California taxation of homeowners associations is still a mystery to many people. That’s because the rules are a little complex, especially as compared to taxation of individuals in the state of California. Let’s look at the basic rules that apply to taxation of California homeowners associations.
- All corporations in California are automatically subject to the franchise tax unless they are exempt from taxation under one of the subsections of revenue and taxation code section 23701. The franchise tax is essentially a tax on gross receipts less allowable deductions. One of the key applications of this concept that potentially affects homeowners associations is that U.S. Treasury interest, which is generally considered exempt interest income under income tax rules, is taxable under the franchise tax rules.
- Corporate homeowners associations can apply for exemption under Revenue and Taxation Code section 23701t. This requires filing exemption application Form FTB 3500, which is a significant process in itself. It also means that the Association must meet the qualifications set forth in that section of California code. The benefit is significant because exempt associations are subject to the income tax rules rather than the franchise tax rules. What this means is that U.S. Treasury interest for an exempt Association is not considered taxable income.
- Qualification under Revenue and Taxation code section 23701t is roughly equivalent to qualification under Internal Revenue Code section 528 for federal tax purposes. That means if an Association can qualify to file Form 1120-H, it generally can also qualify for exemption under California law.
- However, there are some differences between federal and California law. One difference is that cooperatives may not file Form 1120-H, but will still qualify under Revenue and Taxation Code section 23701t for California purposes.
- Another difference relates to unincorporated associations, which are automatically subject to the income tax rules rather than the franchise tax rules for purposes of California taxation.
- All corporations are required to file Form 100, which reports all taxable activities. Exempt Associations are also required to file Form 199, which reports all exempt activities. While FTB allows a “postcard” filing of Form 199 online, many associations still prefer to file the paper form both as proof of filing and for an internal record.
The California Franchise Tax Board (FTB) has long had a policy of suspending corporate status for associations that either failed to file tax returns, or failure to file the biennial statement of officers with the Secretary of State’s office. Failure to file any of the tax forms or officer notice can result in suspension of the Corporation. While that has certain legal implications, such as the inability to legally contract for services, and the loss of rights to the name of the corporation, it also has a financial impact.
The Franchise Tax Board in recent months has been very aggressive and also revoking exempt status for corporations that have been suspended for any reason. The impact of this is that the Association must not only supply any missing tax returns or statement of officers, but they must also file a “Certificate of Revivor” and a new application for exempt status on Form FTB 3500.
Exacerbating the situation is the fact that the Secretary of State is not particularly timely in posting its receipt of the statement of officers. This has resulted in two situations in our firm where associations have had their exempt status revoked and have been suspended, when in fact they had made all timely filings. We recently dealt with an association that had its exempt status revoked and placed on suspension in July, because the Secretary of State failed to post notice that the statement of officers had been received in May. In this case there was about a six-week time delay in the posting of the notice, and FTB happened to take action during that six-week period. The matter was easily resolved by a single phone call to the tax practitioners Hotline with FTB and working through the situation. However, if someone were relying strictly on the positions taken by FTB without challenging them, it would have resulted in an extensive effort by the Association and significant cost in re-applying for exempt status.
The caution to associations is to not blindly accept the positions of the Franchise Tax Board if you believe you have filed all necessary forms with the State of California.
Associations can check their corporate status on the California Secretary of State website at http://kepler.sos.ca.gov/.
This does not allow you to check exempt status with Franchise Tax Board. but it will at least let you know whether your corporation is active or has been suspended.