As April 15th approaches, many Michigan residents are reviewing various sources of gross income, tax credits and tax deductions in order to prepare individual or joint income tax returns. In addition to personal income taxes, newer directors may be unaware that their condominium or homeowners’ association is also required to file federal income taxes on an annual basis. For the inexperienced, filing federal taxes on behalf of a Michigan condominium or homeowners’ association may be an intimidating or overwhelming experience best left to the professionals. This article explores when filings must take place and the various IRS forms that may apply to your community.
Filing as a Corporate Entity
Most Michigan condominium and homeowner’s associations are nonprofit corporations pursuant to the Nonprofit Corporation Act, MCL 450.2101, et. seq. Importantly, even nonprofit corporations are still corporations for federal tax purposes and must file tax returns similar to any other corporation in the United States. If your association follows the calendar year accounting method, the returns are due by March 15th of each respective year. In our experience, the vast majority of Michigan associations follow the calendar year accounting method. If an association needs an automatic extension, IRS Form 7004 called the Application for Automatic Extension of Time to File Certain Business Income Tax, Information, and Other Returns may be utilized. The extension gives an additional six (6) months to file the appropriate tax return. The downside to an extension is that your association will be charged interest on any tax not paid by the regular due date of the return from the due date until the tax is paid. The upside is that if there is no tax, then no interest is owed. Under most circumstances, condominium and homeowners’ associations do not owe the government any money and therefore no interest accrues.
If your association utilizes a different calendar year for tax or other reasons, taxes are due on the 15th day after the third month of your taxable year. It is important to review your taxable year with a professional to determine when the taxes are due and what reminders and safeguards need to be implemented to make sure the appropriate federal forms are timely filed.
Utilizing the Correct Federal Form: 1120-H, 1120 or 990
In the typical Michigan condominium or homeowners’ association, the association takes in funds to operate, manage and maintain the association and its activities. Even if your association does not owe the federal government any money, it is still required to file a yearly tax return. There are three primary ways to file income taxes for your association:
Federal Form 1120-H (Most Common)
Pursuant to 26 U.S.C. § 528 of the Internal Revenue Code, most associations utilize Federal Form 1120-H, which is the standard form for homeowners’ and condominium associations. As of 2015, Federal Form 1120-H is one page and the filing instructions are a mere six pages. The greatest source of revenue to an association on an annual basis typically comes from membership dues, fees or assessments. So long as the payments come from the owners as owners and not as customers, membership dues, fees or assessments are exempt from income. In order to qualify for Federal Form 1120-H, at least 60% of the association’s income must qualify as exempt. Examples of assessments that are exempt include payments made to:
- Paying the principal and interest on debts incurred for the acquisition of association property;
- Paying real estate taxes on association property;
- Maintaining association property;
- Removing snow from public areas; and
- Removing trash.
Examples of income that is not exempt include:
- Amounts which are not includible in the organization’s gross income other than by reason of section 528 (for example, tax-exempt interest);
- Amounts received from persons who are not members of the association;
- Amounts received from members for special use of the organization’s facilities, the use of which is not available to all members as a result of having paid the dues, fees or assessments required to be paid by all members;
- Interest earned on amounts set aside in a sinking fund;
- Amounts received for work done on privately owned property which is not association property; or
- Amounts received from members in return for their transportation to or from shopping areas, work location, etc.
Given that most association assessments go toward maintaining the association’s property, Federal Form 1120-H is the easiest and most often used federal tax form filed by associations in Michigan. When utilizing Form 1120-H, the taxable income of an association is taxed at a flat rate of 30%. The tax rate for timeshare associations is 32%. These rates apply to both ordinary income and capital gains. For more information, see the Code of Federal Regulations, 26 CFR 1.528-9.
Federal Form 1120 (Less Common)
Pursuant to 26 U.S.C. § 277 of the Internal Revenue Code, some associations prefer to utilize Federal Form 1120, which is the standard form for U.S. corporations. As of 2015, Federal Form 1120 is five pages and the filing instructions are a more robust twenty-six pages. Filing under Federal Form 1120 is often called the traditional corporate method. One of the benefits of utilizing Federal Form 1120 instead of Federal Form 1120-H is that Federal Form 1120-H is a flat 30% tax rate, whereas the corporate tax rates under Federal Form 1120 begin much lower (as low as 15% if taxable income is below $50,000). Thus, there are some circumstances where an association has some taxable income and it is better to file Federal Form 1120 instead of Federal Form 1120-H. The most common situations where Federal Form 1120 is utilized are where clubhouses, community pools, golf courses or other significant sources of income such as cell tower leases are available to non-members for a fee. That income is considered non-exempt, taxable income.
When determining whether to file under Federal Form 1120-H or Federal Form 1120, your association should hire an experienced tax professional to weigh the benefits and burdens of each filing, consider the tax consequences and make a recommendation to the Board of Directors. In particular, given the greater complexity of Federal Form 1120 compared to Federal Form 1120-H, we highly recommend to our clients that an experienced tax professional become involved if utilizing Federal Form 1120. This is for practical as well as legal reasons under the Nonprofit Corporation Act’s protections for directors who rely upon professionals or experts. See MCL 450.2541.
Federal Form 990 (Practically Never Used)
Pursuant to 26 U.S.C. § 501(c) of the Internal Revenue Code, very few associations are able to utilize Federal Form 990 since it may only be used by 501(c)(4) tax exempt organizations. As of 2015, Federal Form 990 is twelve pages and the filing instructions are a whopping one hundred pages. By far, Federal Form 990 is the least common option for filing by an association because obtaining 501(c)(4) tax exempt organization status is extremely difficult and time-consuming. At a minimum, obtaining 501(c)(4) status normally requires an experienced attorney to amend to the association’s bylaws to conform to IRS requirements and an experienced accountant to coordinate the appropriate financial records for the IRS application. In addition, there are various requirements that the IRS mandates, which associations do not or cannot meet. As one example, when the association applies for 501(c)(4) status, the association should “submit evidence that areas such as roadways and park land that it owns and maintains are open to the general public and not just its own members.” Often, such park land is restricted to the benefit of just the members. For these reasons, very few associations have obtained the 501(c)(4) tax exempt status that would allow the association to utilize Federal Form 990.
Members and co-owners should check with their associations to make sure the appropriate federal form has been filed with the Internal Revenue Service. If not, your association should have a knowledgeable accountant or tax professional review and decide which federal form best serves the tax needs of your community. If you have any questions about this article or any condominium or HOA issues, generally, please contact our office.
Joe Wloszek is a Member of Hirzel Law, PLC where he focuses his practice on condominium and homeowner’s association law, commercial litigation, commercial real estate, large contractual disputes, and related real estate matters. Mr. Wloszek has been a Super Lawyers Rising Star in Real Estate Law from 2013-2018, an award given to only 2.5% of the attorneys in Michigan each year. He was also named a Top Lawyer in commercial law by DBusiness Magazine in 2014, a Michigan Top Lawyer in real estate law by Michigan Top Lawyers in 2016. He is a Certified Real Estate Continuing Education Instructor through the State of Michigan and the past Chair of the Oakland County Bar Association Real Estate Committee. He can be reached at (248) 480-8758 or firstname.lastname@example.org.