels between the federal tax definition of a partnership and the definition of a DAO, which suggests that DAOs should simply be considered partnerships and so subject to Subchapter K unless a DAO is incorporated under state law or elects to be treated as a corporation, in which case either the C corporation or S corporation rules would apply. This result is also supported by the check-the-box regulations, which make partnership the default tax classification for domestic entities (other than corporations) with more than one owner. And if DAOs are treated as partnerships, then DAO token holders will have the taxable income of the DAO, if any, attributed to them for federal income tax purposes.
However, commentators have identified several areas of tax law uncertainty that the emergence of DAOs may create. One is that because DAOs only have owners but no managers—blockchain technology instead automatically executing the owners’ decisions—it is unclear who has responsibility for fulfilling partnership tax filing, reporting, and withholding obligations, including those relating to Form 1065, Schedule K-1 to Form 1065, and other tax forms such as Form 1099s. The Treasury Department is also seeking input on how the newly enacted legislation modifying certain broker reporting requirements to include digital assets should apply to digital asset trading platforms operated as DAOs.
With respect to charitable contribution deductions of interests in DAOs, the lack of any Service guidance is not particularly troubling given the number and market capitalization of DAOs—and so the potential for donations of interests in them—appears relatively small. Moreover, their similarity to other types of closely held entities suggests that any such donations should be treated in a similar manner as interests in such entities and so in a similar manner as cryptocurrencies and NFTs. That is, the deduction amount for such donations should only be fair market value if given to charities that are not private, non-operating foundations, and subject to substantiation requirements including supplying a qualified appraisal. And for the same reasons as for NFTs, this treatment appears consistent with the underlying goals of the charitable contribution deduction.
As for exemption, law professor Sam Brunson has flagged the issue of whether a DAO could itself qualify for exemption under section 501(c)(3). The one scenario where this seems likely is if the DAO is a giving platform, such as Every.org or, if spun off as a separate legal entity, like Big Green DAO. That appears to be the approach of the stand-alone, section 501(c)(3) DAOs identified previously. This apparent position—that the use of a DAO governance structure to further an accepted charitable purpose does not undermine the otherwise available section 501(c)(3) exemption—could be problematic if that structure is somehow inconsistent with the requirements of section 501(c)(3). This issue will therefore be discussed further in Part IV.
As for UBIT and private foundation excise tax issues, there does not appear to be any reason why the presumed treatment of DAO interests like any other investment when it comes to the debt-financed rules and the jeopardizing investment excise tax should be questioned. As for the private foundation excess business holdings excise tax, there also does not appear to be any reason for DAO ownership to be treated differently than the ownership of any other business.
B. State Laws
State laws impose both general fiduciary duties of care and loyalty on charity leaders that extend to their handling of charitable assets, and specific duties with respect to management of investments. State attorneys general have the primary and sometimes exclusive authority to enforce these duties. The goals of these state law duties with respect to charitable assets is to ensure that decisions by charity leaders regarding them—including acceptance, acquisition, retention, and disposition—are done with appropriate care for the financial health and mission of the charity and in furtherance of the interests of the charity as opposed to the interests of the charity leaders. The key questions are therefore whether existing law provides sufficient clarity regarding how it applies to the new assets and, if it does, whether that application is consistent with these overall goals. The answers to these questions are in some instances relevant to the federal tax law issues discussed previously, particularly the issue of whether ownership of these assets by a private foundation could be considered a jeopardizing investment.
1. General Fiduciary Duties
Charity leaders, that is those with “substantial powers with respect to a charity,” owe fiduciary duties with respect to their charity. These include duties of care and loyalty, which apply both generally and with respect to management, investment, and expenditure of a charity’s assets. These duties require the leaders to act in good faith, with prudence, and in the best interests of the charity.
The primary challenge charity leaders likely face when considering whether to accept, acquire, or retain these new assets is therefore whether it is prudent to do so given their novelty, complexity, and, especially for cryptocurrencies and NFTs, volatility. With respect to novelty, the newness of these assets and the related unfamiliarity of most charity leaders with them suggest that most charity leaders should, given their duty of care, employ intermediaries or advisors who are more familiar with them. For example, if a charity is interested in accepting cryptocurrency or NFT contributions, it probably will be advisable in most instances to use one of the available intermediary platforms discussed earlier that can accept the contribution on the charity’s behalf and immediately sell it so that the charity receives fiat currency. This is in part because of the regulatory uncertainty surrounding digital assets, particularly cryptocurrencies and NFTs, not only with respect to federal tax law but also with respect to federal securities law.
As for complexity, there already have been prominent examples of individuals and entities losing access to, or being defrauded with respect to, new assets, and particularly cryptocurrency. Something as simple as losing track of the private key associated with a digital wallet, if the charity takes direct ownership of a digital asset, could cause the charity to lose that asset forever. And the recent FTX cryptocurrency exchange collapse and previous exchange failures demonstrate that even relatively sophisticated parties have difficulty fully understanding, and therefore protecting themselves, from fraud and theft when dealing with these types of assets. There also is a related risk that it may come to light that the donor obtained the donated assets through questionable or even criminal means, creating potential reputational harm or liability for the recipient charity. For example, Stanford University agreed to return gifts it received from the bankrupt FTX exchange and related entities in the wake of a lawsuit by FTX accusing Sam Bankman-Fried’s parents of using their influence to cause the donations, among other actions. A less high-profile situation involved the apparent collapse of an NFT marketplace, but reportedly only after it had used the funds it raised to fund various philanthropic projects.
With respect to volatility, while equity holdings in existing businesses can also have volatile prices, those prices, at least in the long-term, reflect changing expectations regarding the earnings of the underlying business. In contrast, cryptocurrencies have “no consensus valuation framework” but instead depend for their valuations on “the waxing and waning of enthusiasm for a potentially revolutionary assets class for which at times the sky might seem to be the limit.” And this is even more true for NFTs.
All that said, there do not appear to be any new issues when it comes to considering what is needed to satisfy the duty of care when it comes to these new assets. If anything, their novelty, complexity, and volatility strongly indicate that most charity leaders should either avoid having their charities involved with them at all or should only do so through experienced intermediaries. Similarly, the application of the duty of loyalty in this area does not appear complicated either, in that charity leaders should (as always) be sensitive to possible conflicts of interest—such as a board member who wants the charity to invest in a cryptocurrency in which the board member has a personal financial stake.
There is one caveat to this conclusion. Some charity leaders may want to consider whether to create a philanthropic DAO, along the lines of what Big Green has done. As with any new venture, and particularly one using novel technology, they should do so with caution to ensure that any assets controlled by the DAO can only be used for permitted, charitable purposes consistent with the mission of the charity. The Big Green model is quite detailed in terms of its governance structure and grant-making process, and leaders of other charities considering something similar will need to carefully consider the structure of any DAO they create. But again, the relatively permissive and vague standards imposed by the duty of care would seem to apply to such a venture as much as to any new activity.
2. Investment Responsibility
With respect to investments, charity leaders are subject to the general fiduciary duties described in the previous section. They also are subject to state laws specifically imposing duties with respect to charity investments, which most states base on the Uniform Prudent Investor Act (UPIA) and the Uniform Prudent Management of Institutional Funds Act (UPMIFA). While these sources vary in their details, they generally require that charity leaders manage a charity’s investment portfolio in a prudent manner in light of the charity’s purposes, any donor-imposed restrictions, and other relevant circumstances. This duty extends to property received as a donation. The identified circumstances that are most relevant for the new assets discussed in this article are the role that an investment in one of these assets plays in the charity’s overall investment portfolio and the expected total return from the new asset. Charity leaders also have a general duty to diversity investments.
The same considerations that urge caution under the general duty of care—novelty, complexity, and volatility—strongly suggest that charity leaders should be wary of viewing any of these new assets as an appropriate part of their investment portfolio. And even if those leaders, or their advisors, have the expertise to accurately evaluate the risk/return tradeoff for these assets, they should be only a very small part of charity’s portfolio even for the wealthiest and most future-focused charities, such as large foundations or universities with large endowments. That is because of the need both to consider the overall investment portfolio and to maintain diversification.
V. New Wineskins: Do the New Assets Need New Law?
A. Cryptocurrencies Should Not Be Treated as Readily Valued Property (At Least Not Yet)
As noted above, Chief Counsel has taken the position that charitable contributions of cryptocurrencies with a claimed value of more than $5,000 can only be deducted if the donor obtains a qualified appraisal. Congress enacted the qualified appraisal requirement, along with other substantiation requirements, to prevent abuse of the charitable contribution deduction, and particularly overvaluation of donated property. This requirement does not apply, however, to “readily valued property,” which Congress identified as cash and publicly traded securities, as well as certain types of property (intellectual property, inventory, and vehicles) that are covered by special deduction rules. The definition of “publicly traded securities” for these purposes is “securities for which . . . market quotations are readily available on an established securities market.” The relevant regulations further provide that “securities” are defined as provided in section 165(g)(2). Chief Counsel correctly concluded that cryptocurrencies cannot therefore fall within this definition because they are not securities within the meaning of that last section, which is limited to equity or debt interests in a corporation (or to government debt instruments).
The question is whether Congress should modify the list of readily valued property to include convertible virtual currency—that is, cryptocurrencies—for which market quotations are readily available on an exchange. In that situation an appraisal is arguably not required to reliably determine the value of the donated cryptocurrencies, and therefore imposing that requirement unnecessarily inhibits cryptocurrency donations and creates a trap for the unwary donor. The American Institute of Certified Public Accountants (AICPA) also proposed in 2018 that the Service could (and should) interpret the relevant statute to treat virtual currencies as readily valued property and so not subject to the qualified appraisal requirement if the donor could identify two “established exchanges” that valued the donated virtual currency at the day and time of the donation. The reasons the AICPA gave for requiring two exchanges (and averaging the value provided by them) were that “the value of virtual currency can vary slightly among different published exchanges” and being listed on two exchanges “provides support that the donated currency is widely recognized.”
The problem with expanding the list of readily valued property to include cryptocurrencies, or at least cryptocurrencies for which one or more exchanges provide a value as of the date and time of the charitable contribution, is it relies on the uncertain accuracy of those exchanges with respect to reporting valuation. While the relevant regulations do not explicitly require that “established securities markets” used for valuing publicly traded securities meet certain reliability criteria, they appear to assume that such markets will be subject to federal securities laws or foreign equivalents. That assumption, however, cannot be extended to cryptocurrency exchanges, even “established” ones (whatever that means), given that several of those exchanges are in the midst of litigation with the SEC challenging that agency’s attempt to apply securities laws to them. And the reliability of such exchanges absent SEC oversight is questionable, as illustrated by both the collapse of the FTX exchange in the face of fraud allegations and a recent report questioning the stability of the largest remaining exchange, Binance, which is facing not only SEC but also Department of Justice investigations and whose founder has pled guilty to money laundering.
Even if one or more exchanges are deemed to be reliable, the value provided by different exchanges can vary, as the AICPA proposal notes. Likely for this reason, one appraiser of cryptocurrencies stated that its valuation methodology involves considering all the exchanges on which a cryptocurrency trades and then using “the average of all the pricing indicators to arrive at a fair market value price on the valuation date.” For publicly traded securities such variations are very small and disappear very quickly because computerized trading programs quickly arbitrage any such differences (and thereby eliminate them). But while the AICPA assumed any such variations for cryptocurrency exchanges would be slight, it is certainly possible they would be significant enough that a donor might be able to cherry pick among exchanges to claim a substantially higher valuation than is justified (a problem that would be compounded if the donor had some type of influence over a particular exchange, as Sam Bankman-Fried—a major cryptocurrency donor—had over FTX). And the problem is not completely avoided even for stablecoins, as they do not always maintain their pegged value despite attempts to do so. Also for these reasons, the treatment of cryptocurrency donations to private foundations, for which at this point the amount of donation is limited to lower of basis or fair market value, is also correct absent the valuation of cryptocurrencies becoming as reliable and transparent as the valuation of publicly traded corporate stock. I therefore believe a recent recommendation that “for more liquid and well-recognized digital assts, the Service could allow a simplified valuation process” is premature.
All that said, the unreliability of exchange-determined values may disappear over time, and so Congress should be open to revisiting this issue if that were to occur. For example, if the SEC ultimately wins the litigation challenging whether cryptocurrencies are securities and so the exchanges on which they trade are subject to federal securities laws and the SEC’s authority, that may render all (or at least domestic United States) cryptocurrency exchanges relatively reliable. An alternative approach would be for Congress to explicitly give Treasury the discretion to add to the list of readily valued property and so delegate the ability to address any such changes. As for donations of cryptocurrency to private foundations, Congress would also need to alter the relevant statute if it wanted to extend publicly traded stock treatment to donations of certain cryptocurrency, as that statute currently limits such treatment to corporate stock.
The AICPA’s proposal notwithstanding, it does not appear that Treasury or the Service are currently free to add cryptocurrencies to the statutory list of readily valued property for charitable contribution deduction purposes absent congressional action or modification of a longstanding regulation. Congress defined “publicly traded securities” by cross-reference to section 6050L(a)(2)(B), which simply provides that this term means “securities for which (as of the date of the contribution) market quotations are readily available on an established securities market.” But as noted previously, Treasury has refined this definition in longstanding regulations that further defined “securities” by cross-reference to section 165(g)(2), thereby limiting that term to equity or debt interests in a corporation (or to government debt instruments). Treasury could presumably modify this regulation to drop the latter cross-reference and so open the possibility that cryptocurrency could be considered public traded securities under the statute, but Treasury may be reluctant to change this longstanding rule. However, an alternative approach that would avoid the need for congressional action would be for Treasury to instead provide that, in the context of regularly traded cryptocurrencies, an appraisal would be sufficient if it relied on exchange-reported prices on the donation date (and otherwise satisfied the qualified appraisal requirements).
A related issue is the possibility that cryptocurrencies could come to resemble foreign currency more closely if they start not only to be legally recognized but also to be used as mediums of exchange. In that situation, a reclassification as foreign currency would hinder charitable contributions of cryptocurrency because the amount of any deductions would be limited to the donor’s basis, since gain on foreign currencies is considered ordinary gain and so not deductible. Again, if this were to happen Congress would need to consider whether to permit the deduction of the fair market value of cryptocurrencies even if they are properly classified as foreign currencies.
Finally, providing a negative answer today with respect to the readily valued issue does not necessarily create either a pacing problem or a regulator dilemma problem. The volume of cryptocurrency donations—reaching overall valuation of hundreds of millions of U.S. dollars in 2021—is such that it is necessary to have an answer for donors now, as Chief Counsel has provided, and there is enough information about the unreliability of exchanges to support that answer for the time being. That said, Chief Counsel guidance based—correctly—on existing law does not foreclose Congress in the future from amending section 170 to add cryptocurrencies traded on reliable exchanges to the list of readily valued assets or foreclose Treasury from creating a simplified appraisal rule for cryptocurrencies regularly traded on reliable exchanges, if circumstances warrant doing so. That guidance is therefore unlikely to have much staying power in that situation, especially since presumably the AICPA, other commentators, and promoters of cryptocurrency are likely to push for such a change.
B. Blockchain as a Means But Not an End Under Section 501(c)(3)
While we do not have the benefit of seeing all Service determinations with respect to recognition of exemption under section 501(c)(3) for organizations using blockchain technology in some manner, it appears that the Service has so far taken the position that promoting blockchain technology as an end does not qualify for such recognition, but using blockchain technology as a means to further a more traditional charitable purpose does qualify. For example, the one denial on record involved an organization that existed to develop and promote a particular cryptocurrency, including educating the public about it. In contrast, we know that the Service has recognized the exempt status under section 501(c)(3) of at least one platform that focuses on facilitating charitable contributions of cryptocurrencies and NFTs and of at least three DAOs, one associated with a blockchain project at Vanderbilt University and the other two involved in funding various charitable projects.
The Service’s conclusion that the organization formed to promote a particular cryptocurrency does not qualify for recognition of exemption under section 501(c)(3) is correct, although the Service’s reasoning is overbroad and incorrect in several respects. The Service was incorrect to attempt to narrowly define “educational” in this particular context—in tension with the broad regulatory definition—and to refuse to recognize the public as a whole is an acceptable charitable class. However, the Service was correct to identify private benefit as the disqualifying aspect of this organization, and indeed should have relied on that concept more heavily in that not only did the individuals involved stand to benefit directly from the organization’s activities, but also by developing and promoting a specific cryptocurrency the organization essentially was simply the marketing arm for a non-charitable, commercial asset. The organization therefore resembled other situations where an individual or group of individuals uses a purported charity to promote their particular product, which disqualifies that organization from section 501(c)(3) status.
By comparison, there is nothing about blockchain technology that makes its use the basis for disqualifying an otherwise qualified section 501(c)(3) organization from that tax status. The Service was therefore correct in its determination with respect to the giving platform designed to facilitate charitable contributions of cryptocurrencies and NFTs, since facilitating charitable contributions is itself a charitable purpose (and assuming all the other requirements for section 501(c)(3) status were satisfied, as they apparently were). The Service was also correct that simply having a DAO governance structure is not disqualifying if, again, the relevant organization furthers a charitable purpose—education, cancer research, and religious projects in the three examples known to date—and otherwise satisfies the organizational and operational tests under section 501(c)(3). More specifically, all three appear to have been formed as (presumably nonprofit) corporations, although it is not entirely clear what is the exact legal form of ApostolicDAO, but presumably it similarly satisfies the relevant requirements. And there is nothing to indicate that accepting cryptocurrency or NFTs (or an interest in a for-profit DAO) as a donation or investing in such assets (subject to the state law duties discussed previously) would disqualify an otherwise qualified section 501(c)(3) organization. What is not yet completely clear is how federal tax law would treat a charitable DAO if its organizers wanted to forgo any formal state law legal form (which choice would also raise interesting questions regarding who would be subject to state law fiduciary duties), but a possible approach would be to apply the same rules the Service applies to unincorporated nonprofit associations.
That said, there appear to only be relatively few organizations seeking to use blockchain technology, including a DAO governance structure, to further charitable purposes. There therefore does not appear to be any need for the Service or Chief Counsel, much less Congress, to issue any guidance on this issue beyond the Service making individualized determinations as needed in response to recognition of exemption applications. And given the still developing nature of this technology, particularly with respect to DAOs, it is advisable for the Service and Chief Counsel to avoid issuing any—so far not needed—guidance on these issues to avoid unduly hindering developments in this area. As for the one area where there is significant activity—charitable contributions—the existing guidance should be sufficient for current donors and recipient charities.
VI. Conclusion
The old wineskin of existing charity law holds up well to the new wine of cryptocurrencies, NFTs, and DAOs. This result flows from the comprehensiveness of federal tax law and the relative vagueness of state law, both of which lead to these laws being “future-proofed” to a large extent in that they are able to accommodate these new assets. For these reasons, regulators and practitioners can, for the most part, readily discern how these existing laws apply to these new assets, and legislators and regulators do not need to revisit those existing laws at this time to properly accommodate these new assets.
That said, there are two federal tax areas where the fit of existing law could eventually be in tension with underlying policy goals and so may need to be modified. The first area is with respect to readily valued property that does not require a qualified appraisal to support a more than $5,000 charitable contribution deduction. The exclusion of frequently traded cryptocurrencies from this category is appropriate now, given the uncertain reliability of cryptocurrency exchanges, but may not be in the future if that reliability improves.
The second area is the need for the Service to continue to differentiate when it comes to section 501(c)(3) tax exemption between organizations formed to promote a particular subset of these new assets—such as a particular cryptocurrency or NFT collection—for its own sake, which would provide a significant and so disqualifying private benefit to the developers and owners of that subset, and organizations that use these new assets to further recognized charitable purposes. The limited information available indicates the Service is correctly applying this distinction, even if its arguments in support of it are not always correct. Furthermore, the relatively few instances where it appears this distinction needs to be applied argue against the issuance of formal guidance on this point. However, if the volume of exemption applications implicating this issue increases significantly, the Service should then consider issuing such guidance.
