Form 1120-H Gross Income Is Often Limited to Taxable Interest. Deductions Must Be Directly

IRS Form 1120-H

Homeowner associations are required to file tax returns, even when no taxes are due. Most HOAs qualify to use Form 1120-H. They may also use Form 1120 which could result in lower taxes when ‘outside’ income is high ($1500+). IRS audit activity for Forms1120 is limited; however 15 associations in San Diego and 12 in Florida were audited a few years ago. All of these Associations filed Form 1120 and were found to have erred. They paid more in IRS penalties plus taxes than they would have paid in taxes using Form 1120-H.

Form 1120-H gross income is often limited to taxable interest. Deductions must be directly connected to the production of taxable income and most of the time the deductions do not exceed the amount of the taxable income. The following example illustrates this:

Gross Income

2. Taxable Interest 1358

Deductions

2. Taxes and licenses (State tax paid) 36
15. Other Deductions (attach schedule)

Tax Preparation 200

Cash Management (10% of Management fee**) 520

16. Total Deductions 200 + 520 = 756
17. Taxable income before specific deduction1358 – 756 = 602

18. Specific deduction of $100 100

Tax and Payments

19. Taxable Income 602 – 100 = 502

24. Tax due (30% of Taxable Income) 502 x 0.30 151
** Some Associations rely on the 1989 Concord Consumers Cooperative Case as a basis for taking a cash management deduction of 10% of the total management fees. It is my belief that this is an aggressive interpretation of the Case, particularly when the cash management amount is a high percentage of the taxable interest. The Concord Case provides guidance on what cash management fees may be allowable deductions. The Courts ruled that they would accept a 5% allocation of management fees without any evidence of a correct amount that might be deductible. This was in the face of evidence of 11% of actual costs. The Court indicated that a higher amount may be allowed if the corporation was able to document that it was entitled to a higher deduction. The Court identified activities of management companies that could be allocated against interest income: preparing financial statements; making reports to the board; reviewing investments; making requests to withdraw money; reconciling interest income; checking interest rates at various banks; changing banks or moving bank accounts; and making requests for reimbursements from reserve funds.

Reference: CAI Ledger Quarterly, Fall 2000 issue

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