By Lena Combs
In December of 2017, the President signed into law the Tax Cuts and Jobs Act, which provided sweeping tax changes for the first time in 30 years. In more than 500 pages, the legislation contains numerous changes, some perceived as favorable and some unfavorable. In all of those pages, however, very little affects vacation owners’ associations.
Historically, these associations have had two choices for filing income-tax returns: Form 1120, U.S. Corporation Income Tax Return; and Form 1120-H, U.S. Income Tax Return for Homeowners Associations.
The Form 1120-H typically is the preferred tax return for filing among associations, because when compared to Form 1120 used by regular corporations, it is shorter, simpler, and avoids or decreases exposure to several significant challenges raised in past examinations by the IRS. The tradeoff for the decreased exposure and simplicity of the 1120-H, however, is a higher income-tax rate (32 percent for timeshare owners’ associations and 30 percent for others) than the graduated rates available if filing as a regular corporation on Form 1120.
The Form 1120-H requires meeting certain tests to qualify for use. Condominium and homeowners’ associations must meet a residential test as well as financial tests, expressed as minimum percentages of membership income and expenses compared to total income and expenses. They are charged income tax on net taxable income at a rate of 30 percent.
Timeshare associations, however, cannot meet the residential test, so for an additional two percent in tax (for a total rate of 32 percent), lawmakers enabled these associations to file Form 1120-H as well—if they meet the financial tests.
Another difference is that Form 1120 requires corporations to make estimated tax payments, but 1120-H does not. An association that files Form 1120-H can pay all tax due on the original filing date (or by the extension date) of the return without penalty.
New tax law
The Act did not change the tax rates imposed on filers of Form 1120-H. The 30 percent/32 percent rates still apply. What changed is the regular corporate tax rate. Through 2017, corporations—including associations—filing Form 1120 were subject to a graduated tax rate system as follows:
Many associations have net taxable income less than $50,000, which would be subject to the 15 percent tax rate.
Effective January 1, 2018, the graduated corporate tax-rate structure is replaced with a flat corporate rate of 21 percent. For associations who chose to file Form 1120 because of the large rate differential (15 percent vs. 30 percent or percent), that margin has narrowed and this may be the time to reconsider the type of filing. Evaluate the relative risk involved, the resulting tax under both methodologies, the costs to prepare the different returns, and any state tax implications.
Other notable changes from the Act for filers of Form 1120, but not commonly applicable to vacation-ownership association returns, are:
- The corporate alternative minimum tax is repealed effective January 1, 2018.
- Net operating losses may only be carried forward beginning in 2018 (they can no longer be carried back) and their use is limited to 80 percent of taxable income, rather than 100 percent under the old law.
- Bonus depreciation, which allows taxpayers to deduct the cost of qualifying property immediately instead of depreciating it over a period of years, is increased to 100 percent through 2022. Also, the definition of qualifying property was expanded.
The moral of the story
The changes enacted by the Act are not expansive in their effects on vacation ownership and other types of associations. However, some opportunities for tax savings exist. The new provisions of the law described here are just a small portion of the changes created by the Act, which contains sweeping changes to individuals, pass-through entities, and others.
A new year and new legislation means that a conversation with your tax professional is in order to ensure an understanding of the options and consequences of the changes on each unique taxpayer and situation.
Lena Combs, CPA, CGMA, RRP, is a partner in the firm of WithumSmith+Brown, PC, which provides clients in the hospitality, vacation ownership, and other industries with assurance, accounting, tax compliance, and consulting services. For further information about Withum and its services, contact at LCombs@withum.com or 407-849-1569, or visit www.withum.com.
Photo: Lena Combs. Credit: Photo courtesy of the author.