Does a Utah homeowners association that files federal Form 1120-H owe Utah corporate franchise tax, and does the Commission decide the IRC Section 528 exempt-function-income and expenditure tests?

Plain-English summary

A property owners association in Utah had reinstituted collecting assessments (dues) from lot owners in 1992, and by mid-1998 had accumulated a large balance in retained assessments — only about 50% of total income had been spent on expenses, with the rest kept as a "rainy day fund" without any board or member documentation of its purpose (and without documentation tying the reserve to something like an IRS Section 118 contribution-to-capital rule or a sinking fund). The association had no fee-simple common area to maintain. Its corporate secretary, responsible for state-law compliance, asked the Utah Tax Commission to clarify how to apply the federal Internal Revenue Code Section 528 tests when filing Form 1120-H: specifically, whether excess assessments could be retained without being counted as income when their purpose was undocumented, whether the 60% "exempt function income" test is satisfied by the mere act of assessing dues regardless of purpose, and whether the 90% qualifying-expenditures test is met by spending on qualified items regardless of how much surplus assessment money was retained.

The Commission's response was narrow and largely a jurisdictional redirect. It confirmed that the Utah Corporate Franchise and Income Tax Act relies on the IRC for homeowners associations, but explained that interpreting IRC Section 528's tests — including the 60% exempt-function-income and 90% expenditure questions asked — is the IRS's jurisdiction, not the Commission's. The Commission does not determine federal taxable income or federal tax-exempt status; it directed the requester to the IRS for guidance on those specific questions.

What the Commission did rule on was the Utah-law consequence that follows from whatever the IRS determines. Under Utah Code § 59-7-102(1)(b), a homeowners association is exempt from Utah corporate franchise taxation if (1) the IRS recognizes it as exempt, and (2) it has no federal taxable income under IRC § 528. The Commission noted its own records showed the IRS had deemed this association exempt in 1990. If the IRS ultimately determines the association has no taxable income for federal purposes, then under Utah law it likewise has no taxable income for Utah purposes and does not need to file a Utah return at all. But if the IRS determines the association does have federal taxable income, that same income is taxable income for Utah purposes too, and the association must report it on Utah's Form TC-20HA.

In short, the ruling doesn't answer the substantive IRC Section 528 questions the association actually asked — it tells the association those are IRS questions — but it does confirm how Utah franchise tax tracks whatever the IRS ultimately decides.

What this means for you

Homeowners and property owners associations

If your association files (or is considering filing) federal Form 1120-H under IRC Section 528, don't expect the Utah Tax Commission to referee disputes about the 60% exempt-function-income test, the 90% qualifying-expenditures test, or how to treat undocumented reserve funds — those are federal questions for the IRS. What the Commission will tell you is the downstream state consequence: if the IRS confirms your association has no federal taxable income and recognizes it as exempt, you owe no Utah corporate franchise tax and don't need to file a Utah return. If the IRS finds you do have federal taxable income, expect to report that same income on Utah's TC-20HA.

Accountants and tax preparers

This ruling is a useful reminder that Utah's homeowners-association exemption under § 59-7-102(1)(b) is entirely derivative of the federal IRS determination — Utah doesn't independently test exempt-function income or qualifying expenditures. Practically, that means any documentation gaps around retained assessments (like the undocumented "rainy day fund" described here) are a federal Section 528 issue to resolve with the IRS or a CPA versed in IRC HOA rules, not something the Utah Commission will adjudicate. Once the federal position is settled, the Utah filing question (no return vs. TC-20HA) follows automatically.

Common questions

Q: Will the Utah Tax Commission tell me whether my HOA's retained assessments count toward the 60% exempt-function-income test?
A: No. The Commission stated that interpreting IRC Section 528 — including the 60% and 90% tests — is the IRS's jurisdiction, and it directed the requester to the IRS for that guidance.

Q: If the IRS says my association has no federal taxable income, do I still owe Utah corporate franchise tax?
A: No. Under Utah Code § 59-7-102(1)(b), a homeowners association recognized as exempt by the IRS with no federal taxable income under IRC § 528 has no Utah taxable income and doesn't need to file a Utah return.

Q: What if the IRS determines my association does have some federal taxable income?
A: Then that income is also taxable in Utah, and the association must report it on Utah's Form TC-20HA.

Q: Does this ruling tell me how to document a reserve or "rainy day" fund so it isn't counted as income?
A: No. The ruling does not address that question on the merits; it's part of the federal Section 528 analysis the Commission said belongs to the IRS.

Q: Can my association rely on this ruling?
A: No. A Utah private letter ruling binds the Commission only for the taxpayer and facts it was issued to. It's also nearly three decades old, and the Utah Code and Commission rules have been renumbered and amended repeatedly since 1999, so the statute should be checked against current law before anyone relies on it.

Citations and references

Statutes:

• Utah Code Ann. § 59-7-102(1)(b) — exempts a homeowners association from Utah corporate franchise tax if the IRS recognizes it as exempt and it has no federal taxable income under IRC § 528
• IRC § 528 — the federal homeowners-association tax provision the requester asked about (60% exempt-function-income test, 90% qualifying-expenditures test); the Commission deferred all interpretation of this section to the IRS

Source

• Landing page: https://tax.utah.gov/commission/rulings/
• Original page: https://files.tax.utah.gov/tax/commission/ruling/98-078.htm

Original ruling text

98-078

Response January 6, 1999

REQUEST LETTER

October 3, 1998

RE: Request
for clarification on determining exempt function income and qualifying
expenditures when filing an 1120-H Income Tax Return.

Dear Ms Rees.

INTRODUCTION:

This letter is to request clarification regarding the
Utah State Tax Commission's interpretation of the guidelines of determining 60%
exempt function income and 90% qualifying expenditures for when filing a 1120H
Income Tax Return, particularly considering returns filed by OWNERS Property Owners Association located in
COUNTY, Utah.

FACTS:

In 1992 the Association reinstituted assessing dues 10
the owners or lots located in LOCATION Plats A & B. The following table
sets forth file percentage or Expenses as compared to Total Income:

|
1992 |
1993 |
1994 |
1995 |
1996 |
1997 |
|
% |
% |
% |
% |
% |
% |

By July 998, a total or over $$$$$ had been shown on
balance sheets hr total income of which only 50% had been disbursed for
expenses, the balance has been retained Maximum interest income has been 10%.
additional income not directly related to assessments is minimal. (Tax returns for the association in 1994,
1995 and 1997 were filed on Form 1120H.)
Without a budget being set forth for the Trustees or the membership to
approve, the Treasurer once again sent out Assessments in 1998. The excess
retention of assessments was explained as Arainy
day fund,.but no documentation(such as
for IRS Section 118, or for a sinking find) as to the purpose for the retention
of these finds has ever been presented or documented in Member or Trustee
minutes. The association has NO fee simple common area to maintain.

QUERY

As Corporate Secretary for the Association. I am
responsible for assisting in compliance with State Law, and need the Tax
Commissions=s assistance to clarify my understanding of this
situation. My research of file State of Utah Corporate Franchise and Income Tax
Code indicates that it relies upon Internal Revenue Codes for guidance in
filing 1120H Income Tax. Returns

1. Is it
   allowable to assess for dues and retain excess assessments without claiming
   said dues as income when here is no documentation as 0 the purpose of those
   assessments or when the fluids will be disbursed'? (IRS Section 45(})

2 Is the
60% test for exempt function income satisfied only by the action of assessment,
regardless of the purposes or lack thereof for those assessments? (IRS Section 528)

3 Is the
90% expenses test met by the disbursement of funds for qualified expenses
regardless of the retention of excess assessments during flat tax year? (IRS
Section 528)

Your assistance in clarification of these matters is
greatly appreciated. If you have any questions herewith please feel free to
contact me at #####.

Sincerely

Enclosures

RESPONSE
LETTER

January 6, 1999

RE: Advisory
Opinion - Utah Corporate Franchise Taxation of Homeowner Associations

Dear NAME,

We have received your request for interpretation of
several sections of the Internal Revenue Code (AIRC@) as they pertain to the OWNERS ASSOCIATION (AAssociation@). You have stated in your letter that the Utah
Corporate Franchise and Income Tax Act relies upon the IRC, which is true. Because of Utah=s reliance on the IRC, you have asked us how to
properly complete the federal 1120H income tax return for your Association.

Section 59-7-102(1)(b) of the Utah Code provides that
a homeowner association is exempt from Utah corporate franchise taxation if
that association is recognized as exempt by the Internal Revenue Service (AIRS@) and has no
federal taxable income under Section 528 of the IRC. We currently have records that show that the IRS deemed the
Association to be exempt in 1990. Unfortunately,
we are not in a position to establish federal income tax exemptions or
establish your Association=s taxable
income for federal tax purposes. That
jurisdiction lies not with us, but with the Internal Revenue Service (AIRS@). Accordingly, for interpretations of the IRC,
we suggest you contact the IRS to receive the proper guidance you request.

We can, however, offer you guidance as to your Utah
state tax obligations. If the IRS
determines that your Association has no taxable income for federal tax
purposes, then under Utah law, you will have no taxable income for Utah tax
purposes. In this circumstance, the
Association need not file any Utah state tax return. However, should the IRS determine that the Association does have
taxable income for federal tax purposes, then this income is also taxable
income for Utah tax purposes. In this
circumstance, you would need to report this taxable income on Utah=s TC20HA tax return.

Please contact us if you have any other questions.

For the Commission,

Joe B. Pacheco, CPA

Commissioner

^^