As a tax-exempt organization, the organization has a set purpose for operations that allow the income from that operation to be tax-free. For condominium and homeowners associations this means that the income derived from assessments and operations within the association is tax-exempt.
The key here is that the operational income must be from the operation of the organization and not from other sources. Income derived from non-operational sales, rental of property, commercial operations are not necessarily tax-free income. For example, the condominium association receives income from the filming of a movie. The movie company compensates the Association for using their property or effecting their living enjoyment by the real filming during a defined period of time. The income is not tax-free under the association's tax-exempt purpose. The income must be reported to the Internal Revenue Service as non-operational income that is outside of their tax exempt purpose. Income taxes will be due on this amount.
The company that pays the income that is taxable is required to ask for a completed IRS Form- W-9. This allows them to deduct the income as an expense and also obligates the tax free organization to report the income. The Internal Revenue Service often will match the W-9 to prove that the taxable income is reported correctly. Failure to report the income could result in substantial penlites for the party that fails to comply with the reporting requirements.
For the paying company, the deduction could be disallowed resulting in increased taxable income or disallowance of losses. The tax exempt organization could be forced to pay penalties and interest on the amount not reported. If intent to defraud is determined or if abuse is suspected, the Internal Revenue Services could revoke the non-profit or tax exempt status of the organization. This would make all income regardless the working nature taxable. For a condominium or homeowner organization, this will mean that the assessment income would be fully taxable to the association.
Amazingly, not all management companies or boards are aware of the requirements of non-exempt operational income. The Internal Revenue Service requires that taxpayers be aware of the rules and regulations of the tax code. In some instances, the penalties are waved; but, it is unlikely that the interest would be.
The Association and Management Company should always consult an accounting or tax preparation firm that is experienced in non-profit or tax-exempt organizations. An even better choice is to find a management company that has experience in accounting and legal. This will help provide the association with assurances that the management company is able to help with their compliance needs.
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