Tax Law (Questions About Taxes)/Tax Returns for Condominium HOA
I have some questions about tax returns for a condominium HOA. I apologize for the length of this question, but as per your request, I tried to be as complete as possible.
The condominium includes just 2 units and the HOA was established in Dec 2001 as an unincorporated association. It collects about $5K per year exclusively from assessments paid by the 2 units, and it spends that money exclusively on common expenses: insurance, utilities, repairs, and maintenance for the building.
I purchased my unit in March 2011. The second unit was owned by people who had been members of the HOA since it was formed. The second unit was recently sold. At that point, I found out that the HOA had been using a checking account registered under one of the owner's SSN, not an EIN. I also found out that no tax returns for the HOA had ever been filed. The old checking account was closed (since it was under the SSN of a person who was selling his unit) and it became my job to open a new checking account.
I decided to follow your advice from a post on this site in 2008 and "do the right thing." I obtained an EIN for the HOA and used it to open a new checking account. Right now, I'm very stressed out and really regret my decision. Along with the EIN, I got a form letter from the IRS with the following:
"Based on the information received from you or your representative, you must file the following form(s) by the date(s) shown.
Form 1120H 06/24/2013
After our review of your information, we have determined that you have not filed tax returns for the above-mentioned tax period(s) dating as far back as 2002. Please file your return(s) by 07/09/2013. If there is a balance due on the return(s), penalties and interest will continue to accumulate from the due date of the return(s) until it is filed and paid. If you were not in business or did not hire any employees for the tax period(s) in question, please file the return(s) showing you have no liability."
I'm at a loss about what to do for the following reasons:
1) I have filed form 1120H for 2012 showing no tax liability, but beyond that I don't even know what tax forms (if any) I should file. I thought about filing form 1120H for each tax year from 2002 through 2012, but the instructions for 1120H say the election to use 1120H must be made by the due date for the return. If the election is not made by the due date, then the association must file the "applicable income tax return", such as form 1120. The problem is, I can't find any other applicable form. Form 1120 is for corporations and our HOA is unincorporated. Form 1065 is for partnerships (in your earlier post you said HOAs are partnerships by default), but the instructions for 1065 say:
"A joint undertaking merely to share expenses is not a partnership. Mere co-ownership of property that is maintained and leased or rented is not a partnership."
I believe that is exactly what our HOA is, a joint undertaking to share expenses. Therefore, it is not a partnership under the IRS guidelines. In fact, our HOA doesn't even fit the IRS's definition of a business ("The term trade or business generally includes any activity carried on for the production of income from selling goods or performing services.") let alone their definitions of a corporation or partnership. Probably 99% of the information requested on Form 1065 is totally unrelated to anything our HOA does. So, should I file forms 1020H for all previous years as far back as 2002 and hope that will convince the IRS there is no tax liability, or should I do something different?
2) Even if I can figure out which tax forms to file, I have no financial records at all for the HOA prior to 2010, and I don't know who the HOA members were prior to 2009 (except for the owners who just sold their unit). So, should I file returns for years 2002 - 2009 "to the best of my knowledge and belief" using the assumption that income and expenses for 2002 - 2009 were basically the same as years 2010 - 2013? Or, should I simply write to the IRS and tell them I have no financial records prior to 2010?
3) Finally, in your 2008 post, you said any tax liability would most likely fall to the HOA. I assume that is only in the case where the HOA is a corporation. The instructions for Form 1065 say partnerships have no tax liability; any liability is passed to the individual members. How would that work in this case (assuming the IRS decides our HOA is a partnership by default)? If the IRS decides there is tax liability for years 2002 - 2009, would that liability pass only to individuals who were members of the partnership during that period. Or could that liability pass to current owners who weren't members of the partnership during that period? Further, do current owners have any obligation to prove that there was no tax liability during the period (2002 -2010) when they weren't even members of the partnership?
To sum this all up: I'm quite confident that our HOA has no previous tax liability. However, I really need some help to figure out the best and least expensive way to convince the IRS that there is no liability and that they should just leave us alone.
Thanks for your help!
ANSWER: Let me start with:
The real problem is not yours. It is the previous HOA administrator.
You point out that no money exists other than those used to pay common expenses. The HOA has no money to pay any fines or assessments. Many HOAs run a surplus and have money on account, those monies would be taken first to pay the taxes.
If (and probably when) the IRS pursues this issue you will tell them the truth (always a plus) that you just became involved and you don't know anything about the past finances, You filed for a new EIN/TIN because of a change in the banking, you would have to defer to Mr. Whomever, who was the previous manager of the association.
Here is a little problem. You can't file a tax return for previous years and KNOW that it is true and correct. Could it be that in one year the assessments were higher? or lower? do you KNOW that the money was all paid out?
The tax return has you take responsibility, and fiscal liability, for the accuracy of ALL the information on the tax return. You can't KNOW, and you shouldn't file.
You should not avoid the problem, you should address it, contact the IRS let them know the truth.
They may still suggest that you file a tax return, this would be to your own peril and for their convenience only. They won't have to work as hard if you assume personal responsibility. But don't throw yourself under the bus, let the process take its rightful course.
If things get tough, resign. As long as during your tenure the books were clean, they can't force responsibility on you for other years. YOU CAN TAKE IT ON YOURSELF, they won't stop you, so be aware of the situation.
Give the IRS the name and address of the previous homeowner. He'll have to sort it out. If your presumptions are correct, then the entire matter is one of that individual doing business as a sole proprietor under his own SS number. His problem.
It may not be that bad. If he can validate that all monies in were spent on reasonable and necessary fixes and fees, then it will be a wash, and he'll just have the inconvenience of having to do the accounting and tax returns. He may have actually already done that in his personal tax return.
Penalties only happen if there were unpaid taxes.
---------- FOLLOW-UP ----------
QUESTION: Hello Richard,
Thanks so much for your response. It was extremely helpful. I do have a couple of short follow-ups. Some years the HOA takes in more than it spends, and other years it takes in less than it spends. In your 2008 post you said: "Most HOAs structure their accounting so that reserves are not considered profit but unpaid future expenses." Exactly how do I do that? Does this determine whether I should use the cash or accrual accounting methods? And for lines C and D on Form 1120-H, do I include "unpaid future expenses" as part of the expenditures for the current tax year, so that total exempt function income (line B) matches total expenditures made for purposes described in 90% expenditure test (line C) and also total expenditures for the tax year (line D)? Thanks again!
Accrual is normally the method used to attribute income to future expenses.
Accrual allows you to foresee and prepare for future expenses in the current years tax calculations.
For example, the streets within the association have a projected life of X years with no maintenance or Y years if maintained every 5 years with a resurfacing material. So you can build in the resurfacing on a prorated annual amount.