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Guidance -- Tax -- Advertising Income

Many HOAs are establishing websites to better communicate with their homeowner members.  Sometimes advertising space on the website is sold by the HOA to both members and nonmembers of the association. HOAs need to be concerned how advertising revenue is handled for federal and state tax purposes. The analysis needs to consider whether the HOA will utilize IRC Section 277 or Section 528 when filing it tax returns. This analysis follows.

Taxation under IRC Section 277:

If the Association selects being taxed under IRC Section 277, the advertising income generated from members would be considered membership income, which generally can be sheltered from tax without much difficulty. Even when membership income exceeds membership expenses for the year, taxes can still be avoided on this income by making an annual election to defer the tax in accordance with Revenue Ruling 70-604.

Advertising revenue received from those not owning a home in the HOA is non-membership revenue derived from a commercial activity. Non-membership expenses can be deducted from this revenue.  If non-membership income exceeds non-membership expenses, the resulting non-membership income is taxed at the regular corporate rates. It cannot be deferred.  Non-membership deductions include deductions that are directly attributable to non-membership income. However in this case, the cost of maintaining a website is associated with both membership and non-membership activities and therefore needs to be allocated between the two, on a reasonable basis. Examples of such a basis include the time devoted or computer resources used in membership and non-membership activities. Thus, unless advertising revenue from nonmembers were significant and exceeded related expenses, it appears reasonable that advertising income would not be subject to taxation.

Taxation under IRC Section 528:

IRC Section 528 specifies that an HOA meet certain tests in order to file form 1120-H. One of those tests is an income test which requires that at least 60% of the associationís gross income for the tax year consist of exempt function income. Advertising income from members as well as nonmembers would be considered nonexempt function income.  Thus, unless nonexempt function income is so great as to prevent the HOA from meeting this 60% requirement, the HOA could file using form 1120H, if it desires.

Advertising revenue is taxable to the extent it exceeds nonexempt function expenses. Similar to Section 277, a portion of the total expenses of the website would need to be allocated to the advertising activity on a reasonable basis.  If after this allocation there is net income from this nonexempt function activity, this income would be taxed at 30 percent. Thus, unless total advertising revenue were significant and exceeded related expenses, it appears reasonable that advertising income would not be subject to taxation.