What Every HOA Should Know About Taxes
How hard could a tax return for a Homeowners Association (HOA) be? Certainly it can’t be as difficult as some of these complex business returns, especially if there is not even a requirement to pay taxes in some cases...right? In all actuality, HOA taxation can sometimes be complicated. And not knowing what you are doing could cost your HOA unnecessary tax dollars.
There are three types of tax forms an HOA will typically file: 1120-H, 1120, or 990. Each return is taxed on completely different items and requires a completely different approach to the completion of the return. Each of these types of returns offers its own set of complexities. This article will cover the basics of each of the three forms.
The majority of HOAs will want to file a Form 1120-H - Income Tax for Homeowners Associations. The audit rate for this form is extremely low, which is one of its best-selling points. It is a one page form, which is comparatively simple to complete when compared to the other forms an HOA could be required to file. HOAs must meet certain eligibility criteria to file the 1120-H (which most do):
1. At least 60% of the association’s gross income for the year must consist of exempt function income. (Assessments, late fees, fines, etc.)
2. At least 90% of the association’s expenses for the tax year must consist of expenses to acquire, build, manage, maintain, or care for its property.
3. No private shareholder or individual can profit from the association’s net earnings except by acquiring, building, managing, or caring for the association property or by rebate of excess membership dues, fees, or associations.
The HOA will also have to be organized and operated to acquire, build, manage, maintain and care for the property substantially all of whose lots or buildings are homes for individuals (not commercial).
On the Form 1120-H, income is divided between “exempt” function activity and “nonexempt” function activity. Nonexempt function activity is what is taxed. Nonexempt function activity results primarily from:
1. Revenue from non-association property (interest, dividends, capital gains, etc.)
2. Amounts charged to association members for specific services (laundry, social services, rental of property, etc.)
However, the major disadvantage of the 1120-H is that it is taxed at a flat rate of 30%. This could be a huge problem for HOAs who earn substantial interest on their reserve accounts.
If you do not meet the qualifications to file an 1120-H, or you have substantial taxable income (for example, interest income), the HOA would file Form 1120, or the regular corporate form. While this is the form all other regular corporations file, as an HOA, you will receive certain benefits other corporations are not qualified to receive.
An HOA is not taxed on all its income minus all of its expenses. Instead, the HOA is taxed on its nonmembership income minus expenses attributable to nonmembership income. This is not to be confused with exempt function activity income versus nonexempt function activity income. This clarification is exactly how it sounds, you only pay taxes on the net income received from nonmembers of the association.
The advantage to filing this return is an association will typically pay less tax than if they file an 1120-H as the taxes are graduated from 15% to 39%, not a flat 30%.
The form is more complicated and can have various additional calculations that may have to be prepared because of excess membership deductions or excess membership income. Additionally, there is simply more risk and more tax planning that is needed when the Form 1120 is filed. As a result, any HOA filing of the form should consult with their CPA to reduce risk of any adverse tax consequences should the HOA become the target of an IRS audit.
Form 990 or 990-EZ
For those HOAs that have received tax-exemption from the IRS, the Form 990/990EZ is required to be filed. Of all the forms, this is arguably the most comprehensive form, as it is 12 pages long for just the basic form. Depending on the complexity of the organization, there are numerous schedules that could be required to be attached.
Even though the organization is considered tax-exempt, it may have to pay taxes if it has unrelated business income. Additionally, although the Form 990 is an informational form, there are steep penalties for not submitting in a timely manner.
It is important to understand the pros and cons of each form and how the tax is calculated relative to your specific entity before a return is filed. Be sure to consult with a CPA that is familiar with the HOA industry before deciding which tax form your association should file.
By: Michelle Lee, CPA