Yes, even a fully nonprofit, all-volunteer HOA has to file a federal tax return every year — and the form your board chooses isn't a one-time decision. It's a recalculation that should happen annually, because the better choice can change from year to year.
If you sit on the board of a homeowners association, condominium association, or community association anywhere in Frederick County or central Maryland, this is one area where "we've always done it this way" can quietly cost real money. Here's what actually goes into the decision.
Every Association Has to File, Every Year — No Exceptions
A common and costly misconception: some boards assume that because their association is "nonprofit," it doesn't need to file a federal tax return at all. That's not correct. The IRS treats HOAs and condo associations as corporations for tax purposes, and a return is required annually regardless of whether any tax is actually owed.
Our HOA is a nonprofit, so it doesn't file.
Every association has to file every year — no exceptions.
Two Forms, and the Choice Resets Every Year
Most qualifying associations file Form 1120-H, a return designed specifically for HOAs that lets the association exclude "exempt function income" — dues, assessments, and fees collected from members in their role as owners — from taxable income entirely. Income that doesn't qualify as exempt is taxed at a flat 30%.
The alternative, Form 1120, is the standard corporate return. It can offer lower graduated rates on smaller amounts of taxable income, and unlike 1120-H, it allows net operating losses to be carried forward to future years. But it requires far more careful documentation — separating member transactions from non-member transactions, operating funds from capital reserve funds, and potentially relying on a separate election (Revenue Ruling 70-604) to handle any excess operating income, which itself carries real risk if it's later disallowed.
| Feature | Form 1120-H | Form 1120 |
|---|---|---|
| Exempt function income (dues, assessments) | Excluded from tax | Generally excluded if capital contributions documented correctly |
| Tax rate on taxable income | Flat 30% | Graduated rates, often lower on first $50,000 |
| Net operating loss carryforward | Not allowed | Allowed |
| Subject to AMT | No | Possibly |
| Complexity | Simpler | More complex, more documentation required |
This election isn't locked in permanently. Your association can choose differently each year depending on which form produces a better result for that specific year's income mix — and that comparison genuinely should be run annually, not assumed to stay the same as last year's choice.
The Two Tests That Determine Eligibility for the Simpler Form
To use Form 1120-H, an association generally needs at least 60% of gross income coming from member dues, fees, and assessments, and at least 90% of expenditures going toward managing, maintaining, or caring for association property. An association that earns substantial income from a cell tower lease, a rented clubhouse, or a large investment portfolio can find itself failing the 60% test in a particular year, which would force a switch to Form 1120 for that year regardless of preference.
The Detail That Surprises Almost Every Board: Reserve Interest Is Always Taxable
Member dues and special assessments designated for your reserve fund are generally treated as exempt income, untaxed when they come in. But the interest your reserve fund earns while it sits in a money market account or CD waiting to be spent on a future roof replacement or repaving project is a completely different story — that interest is non-exempt income, taxable under either filing form, every single year it accrues.
What Else Counts as Non-Exempt Income
Anything that looks more like a transaction with a customer than a contribution from an owner generally falls outside exempt function income: pool day passes, clubhouse rental fees, vending machine proceeds, paid guest parking, and laundry facility income are all common examples. Keeping these clearly separated from dues and assessments in your chart of accounts isn't just good bookkeeping — it's what supports the entire exemption if your filing is ever reviewed.
How We Help Maryland Community & Property Associations
At Mercer Flanagan, we work with HOAs, condo associations, and community associations throughout Frederick County and central Maryland to run the 1120-H versus 1120 comparison every year, keep reserve fund interest tracked and reported correctly, and file on time to avoid the severe per-member penalty structure.
- Financial statement preparation with clean separation of exempt and non-exempt income
- Bookkeeping and accounting for community associations of any size
- Tax planning for the annual 1120-H versus 1120 decision
Book a free consultation and we'll walk through your specific situation — no pressure, no obligation.
Frequently asked questions
Yes. The IRS requires an annual tax return regardless of profit, nonprofit status, or whether tax is actually owed. Skipping this exposes the association to real penalties even with zero tax liability.
