Most Tennessee residential developments are planned according to community standards. They often provide social amenities like parks, clubhouses for everyone residing within these communities. Residents contribute towards maintaining these common areas and is done through homeowner associations (HOAs), given the mandate to execute agreements by the residents towards bettering the community.
Over the recent years, issues have arisen over the management of Tennessee HOAs and their communities. One common issue is filing federal and state taxes. Many homeowner associations, especially self-managed associations, do not know about the requirement to file tax on their association and therefore do not file. This article will take you through your association’s tax return requirements and how you should go about it.
Yes, Tennessee HOAs Need to File Tax Returns
Tennessee homeowner associations file their Articles of Incorporation with the Secretary of State as non-profit corporations. This generally means HOA is not a business and therefore does not make a profit. They are not charitable organizations either and must file federal and state tax returns, just like all other corporations. Only a non-profit entity under section 501(a)(4), form 990 is treated differently.
If it has allowed access for the public to its areas and amenities like parks, roads, and pools, it will not be required to file annual taxes. IRS will conduct a thorough investigation of evidence provided to support an application for non-profit association status. The association instead of filing return is allowed to use their funds to improve their areas for the good of the general public.
Form 1120 or 1120–H?
Form 1120 and Form 1120–H are available for Tennessee HOAs to file their returns. Form 1120 is more complex for homeowner associations to file and subjects all income to taxation, but is considered to be more flexible because it does not impose the 90% expense rule and has a lower interest rate of 15% for the first $50,000 taxable income.
Form 1120–H, filed under Section 528 of the IRC, is specifically created for homeowners associations. It is way easier and simple to file, just one page. However, condo associations and HOAs must meet the following criteria to qualify for Form 1120–H:
- 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.
IRS provides that, association dues and assessments, fines and fees from Architectural Control Committee, late fees and interests on late assessment payments, and resident clubhouse and other facility rentals be treated as exempt function income for tax purposes. These incomes are not to calculate an association’s tax liability. Incomes subjected to taxation are the ones generated out of the scope of daily activities of the association. They are considered as income from outside, and may include; interest from banks and dividends, guest fees, such as golf-course usage, renting facilities like clubhouse, and payment for easements, like cell towers.
To arrive at the net taxable amount, we deduct total expenses incurred solely to generate this taxable income, with support from records availed. A $100 deduction is allowed on taxable income, and then you would apply a rate of 30%. IRS, however, allows associations to carry forward the excess to offset future payments.
Electing to File Form 1120-H
Tennessee HOAs and condo associations elect to file Form 1120 – annually. They must file before its due date, including extensions. If an 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.
Once an association has filed Form 1120–H, they cannot revoke it unless IRS consents to it. An association will have to request IRS consent by filing a ruling request; a fee is applicable for every ruling request applied. Associations, however, have the liberty to compare total tax payable by Form 1120 and with that payable by Form 1120-H and file the form favorable to them.