Federal HOA tax law can be confusing. But understanding tax law for Maryland HOA and condo association tax returns can be equally daunting. In fact, many associations (and HOA board members) often assume that associations by definition are non-profit entities and not subject to income tax. Unfortunately, this is just not an accurate statement.
The reality is that there are over 300,000 HOAs in America with thousands in the state of Maryland. But so little is actually known as it relates to tax return filing requirements.
Maryland HOA & Condo Management Companies
Many of the larger communities are governed by professional management companies. Typically these professional manager have a basic understanding of the tax requirements and hire qualified HOA CPAs and accountants to file returns and resolve tax issues. But this isn’t always the case.
A large portion of HOAs are self-managed. In this situation, the member elect board of directors and do not have a professional manager. In many cases, this is the first sign of trouble. Managing day to day operations is the priority and the tax issues are simply an after thought.
Tax Considerations for Maryland HOA and Condo Associations
The good news is that most HOAs don’t have large tax liabilities. But they do have annual filing requirements. So if an association has late or unfiled tax returns it may not be as bad as you think. In fact, I have seen associations that have never filed tax returns. I certainly don’t recommend this but it is often not a huge issue.
HOAs are in a unique situation. They actually have the option to file two different types of tax forms: (1) Form 1120; or (2) Form 1120-H.
But they must qualify under Internal Revenue Code section 528 if they chose to file Form 1120-H. Fortunately, this is not too challenging for most HOAs or condo associations. Nationwide approximately 70% of associations will an 1120-H.
The important part is understanding some of the tax terminology. As an example, HOAs filing under 1120-H do not pay tax on “exempt functional income.” This would be defined as income that is received from members in the form of assessments. Specifically, it consists of monthly (or sometimes) quarterly dues for the general maintenance and administration of the association.
But in contrast to dues, any assessments or fees collected when a member or non-member acts as in the capacity of a customer is considered “non-exempt income.” Once related expenses are deducted, the net amount is taxable to the HOA. Non-exempt profits are taxed at the relatively high rate of 30%.
Because this rate is so high, many HOAs and condo communities will file the standard Form 1120. This form will not separate exempt and non-exempt income and will subject the entire association profit to tax. Just at the lower tax rate of 15% on the first $50,000. This might be a better option and your CPA can run both scenarios for you.
Maryland HOA and Condo Tax Issues?
But don’t fall victim to late filings. Late filing penalties are will be 5% monthly, capped at 25%. Plus late payment penalties and interest will accrue. Don’t put your association in this difficult situation.
In conclusion, associations are required to file annual returns. But the process itself is usually not too burdensome, so the key is ensuring the returns get filed. An experienced CPA who specializes in HOA tax returns can be a great help. At a minimum, he or she can help you understand the tax law and keep you away from the IRS.