As a resident of North Carolina, you probably come from a community with an association created in order to own one shared facility, like parks, roads, or water treatment facilities. You and your association have the following unanswered questions:
- Do we have to file taxes?
- Is my association subject to Franchise and Income Tax in North Carolina?
- Isn’t my association exempt from taxes?
- Do we file Form 1120 or 1120–H?
Well, let’s go through each question one by one and clarify everything you need to know about HOA and their taxation.
Do North Carolina HOAs File Tax Returns?
North Carolina homeowners associations must file Articles of Incorporation with the Secretary of State, and therefore, are considered corporations and must file taxes just like any other corporations across the country. One very rare case to avoid filing is to apply to be a Non- Profit entity under section 501(a)(4), form 990. However, it requires a lot of investing in research and paperwork.
North Carolina Franchise and Income Tax
Under North Carolina law, a homeowner association is exempted from state franchise and income tax if it is solely comprised of residential properties. Associations comprised of commercial property do not enjoy this exemption. This law has caused a big confusion to many HOA management boards and most often, you find associations amending past tax returns including franchise and income taxes, with penalties and interests for late payment.
North Carolina HOAs comprised of residential property have their income from members assessments exempted from income taxes for both federal and state filings. Membership income is derived from members for services like preservation, maintenance or management of the association.
They are generated from; association dues and assessments, fines and fees from Architectural Control Committees, late fees, and interests on late assessment payments, and resident clubhouse and other facility rentals.
North Carolina HOA Filing Options
North Carolina COAs and HOAs have two options to file their tax returns; they could file using Form 1120, which is a traditional corporate method. Form 1120 is flexible with the expense allocation as it does not require HOAs to maintain the 90% rule, and has a lower tax rate of 15% tax rate for the first $50,000 of their taxable income.
However, it is complex for most HOAs to file; it requires some level of accounting and bookkeeping that most HOAs don’t maintain. It also subjects all HOA’s income to taxation; any funds set aside or in excess of expenditure will be taxed.
HOAs can also elect to use the second option, to be taxed under section 528 of the IRC, and to file Form 1120 – H instead of Form 1120. To qualify for this treatment, condo associations and HOAs must meet the following criteria:
- 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.
Filing Form 1120–H means most of the HOA’s income is not taxable. Taxable income is generated from interest from banks, dividends, guest fees, such as golf-course usage, renting facilities like clubhouse, and payment for easements, like cell towers but the association is allowed to carry forward the excess to offset future payments.
Expenses incurred only to generate the taxable are then deducted, with support from records availed. A $100 deduction is allowed on taxable income, and a flat rate of 30% applied. HOAs can, however, apply to carry forward their excess income to offset future expenses.
Once an association has filed Form 1120–H, revoking it will be impossible unless IRS consents to it. HOA will have to request IRS consent by filing a ruling request; a fee is applicable for every ruling request applied.
If HOA fails to file Form 1120–H by its due date, they get an automatic 12 months extension to make an election, after that they may lose the chance to file Form 1120 – H that year and be forced to file Form 1120 and incur penalties on late tax payment. Homeowner association or condo associations have the liberty to compare total tax payable by Form 1120 with that payable by Form 1120-H and file the form with a lower tax.
The exemption privilege and the option to carry forward the excess income do not eliminate North Carolina from filing tax returns. If an association fails to file returns, they will face penalties and interests and preparation fees for the unfiled returns. North Carolina Secretary of State is mandated to suspend an association’s corporate charter until they comply to all returns.