We have no plans to appeal their decision. It looks to be an arduous legal battle we cannot afford.

This is rather sad, and since you were given a 30-day window to contest the decision that was issued on May 22 and it's now July, I have to assume that you decided not to bother and let the window close rather than asking for an extension or suchlike. But I'll address the substantial question anyway.

Maybe you (ie Yorba) shouldn't look at it in confrontational terms. My understanding is that the IRS has standards which it is required to meet by law before granting 501(c)(3) status, not least because of questionable compliance by other organizations in the past, eg the kerfuffle over Acorn, an organization whose lax internal standards led to an unusual Congressional defunding. (Of course that was a heavily politicized case, but that's life inside the sausage factory).

If you look at it from the IRS's point of view, much of the letter explains what sort of materials they need to satisfy the showing of a charitable purpose, eg on page 2 they point out that you have no real idea if the Tools are actually used by the poor and underprivileged. Obviously you don't want to make everyone jump through hoops to download them, or track everyone who does, but you could solicit testimonials from under-privileged people who derive benefit from them, in order to make a showing of having provided aid to the underprivileged. Merely stating this as your goal doesn't qualify, since such statements of good intention are easily employed by people who wish to maintain a charitable front for activities that would otherwise be taxable. In the absence of any showing to the contrary the IRS has to weigh the possibility of an illegitimate purpose. If not, they're arguably just rubber-stamping the application.

We might think the charitable nature of an open-source project is self-evident, but the whole point of regulatory oversight is that you can't always take people's word at face value, because a substantial proportion of people are in fact dishonest and inclined to abuse loopholes in things like tax liability. So you need to provide them with some objective evidence of your charitable endeavor by showing examples of who is helped and how. Doing so would probably obviate the requirement to screen out commercial or political uses.

Likewise, the letter points out that the although you offer educational materials in the form of documentation (presumably of both the code and applications), you didn't include any of this with your submission, so again you can't really blame them for not giving weight to it. Yes, they could go off and look it up, but the fact is that in our adversarial legal system its up to the petitioner (for tax exempt-status) to proactively supply evidence for their claim and make an argument for how it supports their charitable activity, not that of the administrator to go and look for it. Some of the documentation of your site is quite good (eg the Shotwell architectural documentation for programmers), some is pretty perfunctory (eg the Shotweel user documentation, or the almost-non-existent documentation for the deprectated Fillmore project). By 'perfunctory' I mean that the Shotwell documentation (for example) says 'function x is here, configurator Y is there, common task Z can be achieved like so.' This is OK for hackers - let's face it, many of use care as little to read documentation as programmers care to write it - but it's not instructional in the sense of helping someone who was unfamiliar with computers to develop a skill they would otherwise lack.

I could go on, but I don't want to go through the letter right now with a fine-tooth comb. The thing is, when I read it I see them telling you what they need to see and how it should be presented, as well as where the errors in your original submission were. Even if you don't appeal, this is useful information for other open-source nonprofits to use - not just in meeting IRS compliance requirements, but in ensuring that their offerings provide concrete benefits beyond free-as-in-beer software. I don't think the reference to notions of public works extending back 4 centuries is evidence of an antipathy to software or a requirement that the people of the 17th century have foresight of such things, but addresses the underlying notion of what constitutes charitable assistance: it is more than just putting a box on the sidewalk labeled 'free stuff'.

One thing that jumps out at me from page 9 is the tricky issue of copyright assignment in free software licenses. I've always felt that GNU license tried to have its legal cake and eat it by saying it was open to all but preventing its use in closed-source commercial products (GPL 5c - http://www.gnu.org/copyleft/gpl.html). It appears the IRS is saying that if you really want to 'give' software/source to the public, you have to actually put it in the public domain rather than promulgating ideological restrictions; if someone then exploits it to make and sell 'Closed Source Nastyware, Ripoff Edition' that's just too bad.