Unfiled HOA tax returns impact many HOAs across the country. In fact, many HOAs don’t actually realize that they have a filing requirement. It really is not that uncommon. But if the unfiled returns go on for long periods, they can result in large penalties and interest.
We deal a fair amount with back HOA tax returns, condo association returns and mitigating tax penalties. Let’s take a look at a typical example that we have seen:
An HOA that manages 442 homes has annual member assessments averaging $185,000 has not filed tax returns in 7 years. Aside from the back tax returns, the HOA has met the criteria to file form 1120-H. A new community manager has just been hired and is tasked with hiring an accountant and cleaning up the tax mess. Let’s look at some of the steps to filing delinquent or late returns.
Locate any and all tax correspondence and the last tax return filed
Many clients (including HOAs) will tell you they have not filed in so many years. In reality, they are probably more delinquent than they believe. This is because human nature allows us to convince ourselves that things are not as bad as they are. So when an HOA says they have not filed in 7 years it may be more like 10 years. That is why locating the last HOA tax return filed is so important.
Also, a very important step is to locate any and all IRS tax correspondence. The IRS may have been sending letters throughout the years and may possibly have been assessing penalties and interest.
If all else fails, the HOA can give a power of attorney to a CPA who can contact the IRS directly and obtain information regarding the year of the last tax return and whether there is any outstanding tax liabilities. The CPA can also obtain a transcript of the last return filed including whether it was filed on Form 1120-H or form 1120.
Gather books and records
You must then determine whether you have enough financial information to file all back tax returns. For many clients, it can be a challenge to pull together financial information for one year let alone 7 years. If there has been turnover among bookkeepers or community managers then this can be more challenging.
In addition, the profit and loss should breakout exempt and non-exempt income so the CPA can make a determination as to whether you should file form 1120 or 1120-H.
Contact the IRS
One of the big problems with not timely filing an 1120-H is that the HOA may no longer qualify. This results from a form 1120-H being an election that must be made within 12 months from the due date of the return (which includes extensions). So the election is effectively made by filing the 1120-H itself.
If there was no timely filing of 1120-H then presumably the HOA would be required to file Form 1120. The HOA CPA and/or the community representative should review any correspondence received and contact the IRS to discuss the situation. The IRS has often allowed HOAs to utilize Form 1120-H even though they may not actually qualify under the election. This is not an absolute, but it is an important reason to discuss the situation with the IRS.
Address state tax concerns
State tax considerations are often overlooked. Depending on the state, this may not be an issue. This is because certain states do not have a filing requirement. Many also will classify the HOA as a non profit, which can have different filing requirements.
Dealing with unfiled HOA tax returns
Once you have determined the prior forms to be filed and for what years, you can now formally review the financial statements to make sure that they are complete and accurate.
The goal is to minimize the late filing issues with the returns. Make sure that there is a careful analysis of exempt and non-exempt income. Also, carefully analyze the different tax rates between Form 1120 and 1120-H.
What are penalties for late filing of an HOA tax return?
Late filing tax penalties are one of the steepest. For any tax balance, the HOA will be penalized 5% of the unpaid tax liability for each month the return is late. This penalty is capped at 25%. There is also a minimum penalty for any return that is over 60 days late that is the smaller of the tax due or $205.
But there are also late payment penalties. An HOA that doesn’t pay the tax when due will face a penalty of ½ of 1% of the unpaid tax for each month, subject to a maximum of 25%.
Realize that in certain situations the IRS can impose penalties based on negligence, fraud, and substantial understatement of tax. These penalties are highly unlikely for an HOA.
In addition, the IRS will assess interest on any unpaid balances. Interest is also charged on any penalties imposed. Interest will continue to accrue until paid. The interest charge is based on the federal applicable rate (4% as of this writing).
It is important to note that the penalties addressed above will not be imposed if the HOA can demonstrate that the failure to timely file was due to reasonable cause. If the HOA receives a notice about a penalty after filing prior or past tax returns, it can submit to the IRS an explanation and the IRS will make a determination for penalty abatement.
Getting unfiled HOA tax returns filed
If you have back HOA tax returns don’t be discouraged. It probably is not as bad as you think. The important thing is to get a game plan and implement it as soon as possible.
The longer the returns go unfiled, the greater the problem. In addition to penalties and interest, the HOA may lose the right to elect to file Form 1120-H. This can cause a significant tax liability in addition to increased risk of filing a C-Corp return on Form 1120.
Filing back or late HOA tax returns is more common than you might think. In most situations, the HOA will not have a substantial tax liability, so penalties and interest will not be significant. In any case, the issue will no go away on it’s own.