Do Associations Pay Taxes?
Yes, associations pay taxes. Being a nonprofit organization does not make an association tax-exempt. Associations must file both federal and state tax returns, even if the association does not owe any taxes in a particular fiscal year. An officer must sign the return.
Federal Taxes
Employer (Tax) Identification Number (EIN). All associations must obtain an EIN from the IRS. IRS Form SS-4 is used for this purpose. The IRS also has an online process on its website at www.irs.gov. This number is used in all Federal and state income tax filings. Banks will also require the number to open bank accounts. If you are a new director or manager for an existing association, you should be able to find the number on a 1099-INT issued by the bank for interest earnings or a prior-year tax return. The association’s tax preparer will have the number.
Federal Income Tax Return. All associations must prepare and file a tax return with the IRS at the end of each year, regardless of size. For associations with a calendar year (December year-end), the return is due March 15. A six-month extension of time can be obtained by filing IRS Form 7004.
1. Form 1120. Form 1120 is used by for-profit corporations but can also be used by homeowner associations. Sometimes, large associations with significant taxable income will file this form. The downside is that this form carries a higher audit risk.
2. Form 1120-H. Most associations file Form 1120-H. With this form, there is no tax on exempt income, i.e., assessments. Other sources of revenue, such as bank interest and laundry machine income, are taxed at a flat 30% rate. Because Form 1120-H is designed specifically for associations, it carries little or no tax risk. To qualify for this form, at least 60% of the association’s gross income must consist of exempt income, i.e., regular and special assessments, and fees used to manage and maintain the property. If an association files Tax Form 1120-H, Revenue Ruling 70-604 does not apply, and an excess income tax resolution is not needed.
3. Form 1120-C. Cooperatives are subject to Subchapter T of the Internal Revenue Code, IRC Section 1382 through 1388. Subchapter T represents a completely different scheme of taxation. All activities are divided into patronage or nonpatronage activities. This is roughly similar to the member vs. nonmember division on Form 1120 or the exempt vs. nonexempt on Form 1120-H. But the definitions are different under all three scenarios. Because Subchapter T consists of only a few individual code sections, the tax scheme has been largely defined in Revenue Rulings and Court cases. The benefit co-ops have over condominiums or planned developments is that interest income from invested reserve funds is considered patronage income. That means in almost all cases the reserve interest income becomes nontaxable. Interest income earned in the operating fund is still taxable because it is considered nonpatronage income. Even so, housing cooperatives have the option of filing Form 1120-H. (See Revenue and Tax Code Section 23701t (a)(1)(A))
Payment of Tax. If tax is owed on a Federal return, the tax must be remitted using the IRS Electronic Funds Tax Payment System (EFTPS). Go to www.eftps.gov to enroll in the program or make a payment. To enroll, you will need the association’s name, mailing address, and EIN. You will also need the routing number and bank account number. The IRS will issue a PIN to access your account information when you pay. To make a payment, you must know the tax form and the period to which it applies.
California Taxes
Franchise Tax Board. All corporations formed in California are taxable. As such, they are subject to an $800-per-year minimum tax by the California Franchise Tax Board (FTB). To obtain tax-exempt status under Revenue and Taxation Code 23701(t) (no longer subject to the minimum tax), the Association must file Form 3500 with the Franchise Tax Board. Governing documents and income and expense information are submitted to the FTB. If the association has been in existence for several years, it may request additional information to verify its tax-exempt status. If the association has tax-exempt status, it is only subject to tax on its nonmember income, such as interest, not on its assessments.
Verify if the association is tax-exempt. The FTB lists all tax-exempt corporations in California on its website. The list shows the California Corporation Number (different from the EIN), the corporation’s name, the city, the fiscal year-end, whether the corporation is exempt, and whether the corporation is “active” or “suspended” by the California Secretary of State (SOS) or the FTB.
Check whether your exempt status has been revoked. Recently, the FTB contacted many associations and other tax-exempt organizations in its database to determine whether they still existed. Those who did not respond to their inquiries have had their exempt status revoked. If you believe that your association had been exempt at some point and you cannot locate it on the tax-exempt list, you can check the revoked exempt organization list. If your association’s exempt status has been revoked, you must file for it again using FTB Form 3500, referenced earlier.
California Income Tax Return–Form 100. If the association has more than $100 in nonmember income (e.g., interest), it must file a corporate income tax return with the FTB (even if it is not incorporated). Form 100 is used for this purpose, and any taxable income is taxed at a flat rate of 8.84%. Payment can be made by check, and quarterly estimates may be required in future years (Form 100-ES). I recommend that, even if the association has less than $100 in nonmember income, the association file the return anyway to stay in the FTB’s system and avoid future correspondence from the FTB about why you didn’t file a return.
Small Tax Exempt Organizations–Electronic Return Form 199N. Tax-exempt organizations with $50,000 or less in total revenues (assessments, interest, laundry income, etc.) must file an information return electronically with the FTB each year. Complete filing instructions and information needed can be found on the Franchise Tax Board website. There is no filing fee with the 199N filing. The return is due 4 ½ months after the end of the fiscal year (May 15 for a calendar year association). A small association can also file Form 199 on paper. See the following discussion.
Exempt Organization Annual Information Return–Form 199. For tax-exempt organizations with gross revenues exceeding $50,000, a paper Form 199 is filed with the FTB. There is a $10 filing fee to remit with this form (none if revenues are less than $50,000). The return is due 4 ½ months after year-end, but is automatically extended six months if needed. If the form is filed after the extension period, the fee can increase to $65 plus interest. An association with revenues less than $50,000 can elect to file a paper 199 instead of the 199N.
Taxes on Interest Earned
Interest on investments is taxable income. If the interest is part of your reserve study’s funding plan, transferring the interest from your reserve account to pay taxes qualifies as "borrowing" from your reserves, which must be repaid. If that is the case, there should be a line item in your budget for taxes, which are paid out of the operating account. If the reserve analyst considers the interest earned on reserves to be net after tax, the interest can be applied to taxes. Boards should work with their reserve study provider and CPA to determine the best approach.
Suspended Corporation
Failure to file tax returns can result in suspension of an association’s corporate status.
Reserves as Capital Contributions
See the article by Gary Porter, CPA, on the tax rules for reserve contributions.
Are HOA Assessments Tax-Deductible?
Assessments (dues) paid by homeowners are used by the association for maintenance, utilities, insurance, and other operational expenses. Unfortunately, they are not tax-deductible. The IRS treats them as personal living expenses, the same as paying rent and buying groceries. When in doubt, homeowners should always submit such questions to a tax professional.
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