Income From Controlled Organizations

The exclusions for interest, annuities, royalties, and rents, explained earlier in this chapter under Income, may not apply to a payment of these items received by a controlling organization from its controlled organization. The payment is included in the controlling organization's unrelated business taxable income to the extent it reduced the net unrelated income (or increased the net unrelated loss) of the controlled organization. All deductions of the controlling organization directly connected with the amount included in its unrelated business taxable income are allowed.

For a payment made under a contract in effect on June 8, 1997, and received during the first 2 tax years beginning after August 4, 1997, the definition of a controlled organization and the computation of the amount included in the controlling organization's unrelated business taxable income are different. See section 1.512(b)-1(l) of the regulations for details.

Net unrelated income. This is:

• For an exempt organization, its unrelated business taxable income, or
• For a nonexempt organization, the part of its taxable income that would be unrelated business taxable income if it were exempt and had the same exempt purposes as the controlling organization.

Net unrelated loss. This is:

• For an exempt organization, its net operating loss, or
• For a nonexempt organization, the part of its net operating loss that would be its net operating loss if it were exempt and had the same exempt purposes as the controlling organization.

Control. An organization is controlled if:

• For a corporation, the controlling organization owns (by vote or value) more than 50% of the stock,
• For a partnership, the controlling organization owns more than 50% of the profits or capital interests, or
• For any other organization, the controlling organization owns more than 50% of the beneficial interest.

For this purpose, constructive ownership of stock (determined under section 318) or other interests is taken into account.

Therefore, an exempt parent organization is treated as controlling any subsidiary in which it holds more than 50% of the voting power or value, whether directly (as in the case of a first-tier subsidiary) or indirectly (as in the case of a second-tier subsidiary).

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