The questions surrounding the Corporate Transparency Act have made property owners associations (POAs) take a closer look at their tax status. POAs that are tax exempt usually maintain an exemption under Section 501(c)(4) of the Internal Revenue Code. Some non-profit corporations, including those that maintain a 501(c)(4) tax exemption, may be exempt from the filing requirement of the CTA, if the recent injunction is overturned, depending on their 501(c) tax status. Due to the CTA, POAs may be considering updating their tax status, but they should proceed with caution as securing a tax exemption can have far-reaching implications for the communities over which they have jurisdiction.
Section 501(c)(4) of the Internal Revenue Code
Section 501(c)(4) of the Internal Revenue Code provides an income tax exemption for “social welfare organizations.” These are organizations that are not operated for profit, but, rather, are operated exclusively for the promotion of social welfare. Unfortunately, what it means to promote social welfare, as provided in Section 501(c)(4), is not entirely clear. Recognizing this lack of clarity, Congress attempted to provide guidance. It enacted Chapter 20 of the Code of Federal Regulations, Section 1.50(c)(4)-1, which provides that an organization is operated exclusively for the promotion of social welfare, as is required by the Code, when it is primarily engaged in promoting in some way the common good and general welfare of the people of the community. Unfortunately for POAs, this guidance doesn’t quite eliminate the conundrum of what it means to operate exclusively for the promotion of social welfare – rather, this guidance really just serves to substitute one amorphous phrase – social welfare – for another – community. Why is this important?
Identifying the “community” that is served by an organization is the essential first step in determining the group of individuals whose common good and general welfare must be promoted by the organization. In other words, who does the organization have to benefit if it secures a 501(c)(4) exemption? What are the practical implications of securing this exemption? For POAs, this question often manifests itself in a particular way – that is, in securing a tax exemption, can POAs restrict the use of their amenities – i.e., the pool, the clubhouse, sports courts, etc. – to POA members only, or does the requirement that the POA operate for the common good and general welfare of the community mean the POA has to open their amenities for the entire world to use?
Two Paths for Tax Exempt POAs
For POAs, the answer to this question depends on the community the POA serves. Specifically, the answer changes depending on the following:
- Whether the POA governs the entirety of the community (i.e., the subdivision over which the POA has jurisdiction, alone, constitutes the community); or
- Whether the POA governs less than the entirety of a community (i.e., there are areas lying outside of the subdivision that are part of the community).
In the case of a POA that is found to have jurisdiction over the entirety of a particular community, the restriction of POA amenities to use by residents alone is permissible. Why is this? If the community is only comprised of residents of the subdivision, restricting access to POA amenities to those residents alone constitutes the promotion of the common good and general welfare of that community. POAs in this situation that extend use of their amenities, for example their open air parks and trails, to the general public are just going the extra mile. Federal case law indicates that there is no requirement that a POA serving its community needs to open its amenities up to the city or to the country or to the world at large. The amenities only need to be open to their community. By contrast, where it is determined that a POA does not represent the entirety of a community, that POA may not close off its amenities to use by its residents alone. This constitutes the promotion of the common good and general welfare of a specific group of individuals, the residents, rather than the community as a whole.
What is the Scope of “Community?”
The crux of the issue regarding POAs considering tax exempt status lies with the scope of the “community” served by the POA. The scope of the community indicates whether the POA can shut itself off to the outside world and benefit only residents of the community over which it has jurisdiction, or whether it must open its amenities up to the world at large.
When applying for a 501(c)(4) exemption, some POAs try to skirt this issue by making representations that the subdivision that they serve constitutes a “community” in and of itself. There are many factors that POAs can list in making this representation, including the size of the community they govern, the amenities located in the community, is the community largely self-contained (i.e., does it have everything an individual would need to live there without having to leave the community), is the community inclusive or exclusive, how accessible is the community, etc. The goal of POAs, in general, is to demonstrate that their subdivision bears a reasonably recognizable relationship to an area ordinarily identified as a governmental subdivision or a unit or district thereof.
With that being said, the IRS is well aware that the scope of any one particular community is almost purely a fact-based question. It has issued Revenue Ruling 80-63 and 74-99 to specifically indicate that there is no minimum area or number of homeowners that a subdivision must have to qualify as a “community”.
The Pros and Cons of Tax Exemption
Now that the two paths are outlined and the scope of the community is defined, what comes next? Should a POA proceed with its application for a tax exemption, it should do so with caution as the potential savings in money and exemptions from CTA filing may not outweigh the cons of the increased reporting and procedures that must be followed for 501(c)(4) status.
Federal case law and associated IRS guidance are clear. For POAs that represent the entirety of a community, the POA is allowed to restrict access to its amenities to residents and their guests only. By contrast, if the POA represents less the entirety of a community, it may not restrict access to its amenities as this does not benefit the general good and welfare of the community.
This topic becomes complicated because of its subjective nature. Conclusions regarding the scope of a community and the flow of benefits to or outside of a community can vary substantially based purely on the IRS agent reviewing a 501(c)(4) exemption application. Because of this insecurity, POA should work closely with their CPAs and legal counsel. This will help ensure that the POA’s application for tax exempt status adheres to the wants of the IRS and, in addition, will help the POA avoid a circumstance in which the IRS must re-review the POA’s application for failure to adhere to any requirements of the Internal Revenue Code.
It is important to note that the granting of a 501(c)(4) exemption is not always the end of the road. Many of the controlling federal cases came about because a POA that was previously granted a 501(c)(4) exemption had its exemption revoked and was made to pay income taxes retroactively for failure to benefit the “community” or for failure to promote social welfare. Therefore, POAs need to ask themselves if the potential to retroactively be required to pay income taxes and potentially lose control of their amenities is worth the monetary savings and exemptions from filing beneficial ownership information under the Corporate Transparency Act.
