Minimum Annual Tax. Incorporated community associations must pay a minimum annual corporation tax of $800 unless they receive an exemption by filing FTB Form 3500. If granted, HOAs are still required to annually file Form 199 and pay taxes on net nonmember income.
Income Taxes. Even though associations are nonprofit and generally not subject to property taxes, they must file income tax returns both with California's Franchise Tax Board (FTB) and the Federal Internal Revenue Service (IRS) and, if necessary, pay taxes. (Internal Rev. Code 528). For income tax purposes, associations are nonexempt nonprofit corporations. That means they are not tax-free like a charitable organization and they are not taxed as a trade or business. Following are typical tax forms for homeowner associations.
- Federal Form 1120. This is a regular corporate filing which treats associations as nonexempt membership organizations under IRC Section 277, which carries a tax rate of 21%. The risks in filing this form are that excess member income is subject to taxation (unless an election is made under Revenue Ruling 70-604) and reserve contributions may inadvertently be taxed because the association failed to comply with all the requirements to exclude reserves from income by treating them as capital contributions. The return is more difficult to prepare and requires associations to use more restrictive accounting procedures during the year.
- Reserves. IRC Section 118 defines contributions of capital to a corporation. This code section is used by associations to identify reserve assessments as capital contributions that are not subject to tax. IRC 118 has been interpreted and modified by treasury regulations, revenue rulings, and various court cases. This article on "Reserves as Capital Contributions" explains the requirements for reserve assessments to be considered capital contributions for tax purposes. Failure to comply with all these requirements may cause the IRS to challenge the exclusion of reserve assessments from taxable income.
- Excess Income Resolution. Because associations are nonprofit entities, any excess income at the end of the fiscal year must be returned to the membership or applied to the following year's budget, otherwise, it will be taxed. The decision of what to do with the excess income is addressed in an "Excess Income Resolution."
- Federal Form 1120-H. This filing is specific to associations, is easier to prepare, and has a lower audit risk. It applies a 30% tax rate to all non-dues income (interest earnings, laundry income, rental income, etc.). This filing does not require an excess income resolution. Even so, many associations routinely include the resolution on their annual ballot thereby giving their CPA the flexibility to file either tax form.
- California Form 100. If an association has more than $100 in non-membership income, a return must be filed with the State at the same time as the Federal filing. Failure to file Form 100 can result in the suspension of the corporation.
When to File. Tax returns must be filed within 2 1/2 months of the end of the association's fiscal year. The deadline may be extended for six months by filing the appropriate form.
Failure to Pay. Current boards are not relieved from their duty to file tax returns even if prior boards failed to file them. Failure to file returns can result in penalties, back taxes and interest.
Recommendation: When hiring a CPA, associations should choose one who specializes in homeowner associations. There are issues involving an association's reserve accounts and tax filings that are unique to associations, which a generalist would not know. Homeowners associations should always be on an accrual basis for filing purposes.
ASSISTANCE: Associations needing legal assistance can contact us. To stay current with issues affecting community associations, subscribe to the Davis-Stirling Newsletter.