Whether you view taxes as a necessary evil or you adopt Mark Twain's darker view that: -the only difference between the tax man and a taxidermist is that the taxidermist leaves the skin-, taxes are simply not a pleasant topic. Nonetheless, with some trepidation, we broach that topic here but, hopefully, with an eye towards keeping the tax man away from the Association.
Naturally, we must caution that we are not tax accountants and your CPA is the person to advise you best on the tax strategy that you should employ for the Association.
What this post covers is an often overlooked prerequisite for a tax exemption when you use form 1120 to file the Association's tax returns. As the following explains, however, form 1120 is not always applicable and you will need to contact your CPA to determine if it is used, or if it should be used for your Association.
Generally, community associations can file tax returns using either form 1120 or form 1120-H. Form 1120-H is based on section 528 of the IRS Code which is specifically designed for residential community associations that use assessments for the management, maintenance, and care of the Association. The tax rate when using 1120-H is 30%. Form 1120, however is a corporate income tax form that can be used by many community associations and it has the advantage of a lower federal income tax rate of 15%.
Obviously, which form you use depends on what taxable income the Association has and another major difference between the two forms is what counts as taxable income under each. When using form 1120-H, assessments that are collected but not used during the year are generally not taxable. However, if you use form 1120, assessments that are not used in a given year to meet Association expenses are taxable income unless the Association takes advantage of Revenue Ruling 70-604.
Revenue Ruling 70-604 allows the Association to avoid taxation on assessments, that are not spent in a given year, by making an election to either refund the excess assessments to the membership or to roll that excess membership income over to the following year. The catch is that the IRS indicates the election to be made by the members (though this is slightly debated). This is generally done by a vote of the members either at an annual or special meeting of the members and that vote is memorialized by a Resolution signed by the Board. Of course, the IRS is rather disconnected from the logistics required to get a membership vote.
Importantly, the election for next year's taxes must be made this year and the Association should, after consulting with your CPA, consider whether the election under form 1120 should be made.
If after that consultation, you decide to take advantage of the lower tax rate under 1120, feel free to contact our office for assistance in getting a letter to the community explaining the process and any assistance that may be required with proxies or a resolution relating to the election.