Frequently Asked Questions
Question – Is there any limitation on the amount of unrelated business income that our Association can have without affecting our tax exempt status?
Answer - IRS Publication 557 - Exempt Organizations, establishes an 85% of gross income requirement. This requirement is that the exempt organization must ". . . receive 85% or more of their gross income from their members for the sole purpose of meeting losses and expenses." This 85% rule applies to ALL exempt organizations, not just 501(c)(4) social welfare organizations.
Question – What exactly IS unrelated business income for a homeowners association qualifying as tax exempt under IRC Section 501(c)(4)?
Answer - Internal Revenue Code Section 512(a)(1) states ". . . unrelated business taxable income means the gross income from any unrelated trade or business regularly carried on by it [the exempt organization], less the deductions allowed by this chapter which are directly connected with the carrying on of such trade or business. . ."
Question – What is considered exempt income for a homeowners association qualifying as tax exempt under IRC Section 501(c)(4)?
Answer - Exempt income is defined to mean gross income from dues, fees, charges, or similar amounts paid by members of the organization for providing the members and guests with goods, services, and facilities in connection with the purposes constituting the basis for the tax exemption of the [social] club.
This is construed to mean that any amounts received directly from non members constitute unrelated business taxable income, even if that person is a guest. If a member pays directly for the guest, then it is considered to be exempt income per the explanations above.
Question – Are there any special record keeping requirements for a homeowners association qualifying as tax exempt under IRC Section 501(c)(4)?
Answer – Yes. An exempt organization must establish an accounting system capable of tracking source of income and source of payment of that income. The system should also be able to identify those expenses directly connected to the production of income by source. Unfortunately, my experience is that, because they have had no prior requirement to do so, most new exempt organizations have not yet established accounting systems that can adequately track source of payment of fees well enough to actually know who paid it, unless the organization has a strict rule against non member payments. Consequently, the normal (and safe) approach is to consider all non member revenue to be unrelated business taxable income for tax purposes.
Question – How significant are the taxes on unrelated business activities?
Answer – The tax rates are the same as those that apply to regular corporations on Form 1120. However, an exempt association files Form 990-T to report its unrelated business taxable income.
Most associations, simply by the nature of their operations, will not pay any significant income tax. This is because there is usually no net taxable income resulting from the unrelated business activities after allocation of expenses.
A notable exception to this rule for many associations is newsletter advertising revenues, which normally will result in net taxable income. While most associations do not achieve a net income form the newsletter activity on an overall basis, they will end up with a net taxable income because of the special expense allocation rules applied by the IRS. As an example, an association has $100,000 of newsletter expenses, but only $80,000 of advertising revenue. But when the content of the newsletter is examined, it is determined that 25% of the pages are devoted to advertising, and 75% are devoted to community news. Applying the IRS formula, allowable deductions against the $80,000 of advertising revenue are calculated as $100,000 X 25%, or $25,000. Therefore, taxable income from this activity is $55,000 ($80,000 - $25,000).
Please contact Gary Porter for your association tax exemption services. We serve associations nationwide.
Background information on Gary Porter, CPA
Gary Porter, CPA is licensed by the California Board of Accountancy and the Nevada Board of Accountancy. His CPA practice is limited to Common Interest Realty Associations, including homeowners associations, condominium associations, timeshare associations, fractional ownership associations, and condo hotel associations. Mr. Porter is the co-author of the PPC (Practitioners Publishing Company) Guide to Homeowners Associations and Other Common Interest Realty Associations, and Homeowners Association Tax Library. He is also the author of more than 200 published articles on financial matters related to homeowners associations. He has been working with homeowners associations since 1976