|
Department of Revenue Issues New Tax Filing Requirements for Condominiums
2/1/2010
Under the new law, the annual Massachusetts tax return filing requirement is (in all but a few isolated instances) determined by which federal tax return a condominium association files with the Internal Revenue Service. Condominiums that qualify and elect to file a Federal Form 1120-H will continue filing a Massachusetts Form 3M, a simple tax form to prepare with minimal income tax. Condominium associations that file a Federal Form 1120 will be required to file a Massachusetts Form 355, a much more complicated tax return to prepare, and will result in a significant tax liability. The primary exception to these rules is for those Massachusetts condominium associations that were created as corporations.
FILE FEDERAL FORM 1120-H
Form 1120-H is a federal tax return specifically designed for most homeowner associations other than cooperatives. The filing of Form 1120-H is elective – it is an annual election, and the election is simply made by the timely filing of an 1120-H. There are various qualification tests that must be met in order to qualify to file an 1120-H, but given the nature of most associations in Massachusetts, only a small handful of associations will fail to meet the qualification tests.
The qualification test that creates the most problems for Massachusetts condominiums is the “residential test”, which requires that at least 85% of the total square footage of the association must be residential. Mixed-use associations require a careful analysis of square footage to test for qualification, and commercial condominiums simply do not qualify to file Form 1120-H.
If an association qualifies to file an 1120-H and properly elects to do so, it will generally be allowed to continue filing the simple Massachusetts Form 3M, and in many cases not owe any tax to Massachusetts. The word “generally” was used in the previous sentence because there is one exception to this rule. A very small number of Massachusetts homeowner associations are created as corporations (the vast majority are trusts), and these associations are required to file a Form 355 with Massachusetts, regardless of which federal form is filed.
The tax rate that applies to taxable income (generally interest income net of certain allowable deductions) on Form 3M is 5.3%
FILE FEDERAL FORM 1120
If a Massachusetts condominium either chooses, or is required to file a Federal Form 1120, it must file a Form 355 corporate income tax return with Massachusetts. Unfortunately, Form 355 is much more complicated to prepare, and will always result in a higher tax than a Form 3M.
The Massachusetts tax due with the filing of Form 355 is calculated as follows: 1) multiply net taxable income (generally interest income net of certain allowable deductions) by 9.5%, 2) multiply “Net Worth” by .0026, and 3) add the tax on income and the tax on net worth and that’s the tentative tax. Here’s the kicker – if the total tax on income and net worth is less than $456, then a minimum tax of $456 is owed. That’s right, even if there is no interest income there is a minimum tax due of $456.
COOPERATIVES
Cooperative housing corporations have their own filing status with the IRS. They are required to file a Form 1120-C for Federal Purposes and are required to file a Form 355 with Massachusetts.
TIMESHARES
Timeshare associations, for reasons beyond the scope of this article, should always file a Federal Form 1120-H (unless one or more of the qualification tests is failed). For Massachusetts purposes timeshares should also file Form 3M, unless the association is incorporated, in which case Form 355 should be filed.
CONCLUSIONS
Historically, the decision to file either a Federal Form 1120 or Form 1120-H has largely revolved around the tax rate differential. Form 1120-H carries with it a flat tax rate of 30%, while Form 1120 uses the graduated rate schedule that applies to corporations, and in most cases the 15% tax rate will apply. So, as you can see, the Federal tax rate with the 1120-H is double that of the 1120 (30% v. 15%). As a result of this differential, many condominiums with significant amounts of interest income have historically found it advantageous to file the 1120. The new condominium tax law in Massachusetts has significantly changed the decision making process between the Form 1120 and Form 1120-H.
Since filing Form 1120 now requires the filing of Massachusetts Form 355, the net (federal and state tax combined) tax differential is significantly less, and in some cases, filing Forms 1120 and 355 could prove to be more costly when considering the combined tax cost. Thus, any federal tax savings associated with filing a federal Form 1120 will largely be mitigated by the dramatically increased state tax due to the required filing of a Form 355.
Please note that as of the date this article was written (January 2010) we are awaiting guidance regarding the new tax law by the Massachusetts Department of Revenue (DOR). The author of this article has been in frequent contact with officials at the DOR, and accordingly does not expect any “surprises” when the interpretation is issued. However, if when published, the interpretation does contain an unexpected interpretation, CAI-New England will promptly disseminate that news.
Kenneth A. Bloom, CPA is with the accounting firm of Bloom Cohen Hayes LLC in Needham, MA. He is a long time CAI-NE member and frequent chapter speaker and author.
|
