Small HOA discovers decade of unfiled taxes

Q: I recently purchased a unit that is part of a small (eight unit) self-managed HOA. The units were built in the late 1970s. Because we’ve been self-managed and around for some time, we don't have the best files and records, but we have some. We believe that no income tax returns have been filed for this association in the last 10 years or so, possibly ever. How can I check this and if that's the case, how can we get back on track? Our HOA has almost no money in reserves and we are looking to see if we qualify for any grants and we can't do that without our taxes being up to date.

Do you have any advice for resources for small self-managed HOAs to educate ourselves on what we should be doing on a regular basis to get this HOA solid and then keep it solid?

A. As an association counsel, I treat this as a high-priority governance issue and recommend the board engage both a CPA and legal counsel promptly. This allows corrective action to be documented and implemented in an orderly manner. We acknowledge finances are tight. However, your governing documents likely provide for the board to adopt an amended budget or a special assessment.

For the board, unfortunately, unfiled tax returns are not merely an accounting issue. Unfiled taxes can raise fiduciary duty concerns, disclosure issues when units are sold, and questions during audits or lender reviews. Most community associations are required to file income tax returns annually using either IRS Form 1120-H (Homeowners Association Return), or IRS Form 1120 (regular corporate return). Many associations qualify for Form 1120-H because it is simpler and generally results in little or no tax liability if the association's income is primarily assessments from owners.

Typically, we first advise the board to engage a CPA familiar with community association taxation and filing. This is not a (should not be a) do-it-yourself project. A CPA who regularly works with condominium and homeowners associations can communicate with the IRS if necessary. If your board retains a CPA, we suggest delaying contacting the IRS until the CPA has evaluated the situation and developed a filing strategy. The board should document, in meeting minutes, that it discovered the issue and has retained professionals to correct it. The board should do their best to locate copies of, or electronic access to, their basic financial information such as annual budgets, bank statements, etc.

Next, the IRS should be contacted to confirm that no returns were filed and determine which form should be used for each year. If not through a CPA, an authorized officer of the association (typically the president or treasurer) can request information from the IRS if they can establish authority to act on behalf of the association (Secretary of State Annual Report and possibly a board resolution). The IRS can often provide filing history, account transcripts and records showing which year’s returns were filed. You will need the association's Employer Identification Number (EIN).

The IRS can assess back taxes, failure-to-file penalties, failure-to-pay penalties and interest. However, many associations have relatively little taxable income, particularly if assessments were used solely for association operations and reserves.

Legally, if returns were never filed, the IRS can generally require filing of all delinquent years. In practice, the IRS sometimes accepts a limited number of years in voluntary compliance situations, but this is fact-specific and should be handled through an experienced CPA.

In our experience, associations that have failed to file for years ultimately discover that:

• Their taxable income was relatively modest.

• The primary issue is filing delinquent returns and resolving penalties.

• The problem is far less expensive to fix before the IRS discovers it than after receiving an IRS notice.

• Matthew Moodhe is an attorney with Kovitz Shifrin Nesbit in the Chicago suburbs. Send questions for the column to him at condotalk@ksnlaw.com. The firm provides legal service to condominium, townhouse, homeowner associations and housing cooperatives. This column is not a substitute for consultation with legal counsel.