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Russian Roulette with the IRS?

Started by RandalR • 14 replies • 1654 views

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RandalR (Tennessee)
Posts: 98
Posted:
Our new Board has come up with an "angle" to try and avoid having to pay taxes on the money we collect from outside entities, primary from non-resident recreation users and swim team members. They are now selling "Non-resident Homeowners Association Memberships" which entitle the purchaser to "enjoy the same benefits as our other residents". Then it goes on to list several examples primarily having to do with the recreation area.

The issue has been that we've been collecting enough outside revenue that it could possibly jeopardize our "non-profit" status, or at least that's what an attorney is advised them. That would then require us to pay about $3K in taxes on that money. We may already be in hot water over the issue due to the money collected in previous years but that's a "keep you mouth shut and hope no one finds out about it" situation.

I have several concerns over the issue. First off it appears that they're trying to play a word game with the IRS. Same money we collected before but they're just trying to call it by a different name. Second, I don't think our Covenants and Bylaws ever intended to allow non-residents to be able to buy their way into the Association. Don't think it expressly prohibits it but... And thirdly, if they are members of the Association the wording doesn't preclude them from being able to cast ballots in the same manner as the residents. I find this particularly troublesome in that the Board is already in the pocket of the swim team and most of these "new members" will be made up from out of neighborhood swim team families which could ensure their control over our pool can't be broken without legal action.

Worried about nothing? A disaster waiting to happen? Opinions out there from the tax experts?

RogerB (Colorado)
Posts: 5,067
Posted:
Randal, I haven't checked out the restriction for using IRS form 1120-H but think it may be 40% of total income. Then I would consider using IRS form 1120. Check this out and if you are near 40% check with a tax expert.
RandalR (Tennessee)
Posts: 98
Posted:
Roger, If I remember our budget correctly then we usually only collected about $29K (out of $54K) from the residents (~54%). The rest came from swim team fees and selling memberships (resident and nonresident) to our recreation area, most of which was paid by residents that wanted to use the pool. Forty percent sounds like a much higher number than they were quoting as the break point though I don't remember what the attorney actually quoted them.

What's your take on making out of neighborhood families members full fledged members of our Association?
HaroldS1 (Arizona)
Posts: 314
Posted:
Randall - how can they be full fledged members of your association? That usually requires lot or unit ownership. Sounds like your board is getting mighty slippery. Why don't you just report them to IRS for an audit? You could even get a finder's fee. Harold
MelissaP1 (Alabama)
Posts: 13,836
Posted:
Bad advice on reporting there buddy. Remember that HOA stands for HOMEOWNER'S Association. That means your reporting yourself to the IRS too and subject to paying any fines they may issue. It's like reporting your company for fraud, and losing your job because they have to fold. It's not an easy road to straddle here.
Are you sure your a Non-profit corporation. Not all HOA's are non-profit. Your HOA could well be a For-Profit corporation. That means it would be allowed to collect funds and spend it beyond it's own needs. Non-profit means any money they collect has to be spent on ONLY it's operational costs.
You can't be a member of a HOA unless you are a homeowner. I would want to question your setup. Are you a volunteer HOA? That would lend a different view on the situation.
All in all, I believe there may be more than meets the eye. Have you attended meetings? Something doesn't seem to click with what your describing and what the setup of your HOA is. I would need to know more about the setup of your HOA before I can say it's doing anything wrong.
Former HOA President
RogerB (Colorado)
Posts: 5,067
Posted:
Randal
If the HOA owns the pool then check to see if the amount the association members pay to use the pool could simply be catagorized as a special assessment. If so, it would not be outside income which is taxable. This could resolve your concerns. I am not a tax expert so check this out.
RogerB (Colorado)
Posts: 5,067
Posted:
I reviewed 1120-H at this link: http://www.irs.gov/pub/irs-pdf/f1120h.pdf

To qualify to use 1120-H at least 60% of the non-profit association’s gross income for the tax year must consist of exempt function income.

One of the items listed which does not qualify as exempt income is:
" 3. Payments from members for special use of the organization’s facilities, apart from the use generally available to all members."

So long as all members may chose to pay an additional fee and use the pool then I would think it is exempt income which is not taxable and is included as part of the 60% requirement. For accounting purposes I would list this income as an assessment. For "outside" memberships to non residents of the HOA I would maintain a separate accounting code. This is taxable income similar to investment, income such as interest from CD's.
HaroldS1 (Arizona)
Posts: 314
Posted:
Unt so Mellissa: Everyone should just keep quiet about suspected fraud because it might affect them? So just let it continue? Nice values you have there. Harold
BradP (Kansas)
Posts: 2,640
Posted:
I don't know a whole lot, but I would report them. Better to nip it in the bud than let it go on for 10 years.

I would also question how they could buy their way into the association. I am assuming to be a member you have to be a lot owner, or member of that immediate family. The docs could be altered to allow that, but the current membership would have to vote on it.
JM2 (Oregon)
Posts: 439
Posted:
Hi Randal:

It sounds like it's time for a professional audit by a CPA who is very familiar with HOA finances...and by the way, the HOA would do well to use a CPA to file their taxes. The Board could have them review previous tax years as well, if those were not done by a CPA, and refile those as necessary... that might be the best way for them to "come clean" on this issue. It might be that they wouldn't even have more money to pay.

Let's face it, nobody likes to pay taxes and nobody wants to pay more than they need to... but if your HOA doesn't pay its fair share, all of us have to make up the difference.

J. Patrick Moore, CMCA
HaroldS1 (Arizona)
Posts: 314
Posted:
Let's face it, nobody likes to pay taxes and nobody wants to pay more than they need to... but if your HOA doesn't pay its fair share, all of us have to make up the difference. >>
Great advice J. Patrick. Strange. That same argument is frequently used when HOA homeowners don't pay their dues. Harold
RogerB (Colorado)
Posts: 5,067
Posted:
Brad, it can and has been done. Many years ago I was President of an HOA in a suburb of Houston, TX. We purchased 4 1/4 acres of land adjacent to the subdivision, fenced it, provided water throughtout, landscaped, put in playgrounds, and a ball field.

Ultimately we planned and built an L-shaped olympic-sized pool with a separate diving area, kiddy pool, pool fencing & landscaping, club house, and parking lot. The Board decided the only way we could afford these was to sell "associate memberships to the pool" to homeowners in a small subdivision also adjacent to the acreage. The associate members who elected to buy in were charged an initial fee plus a yearly useage fee. With each homeowner we signed an agreement which allowed us the first option to buy back their associate membership if we so chose. These plans were immediately approved by the HOA members; they wanted the pool ASAP

The HOA never violated any rules nor regulations.

BradP (Kansas)
Posts: 2,640
Posted:
cool, I guess the old adage you learn something new everyday applies to me today.
RandalR (Tennessee)
Posts: 98
Posted:
Melissa - To the best of my knowledge we're a non-profit association. We're also a voluntary association so our membership can vary from 1-263 (or more now)! We used to get ~220 (out of 263 households) join every year when our dues were $135/yr. This year they jacked our dues to $215 and threw in the pool which used to cost $300 extra. So far we've only had ~168 people join but that will go up a little once the pool opens later this month. From my discussions with residents we'll be lucky to top out at 180 actual households which would put us at a ~$25K+ deficit. Funding the pool is a real contentious issue.

As for attending meetings... the new Board will no longer allow us to attend their meetings in order to listen to the discussions or provide input. We may only have a couple of minutes at the start of their monthly meetings to make a presentation or whatever and then you have to leave. Of course it now appears that they've also decided to quit notifying us of when and where the meetings are even being held. They continue to hold them in the private residences of the various Board members.

I only found out about this change because they finally updated the Board meeting minutes on the website (which no one hardly looks at anymore because it has fallen into such disrepair). They also didn't notify anyone that new Board meeting minutes had been posted! Of course they also haven't told the residents that they're going to continue to let the swim team have our evening hours (5-7) for the fifth season in a row even though everyone is now also a pool member!

JM2 - The Board continues to rely on the free advise of a former Board member that also just happens to be a CPA and a good friend of this years Board President. They can't find any of our tax filings except for maybe the couple of years because of the manner in which they were passed from one Board to another. Why they won't just get a copy from the IRS is anyone's guess.

Brad - I think the (#3) rule you quoted is what they're trying to get away from by making the pool "generally available to all members". Now that memberships include the pool, their plan is to just consider EVERYBODY (in and out of the neighborhood) a member. That would only leave the money we collect from the swim team members whose families don't become non-resident Association members as taxable income in the scenario. That would reduce the taxable amount to about $5K. As for having to be a lot owner to be a member of the Association, that's in the Bylaws but the Board has an exemption from having to go through the membership to change the Bylaws. So when pressed they'll argue that the Bylaws are being changed when in fact nothing will ever be put down in writing. Or they will change them and not tell the neighborhood under their new policy of secrecy.

Roger - As you probably remember, the Board is also in the process of trying to secure 50.1% of the neighborhood's approval to become a mandatory association. After I realized that the Board was using fuzzy math in order to balance (and sale) the concept of including the pool in our annual dues I had suggested that the $300 Recreation Association fee be handled as a "special fee" that is only charged to those that wanted to use the pool. That idea was rejected for whatever reason and it may or may not have been a solution to the non-exempt income issue. Also assessing a "special fee" against just those that actually use the pool is a concept that only exists in the covenants they're trying to get passed now. Under the current covenants, those fees cannot be applied against just one group of residents. It was more of a budget balancing assessment.

I'm going to go find the Advil now....
RonR1 (California)
Posts: 2
Posted:
don't know about what state this question is being asked in, but
as an aside, in california, any profit above expenses was taxed
at the corporate rate of 35 percent and I understand that a law
was passed to allow any new profits to be rolled into the reserves
so as not to be taxed. this is a california thing, not a federal
thing so I dunno on that...

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