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Tax season is always stressful, especially for homeowners associations with no experience on the subject. But, filing your HOA tax return does not have to be an uphill battle. HOA TAX RETURN: IS IT NECESSARY?
Does an HOA have to file a tax return? There is a common misconception that HOAs do not need to file tax returns, and a lot of people still believe it to this day. This fallacy primarily stems from the notion that, since HOAs are non-profit entities, tax returns are unnecessary.
But, the truth is homeowners associations do pay taxes and are therefore required to file tax returns. Although it is true that such associations are non-profit, the Internal Revenue Services does not treat them that way. This applies even if your HOA is registered and officially designated as a non-profit organization in your state.
Since an HOA’s main purpose is not to make money, you will find that most of the income your HOA generates is tax-exempt. That means you do not have much in terms of tax liability. Even if your HOA’s entire income is exempt from taxation, though, you will still need to file a homeowners association tax return annually. TWO TYPES OF HOMEOWNERS ASSOCIATION TAX FORM Unlike other kinds of organizations, homeowners associations are allowed more flexibility by the IRS. In fact, there are two types of forms you can use for HOA tax filing: Form 1120 and Form 1120-H.
But, how exactly do these two forms differ?
Form 1120, also known as the Corporation Income Tax Return form, is the one traditional corporations use. Before the introduction of Form 1120-H, the IRS required HOAs to use Form 1120. But, many associations dislike this form for a couple of reasons.
Labor-intensive. Form 1120 objectively involves more work, so it is both time-consuming and troublesome to file. It demands a large amount of detailed information that most associations just do not have. To file Form 1120, associations would have to keep their books in an advanced manner. This makes it significantly harder for the HOA treasurer, who must also manage to make estimated tax payments.
Taxable leftover income. If you choose to file Form 1120, that would make any income your association does not spend for the year taxable. This applies even if you deposit the surplus in your reserve fund.
In contrast, Form 1120-H is much easier to file because the IRS specifically designed it for homeowners associations. Compared to the multi-paged Form 1120, Form 1120-H only consists of one page, making it significantly less labor-intensive.
It is worth noting that the IRS allows HOAs to choose between Form 1120 and 1120-H every year. That means you can file Form 1120 one year and then Form 1120H the next. You do not have to stick to a single form forever. This gives you the unique opportunity of calculating how much tax you need to pay for each form and then using the one that demands the least tax amount.
EXEMPT VS NON-EXEMPT INCOME
While impatience might immediately push you to file your HOA tax returns, you must first understand how exempt and non-exempt income work. Failure to do so can lead to problems with your taxes and paying more taxes than required.
What is exempt function income? Often simply referred to as exempt income, this type of income comes in the form of membership dues, special assessments, fines or fees, and any interest. Exempt income must be sourced solely from the association’s members acting as owners and not as the HOA’s customers.
What is non-exempt function income? Non-exempt income is the income your HOA earns through providing services to association members or the public. Some common examples of non-exempt income for an HOA would be income earned by vending machines, laundry services, and facility rentals.
As a general rule, exempt income is not taxable and non-exempt income is taxable. Some cases allow for certain exceptions to this rule. But, since it varies depending on the case, it is best to have a professional or accountant review your homeowner association taxes before filing.
UNDERSTANDING NON-EXEMPT EXPENSES
If you have non-exempt income, you are then given the opportunity to deduct any expenses that directly relate to the creation of that income. But, you might have expenses that indirectly contributed to this non-exempt income. Can you then use these indirect costs to lower the amount of taxable income you have?
According to IRC Section 528, you can deduct a portion of any expenses your association used for maintenance, repair, construction, or management. This includes insurance expenses, accounting costs, tax fees, bank charges, and HOA management fees.
This is a double-edged sword, though. While this reduces your HOA’s taxable income, it also means that you might not qualify for Form 1120-H because it will negatively affect the 90 percent expense calculation (discussed below).
HOW TO QUALIFY FOR FORM 1120-H
Most homeowners associations opt to use Form 1120-H because it offers a lot of benefits. One of the biggest benefits of this form is that you can exclude exempt function income from your gross income. In essence, this means you will only need to pay taxes on non-exempt income. But, there are certain pre-requisites for an HOA to qualify for Form 1120-H.
According to IRC Section 528, your HOA can file Form 1120-H if you meet the following homeowners association tax filing requirements:
At least 60 percent of your association’s gross income for the tax year must consist of exempt income. This type of income typically comes from homeowners such as monthly dues, assessments, interest, and fines.
At least 90 percent of your association’s total expenses must be used for the acquiring, building, managing, maintaining, or caring of the association’s properties.
No private individual or shareholder must monetarily gain from the association’s net earnings except through acquiring, building, managing, maintaining, or caring for the association’s properties or through a refund of dues, assessments, or fees.
FORM 1120-H INSTRUCTIONS: HOW TO FILE IT
Once you have your forms ready, it is time to fill them up. Determine your exempt and non-exempt income amounts. Then, to calculate your tax amount, start by deducting $100 from your non-exempt income. The remainder of your non-exempt income will then be subject to a flat rate of 30 percent. For timeshare associations, the rate is set at 32 percent.
After filling out your form of choice, an authorized person will then need to sign it. This can be the board president, vice president, secretary, treasurer, accounting officer, etc. Finally, send your HOA tax return to the appropriate address.
WHERE TO MAIL FORM 1120-H
Homeowners associations must mail their accomplished forms to the Department of the Treasury Internal Revenue Service Center. There are two addresses within the United States. The first is located in Kansas City, MO 64999-0012. You must mail your HOA tax return form to this address if you live in the following states:
District of Columbia
For the rest of the states, mail your tax return forms to the IRS center in Center Ogden, UT 84201-0012.
WHEN TO FILE HOA TAX RETURNS
Generally, the deadline for HOA tax return filing is on the 15th day of the 4th month following the conclusion of your tax year. But, if your association’s fiscal year closes on June 30, you must complete your tax return and file it by the 15th day of the 3rd month following the end of your tax year. The same goes for associations with short tax years that end any time in June.
If the deadline coincides with a holiday or a weekend (Saturday or Sunday), you may file your HOA tax return on the next business day.
EXTENSION TO FILE FORM 1120-H
Given the complexity of filing a tax return for homeowners association communities, you are bound to experience a few bumps in the road. In that case, you can file for an extension with the IRS to give you more time. Keep in mind, though, that this extension only applies to the deadline for tax filing. You must still pay your taxes on time.
Homeowners associations can file an extension by accomplishing Form 7004 before the tax return deadline. This will give you an extra 6 months. It is worth noting that this extension does not need to undergo an approval process. Your extension is automatically applied.
HOMEOWNER ASSOCIATION TAXATION FAQS
DOES AN HOA FILE A TAX RETURN?
Yes, homeowners associations do need to file tax returns. Even though HOAs are not-for-profit, the IRS still recognizes them as corporations.
WHAT TYPE OF TAX RETURN DOES A HOMEOWNERS ASSOCIATION FILE?
Homeowners associations have a choice between two tax return forms: Form 1120 and Form 1120-H. Form 1120 is typically used by traditional corporations, whereas Form 1120-H was designed with HOAs in mind. Many HOAs prefer to use Form 1120-H because it poses more benefits and is easier to accomplish.
WHAT HAPPENS IF HOA DOES NOT FILE TAXES?
If an HOA never filed a tax return or missed a few years, it can still remedy the situation. What you must do is look for your most recent tax filing and determine how many years have passed since. Then, contact IRS to ask them if you can file Form 1120-H for the years you skipped.
WHO MUST FILE FORM 1120 H?
Form 1120-H is reserved for homeowners associations, though such associations can choose to file Form 1120 instead. Typically, the board or the HOA’s accountant accomplishes this form. An authorized person will then need to sign the form before mailing it to the IRS.
CAN FORM 1120-H BE FILED ELECTRONICALLY?
As of now, the IRS does not allow homeowners associations to file Form 1120-H electronically. Depending on where your HOA is located, you must accomplish the form and then send it to the Department of Treasury Internal Revenue Service Center either in Kansas City, MO or Ogden, UT.
CAN HOA BE TAX EXEMPT?
Generally speaking, HOAs are not tax-exempt organizations, even if they are non-profit. But, there are ways to qualify for federal or state tax exemption. For federal tax exemption, associations must make 501(c)(4) or 501(c)(7) status, though accomplishing either one is very difficult and rare. For state tax exemption, you must check your state laws.
DOES AN HOA NEED A TAX ID NUMBER?
Yes, homeowners associations do need a federal tax ID number, often referred to as an Employee Identification Number (EIN). You will typically need this number when filling out tax forms or other forms. To acquire a tax ID number for your HOA, call the IRS or visit their website.
GETTING THE LOWEST TAX FOR YOUR HOA
When it comes to HOA tax returns, Form 1120-H clearly trumps Form 1120 in many ways. But, there are some instances when Form 1120 might result in lower taxes for your association. To get the lowest possible tax liability, it is best practice to compute for both Form 1120 and Form 1120-H, then go with the one that requires you to pay a lower amount.
Many HOA management companies offer help with HOA taxes. Begin your search for the right one in your area using our online directory.