To the surprise of many, homeowners and condominium owners (community) associations are taxable entities even though they are generally not-for-profit. FORM 1120-H However, the tax law provides an option for community associations comprised of units owned and used by individuals for residences that exempts most income from federal income taxes, assuming the organization performs only the administrative tasks involved with maintaining the common areas of the association and:
at least 60% of gross income consists of "exempt function income";
at least 90% of expenses are to acquire, build, manage, maintain or care for the common area property; and
no owner/member may profit from the association's net earnings.
Form 1120-H Internal Revenue Code (I.R.C.) §528 allows the community association to file Form 1120H, which provides that monies received for membership dues and assessments are exempt from tax (as ?exempt function income?). On the other hand, any income received by the association for other purposes is taxed at a flat 30% tax rate. Examples of earnings subject to tax include interest income (CDs, money market funds, bonds, etc.) and fees charged for optional or additional services, unless those fees are charged to all owners/members and/or are stated on an annual basis.
Form 1120 Because of the 30% flat tax rate under Form 1120-H, there is sometimes a tax savings by filing Form 1120 for the lower tax rate of 15% on the first $50,000 of net taxable income.Use of Form 1120 presents other challenges if the association ends a year with excess member assessments, which are includible in gross income and are taxable.The instinctual response is often to transfer the excess funds to reserves, however, this is not an option under IRS rules and may subject the excess member assessments to taxes.Associations have two choices: (1) refund the excess funds to members, or (2) carry the excess over to the next year.To do so, the association members must make a 70-604 election (for Revenue Ruling 70-604) which defers the excess assessments from taxation for one year.Consequently, it is advisable and encouraged that members make the 70-604 election every year at the annual meeting of members before the income tax return is filed.By doing so, the association protects itself in the event the election is needed.
Download the Association Resolution for Revenue Ruling 70-604 Election form below to document the Association membership's 70-604 election. A copy of the completed, executed resolution should be forwarded to your CPA for income tax purposes.