Living in a house, a condo, or a townhouse that is part of Alabama common interest community, you are most likely required to pay dues and assessments. These payments are used to maintain your homeowner or condominium association.
Many Alabama residents assume that HOAs and condo associations do not have to pay tax because they are classified as non-profit associations. They, therefore, brush away the tax requirements. This is certainly not true.
Alabama HOA and Condo Association Tax Filing Requirements
Alabama Homeowners’ Association Act requires that all HOAs and COAs formed on or after January 1, 2016, to file organizational documents as a non-profit corporation. This Act was passed on June 2, 2015, and it became effective January 1, 2016, and is codified in Code of Alabama Title 35, Chapter 20.
The Secretary of State is vested with the administrative role of the Act and all HOAs and COAs must comply. HOAs and COAs are therefore considered as corporations for federal tax purposes and must file annual tax returns. Only by applying section 501 (a) (4), Form 990 to be considered as a Non-profit entity, an association will not file a tax return.
Filing Annual Tax Returns
Alabama HOAs and COAs have the ability to file two forms, Form 1120 and Form 1120 – H. Form 1120 is a traditional corporate method of filing returns. While it boasts an advantage of being flexible with the expense allocation, (they do not have to maintain the 90% rule), and lower tax rates, (15% tax rate for the first $50,000 of their taxable income), they do not favor HOAs.
First, all HOA’s income becomes taxable; any funds set aside or in excess of expenditure will be taxed. Second, they have proven to be complex, requiring some level of accounting and bookkeeping that most HOAs do not keep and third, HOAs are also required to make an estimate of their payable tax, and as pointed out that they lack a level of bookkeeping, will be a hard task to accomplish.
HOAs and condo associations can file Form 1120–H if they qualify under IRC section 528, have to fulfill the following:
- 60% of revenue is gained from members and not the sale of goods and services.
- 90% of its expenditure is on operations and maintenance of the property.
- 85% of units should mostly be used as residences.
- Annual residual income must not be used to benefit association members.
Qualifying for Form 1120–H means an HOA or condo association will only be taxed on the non-exempt income. The non-exempt income is generated through interests from banks and other reserves, and other for-profit activities, such as renting out a clubhouse, the vending/laundry machine income or golf-course fees.
Expenses used solely to generate the non-exempt income are then deducted; records to support these expenses should be available. Homeowners associations are allowed a $100 deduction on taxable income, and a flat rate of 30% applied.
Form 1120 looks a better alternative to most associations, considering the low tax rate of 15% for the first $50,000 taxable income. But Form 1120 – H was designed specifically for homeowner and condo associations and is much easier and has no tax risk if the association meets Section 528 requirements. No matter the form, HOAs and condo associations must file tax returns.