(drawn from different sources)
The law allows a homeowners association to be either incorporated or unincorporated. An incorporated association has a legal identity that is separate from that of its members, just as Microsoft has a legal identity that is separate from its shareholders. Unlike Microsoft, which is a for profit corporation, an incorporated homeowners association is a non-profit mutual benefit corporation which means that its powers are limited to those normally associated with a homeowners association, and it is exempt from certain governmental fees and taxes.
Traditionally, homeowners associations have been incorporated to protect owners from responsibility for association debts, losses and liabilities. California law extends most of these protections to owners of unincorporated associations provided the associations have proper insurance. Under current law, the advantages of incorporation are some (very limited) additional protection from owner liability, ease of opening association accounts with certain banks and vendors, and qualification of the units or lots for mortgage loans from lenders that require an incorporated association. Balanced against these advantages are the costs of forming the corporation, the burden of annually filing a form with the Secretary of State, and additional procedural formalities such as having officers and directors, and conducting formal meetings. States other than California will have their own laws which could differ greatly.
An unincorporated association can be incorporated by its owners at any time. The process of incorporation involves amending the governing documents, preparing Articles of Incorporation, and filing with the Secretary of State.
Must the HOA have directors?
Incorporated associations are legally required to have directors. Unincorporated associations need not have directors.
Must the HOA have officers?
Incorporated associations are legally required to have at least (i) a chairman of the board or president, (ii) a secretary, and (iii) a chief financial office or treasurer, but, unless prohibited by the governing documents, one person may hold all of these offices. Unincorporated associations need not have officers.
IRS and tax liability?
If an association has lost its tax exempt status through a lapse in its non-profit status, the IRS can certainly begin looking at the money an HOA has raised from dues paying residents. Sun City Anthem in Las Vegas, even though legally incorporated as a non-profit, was hit with millions of dollars worth of fines and back taxes because it failed to declare money from its country club restaurant as income. It’s almost a sure bet that someone will be looking at the books of any HOA that loses its non-profit status.
Does an HOA technically need to be incorporated?
If the CC&Rs lay out the existence of the HOA, and each homeowner’s deed requires the homeowner to adhere to the CC&Rs, then it’s possible to have a defacto association that operates without the benefit of the corporate structure or protections.
Without being a corporation, what you’re left with is one big partnership. That means each homeowner is individually liable for anything the HOA does. If an employee, for example, sues the HOA for back pay or sexual harassment or discrimination, then every homeowner is equally liable as if they had been the employer. That’s because, just like in any business partnership, they are. That’s the nature of partnerships. Everybody is responsible for every other partner’s actions.
It may be that founding CC&R documents require the HOA to be incorporated. If so, ultimately, the homeowners can sue the officers to make them incorporate. In the end, it’s all up to the lawyers.
Based on this information it looks like Stonegate HOA could be off the hook or in for massive tax debt. Either way they will be facing legal bills unless they luck out and have a resident attorney that wants to do some pro bono work for the neighborhood.
I hope one of the activists that watches real estate listings will keep an eye out to see how many homeowner in Stonegate try to bail out and run.
I think readers of your blog may find this information helpful. Good site, and good mission stated on the site, of those offering this information, it appears.
Unincorporated HOAs and the IRS
“What federal tax return do unincorporated homeowners associations file?”
“HOA Tax Help November 26, 2013 General”
“While figuring out what the appropriate homeowners association tax return to file seems like it would be a fairly straightforward process, there are a lot of factors that go into determining the correct form for your association. Some states including California allow for homeowners’ associations to be setup without incorporating. These types of homeowners’ associations are considered unincorporated.
Being unincorporated at the state level does not mean you don’t have to file a federal, or possibly even a state tax return. In fact all homeowners’ associations should file a federal tax return, which tax return that is depends on the structure and operations of the homeowner association. For example a homeowners’ association that receives exempt status from the IRS may file Form 990. Although, receiving exempt status for a homeowners’ association may be done, associations rarely apply for federal exemption. A vast majority of homeowners’ associations file Form 1120-H (U.S. Income Tax Return for Homeowners Associations). Both incorporated and unincorporated homeowners’ associations file Form 1120-H.
The most common fallacy we hear from homeowners’ associations is because they are unincorporated, or have a non-profit motive it exempts them from taxes. This couldn’t be farther from the truth. Federal taxes for homeowners’ associations aren’t determined by the incorporation status, or the stated profit motive, instead they are affected by the sources of income and nature of the operations.
The 2013 instructions for Form 1120-H state:
“If the association does not elect to use Form 1120-H, it must file the applicable income tax return, for example, Form 1120 U.S. Corporate Income Tax Return.”
Even unincorporated homeowners associations that don’t, or can’t file Form 1120-H, must file Form 1120. The IRS actually installed Revenue Code 277 which applies to Form 1120 for membership organizations including homeowners’ associations. The IRS makes no distinction between unincorporated or incorporated homeowners’ associations under Revenue Code 277.
Unfortunately their are no direct IRS tax rules for associations that are forced to file Form 1120. It is entirely based on various court rulings, IRS interpretations and industry standards. If you are not sure whether or not you qualify to file Form 1120-H, give our online software a try for free, our software will let you know if you qualify for Form 1120-H. You only pay if you want to print a completed Form 1120-H.”
Doug McLain, CPA