What a good question, because almost everyone in the homeowners association and those in the industry always ask the same question. Unfortunately there are many forms of taxes and lots of regulations that make that a rather complicated answer.
For federal tax purposes, homeowners associations are treated as corporations. Even if an HOA was created as an association or a nonprofit corporation with its respective state, it is still considered a regular corporation for federal tax purposes. The only exception is the rare instance in which the HOA has filed for recognition and been accepted as a nonprofit by the IRS. Such recognition is expensive, relatively difficult to obtain, and most often requested by filing form 1024 with the IRS and utilizing tax code section 501(c)(4).
If your homeowners’ association is a non-profit corporation, you may think that it is immune to having to pay taxes. However, very few HOAs qualify as tax exempt and the majority of community associations have the obligation of paying taxes on their non-exempt income.There are two basic options for most associations for federal income tax purposes; 1) elect to file Form 1120-H, or 2) file Form 1120. According to recent IRS statistics, the majority of associations and practitioners have taken the easy way out; approximately 70% of associations filed Form 1120-H, with the remainder filing Form 1120.
Corporations are generally required to file Form 1120, U.S. Corporation Income Tax Return, annually. Filing form 1120 has several distinct disadvantages for an HOA. First, Form 1120 is very complex, second in form 1120 all of the HOA’s “income” is taxable. Basically, this means that any funds collected and not spent (for example, funds set aside for road maintenance or replacement) during the year may be subject to corporate income tax. A third disadvantage of Form 1120 for an HOA is that it may subject the HOA to making estimated tax payments, which could be costly to pay someone to do, or just more work for an association’s treasurer.
If the HOA qualifies to file Form 1120-H, only its “non-exempt” income is taxablewhich is why it is so commonly used. Any money not spent in the current year, should be earmarked for specific funds for improvements or repairs. However, they do pay taxes on unrelated income, like interest, dividends or investment income earned on the savings they are holding. So, in general, associations do not pay taxes because they are not designed to show a profit.
