Does Your Community File the Proper Tax Return?
Last week I was fortunate to sit in on a continuing education class provided by Donna Seidenberg and Steven Price of the Fuoco Group (www.fuoco.com), certified accountants and business advisors. The class focused on the issues pertaining to association tax returns.
Realistically-speaking, board members are not all likely to understand the complexities of accounting principles. Even though members of my family are certified public accountants, I chose law for my career so some of these nuances escape me as well. Board members do need to know, however, how to hire a competent accounting professional to assist their communities.
Here are some of my takeaways from this very useful class.I apologize in advance for the simplistic overview but this blog is designed to stimulate your board’s desire to discuss these issues at greater length with your community’s accounting professional.
Associations are not-for-profit corporations, they are NOT a non-profit corporation which is tax-exempt such as a 501 (c) (3) which is typically a religious or charitable institution. Some directors still erroneously believe that the association does not need to file a tax return as a result of its not-for-profit status.
90% of community associations file the one-page federal 1120-H return which is the easiest form to prepare for condominiums and HOAs. The 1120 return is a more complicated form and is, at a minimum, a five-page return which carries greater risk.
Naturally, a common question for most directors is which association revenue is taxable. An example of non-membership income would be laundry fees paid by renters. An example of membership income would be application fees and security deposits. It is important from an accounting standpoint to segregate the membership vs. non-membership income.
The tax treatment of reserve funds has some interesting nuances. Capital reserves are not taxable. A classic example of a capital reserve would be a roof reserve as it adheres to the structure. Non-capital reserves, on the other hand, are taxable. A painting reserve and a hurricane deductible reserve are two examples of non-capital reserves. If you pool capital reserves (ie roof reserve) with non-capital reserves (ie. painting reserve) then all of the reserves will be treated as non-capital reserves. Pooling reserves are a big no-no for commercial condominiums as far as taxes are concerned.
The following associations cannot file the 1120H return.
- Commercial Condominiums;
- Condominium Hotels; and
- Cooperative associations (they must file an 1120-C form).
There are certain thresholds which must be met in order for an association to avail itself of the 1120-H tax return. Those thresholds are:
- 85% of the units must be residential in nature.
- 60% of the association’s income must be derived from assessments.
- 90% of the association’s expenses have to go towards the “acquisition, construction, management, maintenance or care of association property.”
Some associations with substantial recreational amenities fail this test. If your community provides an impressive array of amenities, services and facilities, you will need your CPA to prepare a very specific expense allocation. For example, it becomes important to know just how much of the tennis pro’s time is spent giving lessons and how much is devoted to maintaining the tennis courts and facilities as different activities trigger a taxable event.
Think there are no consequences for getting this wrong? Think again. Penalties may ensue for filing the wrong type of return. This is one area where you want to get it right the first time.