Most communities have a homeowners association that collects dues to pay taxes and improve the overall standard of living on the neighborhood, such as the upkeep of parks. Although an HOA functions much like a nonprofit, most HOAs incorporate, which means they pay taxes. However, most HOAs use accounting tricks to avoid paying tax on any income.
In general, HOAs have to pay income incomes, or at least file a tax return even if they do not have any tax obligation for the year. An HOA can obtain tax-exempt 501(c)(3) status, but this is impossible or difficult for most HOA's, because it would mean proving that the association exists only for the public good. Thus, most HOAs file as a corporation using forms 1120 or 1120-H.
Most HOAs do not end up paying taxes, or they end up owing very little to the IRS. The IRS does not tax HOA dues and assessments as long as the HOA uses income for needs of the community. Also, the IRS exempts the first $100 in income when an HOA files as a corporation. Thus, if an HOA pays taxes, it usually is just on interest from dues or income from special events, such as renting out a recreational facility for a wedding.
Requirements of Filing 1120-H or 1120
An HOA must consist of mostly residential units and at least 60 percent of the HOA's income must come from membership fees and dues. Also, it must spend 90 percent of its income to “acquire, build, manage, maintain or care for its property” and no HOA net income can go to an individual except for overpayments on dues or assessments. An HOA can change what form its uses from year to year.
Consult a CPA for the best way to file taxes for your HOA. If your HOA derives a lot of income from renting out units and clubhouse fees, a corporate 1120 form might offer lower taxes, because filing form 1120-H means paying a flat tax rate of 30 percent on all net income. In general, the IRS gives HOAs a lot of flexibility to use money for the general upkeep of property. For instance, many HOAs avoid taxes by earmarking access funds for the following year's budget.