Indeed, while many concerns about Yorba are valid, the IRS claim that FLOSS is not "public work" is troubling and nonsensical. Yorba is not a charity, and not all public work deserves 501(c)(3) status, but FLOSS is public work.
Yeah, the IRS's letter is incomprehensible on this point. Maybe I can help: at it is typically understood, a "public work" is something like a dam, or bridge, or sewer system. As Black's Law Dictionary defines the term, public works are "structures (such as roads or dams) built by the government for public use and paid for by public funds."
It is impossible to know whether this is what the IRS had in mind. But I can tell you that, according to my understanding of the term, and the dictionary definition, it seems pretty clear that it does not cover open source software.