Florida Homeowner Associations and Federal Income Tax Considerations
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Homeowners’ associations in Florida are governed by Florida Statute Chapter 720. This chapter of the Florida Statutes is known as the Homeowners’ Association Act. Florida Statute Section 720.3015. The statutory definition of a Florida homeowners’ association (“HOA”) is “a Florida corporation responsible for the operation of a community or a mobile home subdivision in which the voting membership is made up of parcel owners or their agents, or a combination thereof, and in which membership is a mandatory condition of parcel ownership, and which is authorized to impose assessments that, if unpaid, may become a lien on the parcel.” Florida Statute Section 720.301(9). An HOA does not include a community development district or other similar special taxing district created pursuant to statute. Florida Statute Section 720.301(9).
Taxation of HOAs.
HOAs have two options for purposes of federal income taxation: (i) an election under Section 528 of the Internal Revenue Code (IRC) or (ii) taxation as an ordinary corporation. HOAs are like any other corporation, even if they’re not for profit. Corporations that follow a calendar-year accounting method are required to file returns by March 15 of every year, and HOAs must also follow that rule. If a HOA does not use calendar-year accounting, its taxes are due on the 15th day after the third month of the HOA’s taxable year. HOAs can file for an automatic extension using the Internal Revenue Service (IRS) Form 7004 allowing six additional months to file the tax return. However, if the HOA owes taxes, the HOA is also responsible for interest for the period after the March 15 deadline that its taxes were not paid. Most HOAs typically only take in funds to operate their facilities and do not conduct income-generating activities therefore do not owe the IRS taxes.
HOA Taxable as an Ordinary Corporation.
A HOA will be taxed as an ordinary corporation if it does not elect to be taxed under IRC § 528. In general, an ordinary corporation is taxed on the excess of current receipts over current expenditures. Excess assessments should not be taxable in the current year if members specifically vote to have the excess refunded or applied to the subsequent year’s assessment. Assessments for capital improvements may be nontaxable if earmarked specifically for capital improvements provided either (1) they qualify as either a HOA capital contribution under IRC §118 (if the association homeowners have an equity interest in the association), or (2) the HOA holds the assessments as an agent for the HOA members. Income earned on the association’s accumulated funds (e.g., interest) is taxable.
Section 528 Election.
All HOA activity related income, including income received to fund future reserves, is not taxable under IRC §528. Prior to the enactment of IRC §528 in 1976 (P.L. 94-455), HOAs could only qualify for tax-exempt treatment under IRC §501(c)(4), which includes civic leagues or organizations not organized for profit but operated exclusively for the promotion of social welfare. However, HOAs may now qualify as an organization exempt from federal income tax under IRC §501(c)(4) only if it meets three requirements. Rev. Rul. 80-63, 1980-1 CB 116. See also Flat Top Lake Association v. United States, 868 F.2d 108 (4th Cir. 1989). The three requirements are (i) the HOA must serve a “community” which bears a reasonable, recognizable relationship to an area ordinarily identified as a governmental subdivision or unit; (ii) the HOA must not conduct activities directed to the exterior maintenance of any private residence; and (iii) common areas for facilities that the HOA owns and maintains must be for the use and enjoyment of the general public. See Rancho Santa Fe Association v. Commissioner, 589 F.Supp. 54 (S.D. Cal. 1984). As a result of these Revenue Rulings and the enactment of IRC §528 a HOA no longer needs to qualify under IRC §501(c)(4). If the HOA qualifies under IRC §528 for a taxable year, it can elect a flat 30% tax (32% for time shares) on its taxable income as defined in IRC §528(d). IRC § 528 taxable income excludes net income from typical HOA activities.
Procedure for Section 528 Election.
A HOA elects taxation as a HOA by filing a Form 1120-H. Ordinary corporate returns are filed on Form 1120. According to Treas. Reg. §1.528-8, a separate election must be made for each taxable year. Once the election is made, the annual election is binding on the HOA for the taxable year and may not be revoked without IRS approval. The process of allowing the HOA to elect IRC §528 status permits the association the flexibility to file Form 1120-H only when it produces a lower tax liability. In Florida, HOAs that are required to file federal returns on Form 1120, or that elect to file federal returns on Form 1120, must file a Florida Form F-1120 annually regardless of whether any tax is due. See Fla. Admin. Code R. 12C-1.022(1)(c)1. However, HOAs that elect to be taxed under IRC § 528 and file Federal Form 1120-H, are not required to file Florida Tax Form F-1120. See Fla. Admin. Code R. 12C-1.022(1)(c)2.
According to IRC § 528(c), to meet the definition of an HOA in order to file Form 1120-H, an entity must satisfy all of the following conditions: (1) it must be organized and operated for an exempt function purpose; (2) at least 60 percent of its gross income for the tax year must consist of amounts received as membership dues, fees, or assessments from member-owners of residential units (or residential lots under the association’s supervision); (3) at least 90 percent of its expenditures for the tax year must be for an exempt function purposes; and (4) no part of the HOA net earnings may inure to the benefit of any private shareholder or individual, except (a) through the rebate of excess membership dues, fees, or assessments, or (b) indirectly through the acquisition, management and maintenance of association property.
An election under IRC §528 may result in less taxable income due to the IRC §528 exclusion, but a higher liability because the flat 30% rate is greater than the lowest two corporate tax rates (in 2015, 15% and 25% apply to taxable income below $75,000). The instructions for the Form 1120-H actually suggest that the HOA compare its total tax computed under IRC §528 and as an ordinary corporation and file the form that results in the lowest tax.
By: James O. Birr, III, Esq. & Robert L. Jones, III, Esq.