“Related party” is defined in Treas. Reg. 1.150-1(b). The definition is a “way finder” – it does not directly define the term but tells the reader whether the applicable definition is found in one section or another, depending on the situation being addressed. In reference to a governmental unit or a 501(c)(3) organization, “related party” means any member of the same “controlled group.” In reference to any other type of person, “related party” actually means “related person” as defined in I.R.C. 144(a)(3). Therefore, when a section of 103 and 141-150 states a rule concerning related parties and governmental units or 501(c)(3) organizations, think “controlled group” – the definition of which is in Treas. Reg. 1.150-1(e).
A controlled group, within the meaning of Treas. Reg. 1.150-1(e), is a group of organizations that is controlled by the same entity or group of entities, either directly or indirectly. The regulations describe what it means to have direct control and indirect control.
An organization is controlled directly by another if the facts and circumstances so indicate. Relevant considerations to determine control are:
- Does the controlling organization the right to approve and remove the members of the governing body of the other entity?
- Does the controlling organization have the effective power to make such approvals and removals?
- Does the controlling organization have the right to require the use of funds or assets of the controlled organization for any purposes of the controlling entity?
- Does the controlling organization have the power to require such use of funds or assets?
Indirect control of an organization can arise from a chain of control relationships. The “parent” organization is considered to be indirectly controlling any entities that are directly or indirectly controlled by an organization the parent controls directly.
I.R.C. 144(a)(3) explains that a person is a related person to another person (and that such persons are “related persons”) if:
- the relationship between the persons would result in a disallowance of losses under I.R.C. 267 or I.R.C. 707(b); or
- such persons are members of the same controlled group of corporations (defined in I.R.C. 1563(a), except that “more than 50 percent” is used instead of “at least 80 percent” each place in such section).
I.R.C. 267 describes when losses and other tax attributes in transactions between related taxpayers are disallowed. Generally, such attributes are disallowed (or suspended) when the persons have any of the following relationships:
- Members of a family;
- An individual and a corporation more than 50 percent in value of the outstanding stock of which is owned, directly or indirectly, by or for such individual;
- Two corporations that are members of the same controlled group (I.R.C. 1563(a), which the exceptions shown above);
- Certain grantors, fiduciaries and beneficiaries of trusts;
- A person and a 501 organization that is controlled directly or indirectly by such person or (if such person is an individual) by members of the family of such individual;
- A corporation and a partnership, if the same persons own (A) more than 50 percent in value of the outstanding stock of the corporation, and (B) more than 50 percent of the capital interest or profits interest in the partnership;
- An S corporation and another S corporation if the same persons own more than 50 percent in value of the outstanding stock of each corporation;
- An S corporation and a C corporation, if the same persons own more than 50 percent in value of the outstanding stock of each corporation; or
- Certain executors and beneficiaries of estates.
I.R.C. 707(b) describes certain disallowed attributes for controlled partnerships. Such controlled partnerships include:
- A partnership and a person owning, directly or indirectly, more than 50 percent of the capital interest, or the profits interest, in such partnership; or
- Two partnerships in which the same persons own, directly or indirectly, more than 50 percent of the capital interests or profits interests.
I.R.C. 1563(a) describes what a controlled group of corporations is. The section describes parent-subsidy controlled groups, brother-sister controlled groups, combined groups and certain insurance companies:
- Parent-subsidy controlled groups are one or more chains of corporations connected through stock ownership with a common parent if: 80 percent vote or value of stock is owned by one or more of the other corporations in the chain;
- Brother-sister controlled group is a group of two or more corporations if 5 or fewer persons who are individuals, estates or trusts own stock possessing more than 50 percent of the total combined vote or value of the stock of each corporation.
Note that I.R.C. 147(a) has a slightly different definition of “related person” for purposes of the substantial user limitation (where a bond is not a qualified bond if it is held by a person who is a substantial user of the facilities or a “related person” to such a substantial user). For purposes of I.R.C. 147(a), “related person” has the same basic meaning, but is expanded to also include (1) a partnership and each of its partners (and their spouses and minor children), and (2) an S corporation and each of its shareholders (and their spouses and minor children).