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A Brief Non-Technical Explanation of HOA Tax Options

Its tax season again! In this month’s segment, we will be discussing a brief non-technical explanation of HOA tax filing options. The IRS provides HOA’s the option of selecting which type of income tax return to file annually. These options include Form 1120-H designated for homeowner associations, or Form 1120, which is designated for corporation income tax returns in the United States.

1. IRS Form 1120-H. The tax rate for Form 1120-H is generally based upon the HOA’s interest and dividend income. The HOA’s taxes are then determined on the net difference between interest and dividend income and exemptions allowed by the IRS. Because this is a one page IRS form, it is easier to complete than the longer corporate tax form. Plus, the “exempt function income” which is a technical classification for homeowner assessments is not subject to taxes. The caveat is that this qualifying exemption is limited to HOA member assessments who share the expenses of the HOA, and does not include non-member assessments from customers of the association. A further attraction is that the 1120-H filing option is not subject to the “alternative minimum taxes.” On the down-side, Form 1120-H requires a higher tax rate against non-exempt income than the Form 1120 for corporate rates. According to the IRS, the federal tax rate for 1120-H is 30%. Plus, HOA’s may not claim net operating losses or write off organizational costs as taxable deductions.

2. IRS Form 1120. The purpose of filing Form 1120 is basically to calculate the tax amount of non­-membership net income and exemptions allowed by the IRS. According to the IRS, federal tax rates on corporate taxable income vary from 15% to 39%. The regular corporate rate of 15% applies to the first $50,000 of taxable income, versus a 30% tax rate when filing form 1120-H. However, keep in mind that Form 1120 is much longer and more complex to complete and tax preparer fees may be higher as a result. While non-operating reserve income may be exempt from taxable income, reserve expenditures for future repairs and replacements are excluded as deductions under Form 1120. Other requirements may include tracking reserves separately from operating funds, separate checking accounts for reserve accounts, budget line items distinguishing reserves as non-operating expenses, quarterly paid estimated income taxes, and assessments reflecting operating and reserve expenses. Perhaps the greatest negative is that Form 1120 may subject an HOA to an IRS audit.

Before deciding which form to use, it is a good idea to discuss options with a professional tax preparer, CPA, or tax attorney specializing in taxes. Tax codes change on an annual basis. Some tax preparers may even look at both filing methods to determine the best avenue for your HOA.

Disclaimer: The following article is educational only and does not constitute or offer legal advice. For legal advice, please contact either an attorney specializing in HOA law or a tax attorney.

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