Community associations are not exempt from paying taxes because they are nonprofit corporations. In very limited cases, an association may qualify as a tax-exempt entity under the terms of I.R.C. Section 501(c). Under the terms of I.R.C. Section 501(c)(4), an association that meets the definition of a political subdivision operated exclusively for promotion of social welfare may qualify as a tax-exempt entity upon application and approval by the Internal Revenue Service. This condition is met if the association extends to the general public use and enjoyment of its common property and does not restrict use to only members of the association.
 
Unless an association obtains a ruling from the Internal Revenue Service that it meets the requirements for tax-exempt status under I.R.S. Section 501(c), the association must file a federal tax return.  The association, however, has several options. The association may make a year to year election as to filing either a Form #1120 or a Form #1120-H. The Form #1120 is the form used for regular corporations. The Form #1120-H is only for community associations (homeowners, condominiums and townhome associations are all included in this generic term).
 
The election to file as a community organization requires that the association meet three criteria: (1) at least 60 percent of the revenue must be exempt function income; (2) at least 90 percent of expenditures must be for the carrying on of exempt function activities; and (3) the association must be substantially residential. Exempt function income consists of assessments and other fees levied on all members of the association to maintain the common property. Non-exempt income includes other association income not derived from assessments, including, but not limited to, interest on funds in bank accounts, income from laundry or vending equipment; rental income for cell towers, and special user fees for association facilities.
 
The advantages of the Form #1120-H include: its simplicity, the fact that the association will only pay taxes on non-exempt income, and that there is an automatic $100.00 deduction. On the other hand, the tax on non-exempt income is a flat 30 percent.
 
Tax advantages of the Form #1120 are a lower tax rate of 15 percent for the first $50,000 of taxable income. However, the return is more complex and requires adherence to a variety of tax code sections and rulings. Under the Form #1120, if there is excess membership income over membership expenses it is taxed unless the association refunds the excess or transfers it to capital reserves through a vote of the members. The options are set forth in IRS Revenue Ruling 70-604 and must be included in a resolution submitted to a vote of the members.
 
Associations should not ignore tax planning issues and should consult with a tax professional. Federal tax returns must be filed not later than the 15^th day of the third month following the association’s tax year (i.e., March 15 if the association uses the calendar year as its fiscal year). For those associations who cannot timely file their returns, an automatic six-month extension of time to file the return may be obtained by filing Form #7004 by the due date of the return. However, the extension is only good for filing the return, not for the payment of tax.
 
In conclusion, be aware that your community association must file tax returns and that there are two options available. Since the election as to the type of return to file is an annual election, the association may file a Form #1120-H when it has little non-exempt income and may switch to filing Form #1120 later when it has reserves generating substantial interest income or other substantial non-exempt income that cannot be offset by expenses. Tax planning may reduce an association’s tax liability.