At its most basic level, a related party is one that is either directly or indirectly able to significantly influence or control another party. Thus, a related party transaction is a transaction that occurs between two or more parties with inter-linking relationships.
Specifically, in the nonprofit sector, a related party is generally a person who serves as a director, officer, or key employee of the nonprofit organization or any affiliate thereof; any other person who exercises the powers of directors, officers, or key employees over the affairs of the nonprofit corporation or any affiliate; or any relative of any of the preceding individuals. “Relative of an individual” refers to his or her spouse or domestic partner, ancestors, brothers and sisters (whether whole or half-blood), children (whether natural or adopted), grandchildren, great-grandchildren, or the spouse or domestic partner of brothers, sisters, children, grandchildren, and great-grandchildren. In addition, any entity in which any of the foregoing individuals have a 35% or greater ownership or beneficial interest, or, in the case of a partnership or professional corporation, a direct or indirect ownership interest in excess of 5%, constitutes a related party. It’s a long and convoluted list, for sure.
It is important to consider the potential ramifications of a related party transaction involving a nonprofit organization in which a related party has a substantial influence over the affairs of the corporation and the five-year look-back period of the federal statute that accompanies such an instance. Consider this admittedly-muddy example: The wife of the great-grandson of an individual who three years ago was a very significant donor to a nonprofit organization provides services for a fee to the organization. As a result of her affinity for the organization, these services are being provided at well-below market rate and the donor has had no other relationship with the organization. In this example, the donor (great grandparent) could be a “key employee” even though never serving as an employee because, as a very significant donor, the great-grandparent may have been in a position to exercise substantial influence over the affairs of the organization within the five-year look-back period. Therefore, a transaction of this nature is subject to the heightened requirements and procedures for related party transactions. The moral of the story here is to be mindful of these issues as they arise, and become educated enough to spot potential areas of risk and exposure.