Introduction to the 90 Percent Expenditure Test
The 90 percent expenditure test is a crucial calculation for homeowners associations (HOAs) filing Form 1120-H. This test determines whether an HOA qualifies for tax-exempt status, allowing it to avoid paying taxes on its income. To pass the test, an HOA must spend at least 90 percent of its exempt function income on exempt purposes.
Exempt function income includes income from membership dues, fees, and assessments, as well as income from investments and other sources. Exempt purposes, on the other hand, include expenses related to the maintenance and operation of the HOA, such as property maintenance, insurance, and administrative costs.
Calculating Exempt Function Income
To calculate exempt function income, an HOA must first identify all sources of income that are subject to the 90 percent expenditure test. This includes income from membership dues, fees, and assessments, as well as income from investments and other sources. The HOA must then calculate the total amount of exempt function income received during the tax year.
It is essential to note that not all income received by an HOA is considered exempt function income. For example, income from non-exempt activities, such as renting out HOA property, is not included in the calculation. An HOA must carefully review its income sources to ensure accurate calculation of exempt function income.
Calculating Exempt Purposes Expenses
To calculate exempt purposes expenses, an HOA must identify all expenses related to the maintenance and operation of the HOA. This includes expenses such as property maintenance, insurance, administrative costs, and other expenses that are directly related to the exempt purposes of the HOA.
An HOA must also ensure that expenses are properly documented and supported by receipts, invoices, and other records. This will help to ensure that the HOA can demonstrate compliance with the 90 percent expenditure test in the event of an audit or examination by the IRS.
Applying the 90 Percent Expenditure Test
To apply the 90 percent expenditure test, an HOA must calculate the ratio of exempt purposes expenses to exempt function income. The HOA must spend at least 90 percent of its exempt function income on exempt purposes to pass the test.
If an HOA fails to meet the 90 percent expenditure test, it may be subject to taxes on its income. In some cases, an HOA may be able to carry over excess expenses to future years, but this requires careful planning and documentation to ensure compliance with tax laws and regulations.
Conclusion and Next Steps
Calculating the 90 percent expenditure test for 1120-H requires careful attention to detail and a thorough understanding of tax laws and regulations. An HOA must ensure that it accurately calculates exempt function income and exempt purposes expenses to demonstrate compliance with the test.
If you are an HOA seeking to ensure compliance with the 90 percent expenditure test, it is essential to consult with a qualified tax professional or attorney who can provide guidance and support throughout the process. By taking the necessary steps to ensure compliance, an HOA can avoid potential penalties and ensure that it remains in good standing with the IRS.
Frequently Asked Questions
What is the purpose of the 90 percent expenditure test for 1120-H?
The 90 percent expenditure test determines whether an HOA qualifies for tax-exempt status, allowing it to avoid paying taxes on its income.
What types of income are included in exempt function income for the 90 percent expenditure test?
Exempt function income includes income from membership dues, fees, and assessments, as well as income from investments and other sources.
How do I calculate exempt purposes expenses for the 90 percent expenditure test?
Exempt purposes expenses include expenses related to the maintenance and operation of the HOA, such as property maintenance, insurance, and administrative costs.
What happens if an HOA fails to meet the 90 percent expenditure test?
If an HOA fails to meet the 90 percent expenditure test, it may be subject to taxes on its income.
Can an HOA carry over excess expenses to future years for the 90 percent expenditure test?
Yes, an HOA may be able to carry over excess expenses to future years, but this requires careful planning and documentation to ensure compliance with tax laws and regulations.
Who can help an HOA with calculating the 90 percent expenditure test for 1120-H?
A qualified tax professional or attorney can provide guidance and support to an HOA seeking to ensure compliance with the 90 percent expenditure test.