The Numbers Game

It will be spring soon. Grass will grow, windows will open, we will step outside and breath in the air deeply, and we will greet the sun by turning our faces upwards and allowing its rays to warm our faces and souls after yet another New England Winter.

And taxes will be due.

Even in condominium associations.

So many smaller associations simply don't file tax returns. Ever. But make no mistake. Every condominium association must file a tax return. No matter how large, no matter how small. Associations are, by definition, not-for-profit entities. But they also take in money, primarily from condo fees, but also from such things as fines and interest on investments. The money has to be tracked and accounted for, hence the need for a tax return, and if not done, the Association is at risk of being fined by the IRS.

Further, the IRS can revoke an Association's tax-exempt status. In 2010, for example, the IRS revoked tax exempt status for 750,000 previously exempt organizations, so it does happen. If it does, it would mean the condominium fees collected would be subject to taxes on all of the income, meaning taxes on the condominium fees themselves. In turn, there would be less money to pay for the operation of the condo association, resulting in higher fees, higher taxes, ever higher condo fees, more taxes … a situation an association wants to avoid.

How to file taxes? There are two forms primarily used. One is IRS Form 1120 and the other is Form1120-H. (The “H” is for Homeowners Associations.) The choice you use at your Association depends upon a number of factors, primarily how much income an Association generates other than through condominium fees. This would include for instance, interest on investments, such as money in a savings account, and other sources of income, such as if an Association has a clubhouse it rents, a laundry facility on site, or if it owns and rents units in the Association.

Generally, if the outside income, that generated other than from condo fees, is less than $50,000, which is the case with most associations in New Hampshire, you are going to be taxed at a flat 30% if you file Form 1120-H. If you use Form 1120, which designates you not as a condo association, but as simply a non-exempt membership type of organization (it applies to all membership organizations that are not exempt under any other section of the IRS Code) you will be taxed at but 15%.

But be cautious. This rate changes in certain instances so the rate gradually increases to 35% based upon higher amounts of taxable income.

Most Association of which I am aware file the 1120-H Form. After all, it was created for condo associations. But looking beneath the designation can give you some thought about which designation and form is right for your association.

For instance,you can only use Form 1120-H if your Association meets certain qualifying requirements. These include:

• 60% of Gross Income must come from membership dues. Sounds easy to calculate and reach, but be careful because reserve assessments, for example, are not considered part of Gross Income.

• 90% of expenditures must be for operating the association. Again, seemingly easy. But, for instance, recreational activities such as cable TV and utility expenditures, if supplied by the Association, are not considered proper expenditures.

• 85% of the square footage in the Association is used for residential purposes. So if it's a mix of commercial and residential, this determination of square footage becomes very important.

A further caveat. As noted H stand for Homeowners Associations. So it is likely some associations, either on their own or through the use of an accountant, use form 1120-H. As noted, unless you have really high outside income, you are actually paying much more in taxes (15% versus the flat 30% tax rate for association use Form 1120.) Save the money if you can.

The best way to avoid problems? Hire an accountant. For most associations, the cost is only a few hundred dollars a year. (After all, it's a one-page form.) Moreover, they are professionals; Boards are not. Don't take the risk of doing it yourself. If there are ever questions asked about it, an Association would much rather refer all such questions to its accountant than have to try to track down a volunteer Board member who in her spare time over a few late nights, cobbled together the form, who has long sold her Unit, and no one knows where the supporting information is.

It's a numbers game, and the last number any association wants to be writing is the amount of a fine being paid to the IRS.