Yalnes, Inc. Blog

A Resource for Condo Owners

The Tax Season for Associations

No matter what type of “business entity” (Condominium, Homeowner, Planned Unit Development, Co-Op, incorporated or not) your Association is, a tax return must be filed with IRS (some States also require Associations to file State income tax returns in addition to Federal taxes). While most Associations are “non-profit” under State corporate statutes, they must file a Federal income tax return. There are very few Associations, which Internal Revenue Service classifies as non-profit.

There are a couple of ways an Association can file its tax return – as a regular corporation (Form 1120) or as a Homeowner Association (Form 1120H). There are some benefits and restrictions with each. For example, an Association must file as a regular corporation if it is not “substantially residential”. Substantially residential usually means that at least 85% of the Association must be Residential (so, if there is a total of 20 Units in the Association and 5 of them are Commercial, your Association may not qualify to file as a Homeowners Association).

While Form 1120H has a higher tax rate (30% for Residential Associations and 32% for Timeshare Associations), most Association revenue is exempt from taxes (i.e. member assessments). Taxable items include, but aren’t limited to, interest on reserves, rental income, and “use fees” (i.e. clubhouse, Guest Suite, etc.).

There may be benefits in electing to file Form 1120. The tax rate is lower (15% for the first $50,000); however, the IRS will see the Association as a regular business/corporation. This means the tax exemption (member assessments) available with Form 1120-H no longer applies. Total taxable income is offset by total allowable expenses and you pay taxes on what’s left. So, if in a given year, your Association’s operating expenses greatly exceeded income and you had substantial interest on reserve funds (which would be taxable under 1120-H), filing as a regular corporation may reduce your tax bill.

Most CPAs familiar with Community Associations will look at your particular situation and recommend which form to file. However, you should double check with your Association’s CPA to make sure they do so as a normal course of business.

Advertisement

February 17, 2009 Posted by | Accounting, Taxes | , | Leave a comment

Methods of Accounting

There are three commonly known methods of accounting: 

  • in “Cash Basis”, income is recorded when it is received and expenses are recorded when they are paid;
  • in “modified accrual basis”, income is recorded when it is earned, and expenses are recorded when they are paid; 
  • in “accrual basis”, income is recorded when it is earned and expenses are recorded when they are incurred.  Accrual basis provides the most accurate financial reporting and is in compliance with GAAP (Generally Accepted Accounting Principles). 

There are several ways to determine the basis on which the financial statements are presented.  Accounts Receivable, Prepaid Assessments, Accounts Payable, and Prepaid Expenses will appear on the Balance Sheet if financial statements are prepared on an accrual basis.  Accounts Receivable and Prepaid assessments will appear on the Balance Sheet if financial statements are prepared on a modified accrual basis.  Since expenses are recorded when they are paid in a modified accrual financial statement, neither Accounts Payable nor Prepaid Expenses will appear on the Balance Sheet.  A Balance Sheet prepared on a cash basis will not contain any of these line items.

Accounts Receivable is an Asset and indicates the total amount of income earned (i.e. assessments levied against owners) but not yet received as of the date of the financial statement. 

Prepaid Assessments represents assessments, which owners paid in advance.  Prepaid Assessments are a Liability to the Association as this is income already received but not yet “earned” (or not charged against owner’s accounts).

Accounts Payable represents expenses incurred but not yet paid and is a Liability to the Association.  Accounts Payable may consist of actual expenses for which an invoice was received but not paid as of the date of the financial statement, and expenses accrued but for which an invoice was not yet been received (or paid).

Prepaid expenses are expenses, which were not yet incurred but already paid as of the date of financial statement.  Prepaid expenses are an Asset to the Association.  An example of a prepaid expense is an insurance premium, which is paid in full for the entire year when an invoice arrives.  When the insurance premium is paid, it appears on the Balance Sheet under Assets but it does not appear as an expense on the Profit and Loss Statement.  The premium would then be “expensed” on a monthly basis in equal monthly installments.

Profit and Loss Statement (P&L) can also help determine on which basis the financial statements are prepared when a budget comparison/variance is shown on the statement.  Because income and/or expenses are recorded when they are incurred, items such as “Homeowner Assessments” in the income section of the P&L, and all “Contract” line items in the Expenses Section of the P&L, should have zero variance from the budget in an accrual basis.  Member of the Association are charged based upon a budget prepared in advance, so 100% of income for a given period will be recorded at the time it is budgeted for and charged to owners’ accounts.  Expenses based upon contracts should also match the budget and have a zero variance because they are recorded when incurred whether or not an invoice is received from the vendor.

December 12, 2008 Posted by | Accounting | | Leave a comment