The IRS Tax Audit Results
Five million dollars and counting!
The Delay
Although key board members were made privy to the IRS tax audit results in mid-December, President Jack Troia decided it was best (for who?) to delay that announcement almost 60 days until the board's scheduled meeting last week on 10 February 2011. While Jack was able to cite the association's recent receipt of IRS's formal audit report, incredibly Jack and Treasurer Dan Forgeron had already been sitting on those results for almost two months since their meeting with IRS auditor Kathy Thomas on 14 December. How do we know that? For the simple reason that's how IRS auditors typically work. Before submitting a formal report, the auditor sits down with the tax payer and explains the results of the audit and the reasons for the proposed adjustments to the tax return being audited, in this case, the association's 2007 tax return. There is no reason to believe that that discussion did not occur when two key board members met with the auditor in December. And besides, Jack Troia had already told us that the audit had been concluded in December.
According to Mr. Troia, the association is required to provide IRS with a response to the proposed adjustments by March 11th. That response may take one of two roads, as noted by the IRS here, as listed below:
If you agree with the audit findings, you will be asked to sign the examination report or a similar form depending upon the type of audit conducted.
A conference with a manager may be requested for further review of the issue or issues. In addition, Fast Track Mediation (if the association qualifies) or an Appeal request may be filed.
Initial Audit Results
So, here we are with the knowledge communicated by President Troia that the association owes $1.345 million in back taxes for the 2007 tax return.
Why $1.345 Million?
Basically, that $1.345 million is broken down as follows:
1 |
Back taxes owed | $1,307,308 |
2 |
Penalties | $6,537 (est.) |
3 |
Interest | $31,155 (est.) |
The reason for the liability stems from the practice of the association to claim a deduction from income for an amount the auditor determined the association was not entitled under Revenue Ruling 70-604. The association's claim to offset such amounts from income under RR 70-604 was denied. That denial was presumably based on the failure of the association to meet the conditions that are set forth in the revenue ruling and discussed below.
In not allowing a deduction for $3.845 million, the amount reported by the assocation as a carryforward to 2008, the association thereby earned that amount as untaxed income. That additional income created a liability of $1,307,308, or 34% (the tax rate) of the $3.845 million. On the other hand, had the association instead returned that amount to the homeowners at the time it was due under RR 70-604, that amount would not be taxable income to the corporation since these funds had been returned to the unit owners. But that did not happen in the 2007-08 period, or at any time prior to 2007.
Under RR 70-604, the association has but two options available as that ruling is applied by the IRS. The association, while carrying forward excess income to the following year, did not opt for either of the two available options. They were:
1. Return excess income to the unit owners; or
2. Apply the excess income to next year's assessments.
The association's failure to do either (1) or (2) triggered the decision to treat such amounts as association income, that is, as taxable income. Whether the association complied with other aspects of RR 70-604 is not known. For additional information on the application of RR 70-604, here is a Guide to RR 70-604 that was prepared by tax expert Gary A. Porter.
IRS Form 4549
According to President Troia, the association received a letter and Form 4549 from IRS. Form 4549 transmits the results of the auditor's proposed adjustments to their 2007 tax return. Except for what Jack was willing to communicate about this matter at the board meeting, the contents of that transmission are secret, at least for now. When an inquiry was made about that form's availability from RMI, Jack said the board would seek legal advice about whether that form could be made available to the association's unit owners.
Completed Sample of Sun City Anthem's IRS Form 4549
However, you can view what Form 4549 (Income Tax Examination Changes) looks like by Clicking here. This form has been filled in by me as if it were prepared by the tax auditor and reporting the same results as it would appear were reported for the tax audit on the 2007 tax return. How was I able to accomplish that? The nature of the tax problem was well know, i.e., represented by a known line item on the association's tax return that reported the amount that had been carryforward to 2008. Also, the additional taxes owed for that particular problem was also well known, based on a tax rate of 34% for taxable income for the U.S. Corporation Income Tax Return Form 1120 for 2007, copies of which are available from RMI.
While some portions of this sample illustrated tax form are understandably guesstimates on page 2, all of the income, deductions and tax figures are deemed reasonably accurate on page 1, as well as Items 19(a) and (e) on page 2.
What is the Association's Total Tax Liability? Is it $5 million?
While some may jump to the conclusion that the payment of $1.345 million, or perhaps some lower amount, might settle the association's tax liability, that has yet to be determined. Having adjusted the tax return for 2007 for a known noncompliant tax issue, it would be unusual for the IRS not to adjust the tax returns for 2008 and 2009 for the same tax issue. Those two years taken together have the potential of adding $3 million more in additional taxes.
Assuming the association treats their 2010 tax return as the IRS would like, there is another potential tax liability looming depending on how that tax return is prepared. If that 2010 carryforward amount is not returned to the homeowners, the total tax liability for 2007-2010 period may be approaching an overall total of $5 million.
How is President Jack Troia and board preparing the community for that possible outcome?
Does Anyone Accept Responsibility?
One has to wonder whether anyone on the board had the opportunity to address this issue at an earlier time but made a decision to ignore the matter and do nothing.
In closing, if you have any comments or questions about this article please let me know by sending me an email here.
Ron Johnson, 15 February 2011