Are Employee Bonuses Taxable?

This time of year, many associations are considering ways to reward their employees.  If your association is considering paying bonuses to employees, there are some tax issues to consider.

Holiday and other bonuses given to employees are supplemental wages and are subject to payroll taxes.  Internal Revenue Service (IRS) regulations state that if bonuses are gifts of nominal value, such as a ham, turkey, or other merchandise, then the value of the gift is not included in the income of an employee and the association is not liable for payroll taxes.  However, if an association decides to pay a holiday or other bonus in cash, or gift certificates that are readily convertible to cash value, then the bonus must be included in an employee's income on his or her W-2 Form, regardless of the amount.  In addition, payroll taxes must be withheld from the bonus and paid by the association.

Some associations have opted to collect contributions from unit owners to fund employee bonuses.  If the bonuses are paid from one of the association's bank accounts, the association is liable for payroll taxes, even if the individual unit owners originally gave the funds.  Once the bonus contributions are deposited into an association bank account, or any bank account using an association federal identification number, the control of the funds is given from the individual unit owner to the association.  The bonus is then considered to have been paid by the association.

Are Employee Lodging Expenses Taxable?

If an association provides a unit for the use of an employee or reimburses an employee for lodging expenses, there are some tax issues to consider.  IRS regulations require that three criteria must be met in order for lodging furnished by an employer to be excluded from an employee's income on their W-2 Form.  The lodging must meet these three tests:

1. The lodging is furnished on the premises of the employer.

2. The lodging is furnished for the convenience of the employer.

3. The employee is required to accept such lodging as a condition of employment.

If your association's situation does not meet all of these criteria, the value of the lodging provided by the employer should be included as taxable wages to the employee, and the payroll taxes should be withheld and paid.

Filing 1099 Forms

The IRS requires a 1099 Form to be filed annually for any individual that has been paid more than $600 for services provided.  An individual is defined as someone who is not an employee or a corporation.  These forms must be mailed to individuals no later than January 31 and must be filed with the IRS no later than February 28 each year for payments made in the preceding calendar year.

In some cases, an association may engage in an exchange of services.  The IRS specifically defines an exchange of services as a transaction that would necessitate the filing of a 1099 Form.  Such an exchange may be an association providing a unit to a police officer in exchange for a certain level of security services.  If the fair market value of the services provided was at least $600 in any calendar year, then a 1099 Form should be filed.

Income Tax Filing Methods

Condominiums and homeowners associations have two income tax filing methods available to them.  They may file under the Exempt Method or the Corporate Method.  This is an annual election, which means that each association may choose to file under either method each year regardless of how they have filed in the past.

Form 1120-H Exempt Method

Under the Exempt Method, associations must apply Code Section 528, which was specifically designed for condominiums and homeowners associations.  If an association meets certain tests as to its levels of revenues and expenses, then all non-exempt revenue is taxed at the rate of 30%.  Some examples of non-exempt revenue are interest income and rental income.  Under this method, there are no tax consequences related to replacement reserves or excess assessment income.

Form 1120 Corporate Method

Under the Corporate Method, associations must apply Code Section 277, which is a specific section for membership organizations.  The advantage of this method is that graduated tax rates beginning at 15% are used instead of the fixed 30% rate of the Exempt Method.  The types of taxable income are generally interest income and rental income, which is the same under the Exempt Method.

This method can result in reduced taxes.  However, close attention should be paid to IRS Revenue Rulings related to the handling of replacement reserves and the deferral of excess assessments.  Replacement reserves must be accounted for separately and they must be capital in nature.  Such items as painting, contingency and general operating reserves are specifically excluded and are treated as operating items.  The Board of Directors should also pass a deferred assessments resolution prior to the fiscal year-end.  Our firm sends such a letter to each of our clients near the end of the its fiscal year recommending this deferred assessments resolution. 

Income and expenses are separated into membership and non-membership categories.  Only income derived from non-membership sources is taxed.  A net income that results from membership sources may be carried as deferred assessments into the next year as long as the amount is not too high.  The deferred assessments resolution discussed above strengthens the position to file under the Corporate Method.  However, if we determine that the level is too high, we may recommend the Exempt Method in order to protect the deferred assessments from potential taxation by the IRS.

Form 1120 Subchapter T Method (Cooperatives Only)

Cooperative associations file under Subchapter T, Sections 1381-1388.  This method is similar to the Corporate Method discussed above.  The major difference is that interest income is not taxed.  Therefore, the only taxable income is typically rental income.  Two examples of taxable income for Cooperatives are the rental of unit and the rental of roof space for an antenna. 

Income and expenses are separated into patronage and non-patronage categories.  Only income derived from non-patronage sources is taxed.  Cooperatives need to carefully monitor their level of patronage income.  If it becomes too high, it may potentially need to be returned to shareholders in the form of a patronage dividend.

Through Goldklang Cavanaugh & Associates, P.C.'s research on tax court cases involving Subchapter T and its application to cooperatives, many of our cooperative clients have had their income tax liabilities considerably reduced.  Our firm has also helped numerous clients file amended income tax returns to obtain substantial refunds.

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