Tax Exempt Status for Your Association

Tax Exempt Status for your Associations

Be the hero for your Boards and work toward getting the tax exempt status for the Associations you manage. This is not a process that works for every association but the savings for any specific HOA can be downright impressive. It does come with a price tag and based on the expenses of the association the ROI can be better than any Wall Street investment…without the risk.

Not convinced? A real-world example could be an association with 900 units and a budget of $300,000 per year. Easily, $150,000 could be taxable expenses. That figure results in Texas sales tax of $12,375! Cost to acquire tax exempt status usually runs around $4800 and that includes the $850 the IRS requires for submission of the application. In this scenario the ROI is $7,575 for the first year and thereafter this association pays no sales tax going forward! Think of it, over a 10-year period this could be a savings of $123,750!!

Many have expressed concern that tax-exempt status is only available to the large-scale communities with million-dollar budgets, but this is a misconception. All associations should examine the possibility of attaining tax exemption. Maybe you have smaller associations. Another scenario is an HOA with 250 units with an annual budget of $120,000. Taxable expenses compute to around $56,000 resulting in sales tax of $4,620 minus the cost of $4800 for the registration process. In this scenario the ROI is a negative $180 for the first year. Every year after would be a savings of $4,620 or over a 10 year period $46,200.

Sound too good to be true? Not really, but there are nuances that the board must consider before deciding to move forward with this two-step process.

The most critical decision regards access. To qualify for tax exempt status, the association must include with its IRS exemption application evidence that it is operated for the benefit of all the residents of the community. In addition, the association must include evidence that areas such as streets and parks that it owns and maintains are open to the general public and not just its members. It must also show that it does not engage in exterior maintenance of private homes.

This one requirement can scare many boards into not pursuing the tax exempt status. They are concerned that non-homeowners will invade the common areas of the association. Experience has shown this not to be the case. The requirement is that the areas are open to the general public. This does not mean you have to post a sign saying come on in! It could mean you are restricted from posting signs that say, “Members Only”.

Boards must determine if not posting “Members Only” signs is worth pretty impressive amounts of cash. As they say, “Money Saved is Money Earned”.

So, the board reviews the options and decides to undertake this money saving venture. What now? That’s where the manager comes in. You’ve done your homework and feel pretty comfortable answering questions about the process….oh yeah, the process! As I mentioned earlier, this is a two step process. First you must get IRS approval in the form of a letter granting the 501(c)(4) tax exempt status. This is a lengthy process, not for the manager but for the firm the Board enlists to do the IRS application, which when completed is about 1 inch thick. The IRS estimate of average time required to prepare the application is 58 hours. This includes governing documents, budgets, financials, tax forms and IRS forms specific to gaining 501(c)(4) nonprofit status.

The process from beginning to end can take three months for the federal approval once the IRS receives your application and 30 days for the Texas approval after they receive your AT-206 application. The firm must review specific sections of the governing documents, so they can determine if they contain any language that would prohibit the exemption. Some will but many won’t.

The exception to the rule is gated communities, which are by nature exclusive. Not to say they can never gain tax exempt status, but the process will be uphill. The tax-exempt adviser your Board chooses will make that determination.

Once the application is completed your advisor will deliver the 1 inch bundle to you for board signatures before mailing to the IRS. Now you just wait…. and wait and wait for the IRS to review and make a decision on your application. Minimum 5expectation is you will receive an answer within three months.

The best part is there is no up-front cost by the association. Typically, they pay only if the association gets approved for the exempt status. The exception is when you mail the package the Association will have to pay the $850 fee to the IRS. Months later the mailroom delivers an envelope from the IRS and you eagerly open to find a letter from the Director of Exempt Organizations which grants federal tax-exempt status to your association. Exciting, but we’re only half way there. Now your tax-exempt advisor will submit the IRS letter along with form AT-206 to the Texas Comptroller of Public Accounts requesting sales tax exemption from the State of Texas.

Not to worry, if your association received federal tax exemption, it’s just a formality to request the exemption from the comptroller’s office. This process should take much less time than the federal exemption. You will be notified if your Association receives sales tax exemption by an Exemption Verification Letter from the Texas Comptroller of Public Accounts.

Once you have the federal and state exemptions approved and in hand, the next step is informing your vendors. Using form 01-339, provided by the Texas Comptroller, you can now have the vendors remove all sales taxes from their invoices. You will need to provide form 01-339 to each vendor as they will need those to submit to the state as well, showing they are not applying sales taxes to your invoices. Hint: you will need to keep an eye on invoices for a while to ensure they do not charge sales tax. They are not used to this and can easily overlook it.

There you have it in cliff notes form. To really get an education on this process you need to seek a Tax Exempt Advisor (usually a CPA or attorney). If the Board desires to pursue federal income tax exemption followed by Texas sales tax exemption, seek professional advice to create an action plan. Just Google “Tax Exempt Advisors for HOA's”. This should get you well on your way.

What are you waiting on….it’s a Win, Win, When!

Dan Estep, CMCA, AMS Association Manager RTI/Community Associations, Inc., “CMA”

23 • CONTACT, SPRING 2019

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