Tax-exempt organizations should understand the standards applied under Form 990 to determine whether organizations in which they maintain an ownership or controlling interest must be reported on Form 990.

On August 4, 2009, the Internal Revenue Service (IRS) published a series of frequently asked questions and tips (FAQs) regarding the determination of relatedness for Form 990 reporting purposes. The FAQs expand on information contained in 2008 Form 990 and the related instructions, and particularly information found in the Instructions for Schedule R. Schedule R is newly added to the revamped Form 990, and it centralizes certain information regarding related organizations previously required on prior versions of Form 990. Schedule R also requires the disclosure of new information, including more detail about the relationship between a filing organization and its related organizations, and specifically income derived through those related organizations. As a preliminary step in completing Form 990, each filing organization should first understand the standards for relatedness under Form 990 and then determine whether the filing organization is obligated to include any information regarding a related or other organization on Form 990.

General Comments on Form 990 Schedule R – Related Organizations and Unrelated Partnerships

Historically, organizations submitting Form 990 were required to identify whether they were related to other organizations and then disclose certain limited information regarding the relationship with each such related organization. Income, revenue and funding information between a filing organization and related organizations, if disclosed at all, was not collected in a single reference point for the IRS. A significant revision to the 2008 Form 990 is the addition of Schedule R – Related Organizations and Unrelated Partnerships. With the addition of Schedule R, the IRS focuses on a filing organization’s relationship to other organizations, and specifically whether the filing organization derives income from related organizations and/or unrelated partnerships. With this addition, the IRS indicates a clear intent to delve deeper into the relationships by and among filing organizations, and focus on ways in which filing organizations make and share money and resources. Given the IRS’s increased focus on this area, filing organizations should ensure that they understand the basis for relatedness under the new Form 990 so that they can satisfy their reporting obligations thereunder. They should also ensure that they include certain unrelated organizations taxed as partnerships in their reporting.

The FAQs can be loosely grouped into two categories: FAQs describing or clarifying the standards for relatedness, and FAQs identifying or clarifying the information to be reported. The following discusses the more important FAQs for filing organizations.

FAQs Describing or Clarifying the Standards for Relatedness

FAQ #1

FAQ #1 addresses the basis for determining whether organizations are “related organizations” for purposes of Form 990. Relatedness is generally determined by the presence of an ownership or controlling interest, or overlapping ownership or control.

FAQ #2 and #3

FAQ #2 and #3 respectively describe the standard for relatedness for a nonprofit organization and for a stock corporation or other organization with owners or persons with a beneficial interest. In the nonprofit context, relatedness is determined based on control or overlap between one or more organizations in their governing bodies. Generally, the right to appoint, control or remove a majority of the directors of another organization is sufficient to establish control, resulting in relatedness. In the stock ownership and other contexts, relatedness is based on stock ownership, right to profits and beneficial interest. Generally, ownership of more than 50 percent of a corporation’s stock, the right to more than 50 percent of an organization’s profits or the right to more than 50 percent of the beneficial interest in a trust results in relatedness for Form 990 purposes.

It is important to note that relatedness for Form 990 purposes is distinct from that for other purposes. For example, in 2007, the IRS published regulations regarding the relatedness of nonprofit organizations for employee benefits purposes. Relatedness for employee benefits purposes is not the same as relatedness for Form 990 purposes; relatedness for Form 990 purposes imposes a broader standard than that for employee benefits purposes. Nonprofit organizations should ensure that they do not mistakenly use the controlled group definition of relatedness as opposed to that provided in Form 990 and fail to report organizations that are related for Form 990 purposes.

FAQ #6

FAQ #6 explains that controlled entities are just one type of related organization (i.e., they are a subset of related organizations). The FAQ states that a controlled entity can be either a tax-exempt or taxable organization, highlighting that a nonprofit organization is not limited in the type of controlled entity that it must include in its reporting. On Part V of the Schedule R, filing organizations must relay information on transactions with controlled entities. This reporting requirement is the same as the reporting requirement from Part IX of the old Form 990.

FAQ #10

FAQ #10 emphasizes the attribution rule applicable to related organizations. If organization A wholly owns organization B and organization B owns a 70 percent interest in organization C, organization A is deemed to own 70 percent of organization C. This underscores the importance of reviewing not only the relationship between a filing organization and its subordinate organizations, but also the relationships between subordinate organizations and organizations with which they interact or maintain an interest.

FAQs Identifying or Clarifying the Information to be Reported

FAQ #4

FAQ #4 restates the information from Schedule R and the instructions that must be reported on Schedule R. It is a short summary of the reporting requirements and is a helpful reference.

FAQ #5

FAQ #5 restates the information from Schedule R and the instructions that must be reported. It reiterates an important point from the instructions: a filing organization need only report on transactions listed in Part V, Item 1, Lines (b)-(r) if they exceed $50,000. For Part V, Item 1, Line a, the filing organization must report the receipt of interest, annuities, royalties or rent from a controlled entity regardless of amount.

FAQ #7

FAQ #7 identifies other sections of Form 990 that require information from related organizations. Filing organizations should keep in mind that information for related organizations appears in these other locations as well as Schedule R.

FAQ #8

FAQ #8 focuses on exempt organizations participating in joint ventures and other arrangements in which the filing organization does not maintain a controlling interest that would result in a reportable related organization relationship. It reiterates the importance of Part VI of the revised Form 990, which acts as a catch-all through which relationships that might not otherwise be reported on Form 990 Schedule R must otherwise be reported. For example, if a nonprofit hospital maintains a 10 percent interest in a taxable partnership with multiple other partners (e.g., two other local hospitals and a clinic), the hospital would not necessarily be required to report the partnership as a related organization because the hospital’s ownership interest does not meet the Form 990 reporting requirement for a related organization. However, it would be required to report the relationship on Part VI if the filing organization conducted more than 5 percent of its activities through the partnership. Disclosure would not be required if the partnership were merely an investment partnership.

FAQ #9

FAQ #9 focuses on situations in which a filing organization must treat the activities of a related organization as its own. In the case of a disregarded entity for which the filing organization is the sole member, the filing organization must treat the activities of the disregarded entity as its own for reporting purposes. In the case of a partnership, the filing organization must treat the partnership’s activities as its own in proportion to the filing organization’s proportionate interest in the partnership. With respect to corporate ownership, the corporation’s activities are not treated as those of the filing organization unless the corporation acts as the filing organization’s agent, or the corporation is a sham. Filing organizations should keep these rules in mind when completing Form 990.

Discussion

In publishing the FAQs regarding Schedule R, the IRS highlights the need for filing organizations to develop a clear understanding of their organizational structure and business and economic relationships and interests. Schedule R imparts a renewed IRS focus on the standards and reporting requirements for related organizations as well as certain taxable joint ventures in which a filing organization participates. These requirements, and particularly those pertaining to related organizations, affect not only Schedule R, but various other pieces of a filing organization’s Form 990. Therefore, as a threshold inquiry, and before a filing organization begins preparing its Form 990, the organization must consider the entities in which it maintains an interest. It should next determine whether such entities are related, and, if so, the extent to which the relationship and facets of that relationship must be reported. If unrelated, the filing organization is not necessarily in the clear. It should determine whether the relationship rises to the level of a reportable joint venture and proceed accordingly.