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What is 1120 tax form

what is 1120 tax form

What is the Difference Between the 1120 and the 1120-H?

What is the Difference Between the 1120 and the 1120-H?

The area of homeowner association tax law is the only place where on an annual basis an entity can file two different tax returns, under two different sets of tax laws at two different tax rates, and the entity can change from one filing method to the other each year.

One option is to file form 1120-H which is at the flat tax rate of 30% on net taxable income and is based on IRC Section 528. This is a one page form, with minimal tax preparation issues. Filing of this tax form is an annual election. Technically, the election should be made by the due date of the tax return, including extensions. Realistically, I have filed returns going back ten years and they have been accepted. IRC 528 uses the terminology “exempt” and “nonexempt” function for income and expense items. There is a standard exemption for the first $100 of taxable income. There are some basic requirements to be able to file form 1120-H and these are as follows:

  • Must be residential in nature (85% test)
  • 60% of income must be exempt function
  • 90% of the expenses must be exempt function (includes reserve expenses)

The “default” tax filing option (that is, if the election is not made) is to file form 1120 as a membership organization under IRC Section 277. The tax rate is 15% for the first $50,000 of taxable income. This is a more complicated form involving much more knowledge and judgment about tax rulings, compliance issues and unresolved areas of tax law. IRC 277 uses the terminology “membership” and “nonmembership” for income and expenses. Some of the more extensive issues involved with filing form 1120 include the following:

  • Net membership income can be carried over to the next year using Revenue Ruling 70-604 (see ruling, example of election, and a question and answer formatted article for HOA board members in the Appendix). There are no absolute interpretations of this ruling, but it is my opinion that the following should occur:
    • Members should make the election
    • Make the

      election before the end of the year, or at least before the tax return is filed

    • Do not use two years in a row
    • Consider noting something about the excess in the upcoming budget; however no dollar amount is required
  • Excess membership deductions (known as Sec. 277 carry forwards – not net operating losses) can be carried forward to offset net membership income in future years.
  • Contributions to capital are not taxable, if they are:
    • Earmarked for capital purpose
      • E.g. Reserve Study, not used for operating purposes
    • Segregated and held for capital purpose
      • E.g. Separate bank account, segregated on financial statements
    • Advance notification to members
      • E.g. Budget and/or Reserve Disclosure
    • Money expended for capital purpose
      • E.g. Segregation of operating and reserve cash activity and accounting

The biggest difference in the membership/nonmembership and exempt function/nonexempt function terminology is the fees that are charged on a per use basis to members. For 1120-H, they are nonexempt (or taxable). For 1120, they are membership. However, nonexempt income can be converted to exempt function income if the fees are charged on an annual basis.

Side note # 1 - The question has often been asked if a tax return is required each year if net membership income is less than the $100 exemption allowed by form 1120-H. In my opinion, the answer is “yes”. Since 1120-H is an election, if the form is not filed, then no election takes place. If the election does not take place, then form 1120 is required. I know of no justification not to file form 1120 for lack of taxable income. There is the potential that all income (membership and capital contributions) could be taxable. Thus, the association to protect itself should file annually from inception.

Side note #2 – CPAs still do not agree on whether RR70-604 and Section 277 carryovers go through or jump over the 1120-H year. I believe that they go through the 1120-H and get absorbed. Others do not agree.

Category: Taxes

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