Cable companies often enter into agreements under which the associations are billed for the total cost of the services at a reduced rate. The association then has to allocate those cable pass-through costs to the members since they are generally not billed separately. The three basic approaches for recovering these costs from their members are:
a) Basic monthly assessments may be increased to cover the allocated costs.
b) The allocated costs may be billed to the members separately from the monthly assessments. Many associations choose that option so that monthly assessments will not be increased.
c) Estimated allocated costs may be billed to the members annually to avoid possible unfavorable tax treatment for those associations that file Form 1120-H. All members have to use the utility, such as cable service, under that scenario.
The tax consequences are as follows:
a) If the monthly/quarterly assessments are increased so that the cable costs are not passed-through or the cable is billed separately and gross cable revenues and expenses are reported separately in the statement of revenue and expenses it may disqualify an association from filing Form 1120-H. This is because non-maintenance utilities (cable) related to a unit owners property do not qualify as exempt function expense for the 90% test, as does association community property.
b) Reporting the net difference in the statement of revenues and expenses would not disqualify the association under the 90% test for Form 1120-H. However, if the cable revenue and expenses do not offset exactly (especially if there is a net income rather than a net loss) it could introduce a “profit motive” argument. An activity with a profit motive falls into the nonexempt function area and may result in tax.
Now that I have laid the foundation, there could be a case to be made that the cable discounts could be taxable income if Form 1120-H is filed. If Form 1120 and F-1120, using IRS section 277 is filed, the cable discount is membership income and is taxable if there is a net income from the association’s operations.
Therefore, I suggest we look at your association’s potential net income after taking into consideration the cable discount. If there is no net income projected, the Association should consider filing Form 1120 and F-1120. If there is potential net income after taking into consideration the cable discount, I suggest you attempt to structure the transaction to report under Form 1120-H using the following methodology.
1) Do not report a separate income line for cable receipts.
2) If the net cable income (cable discount less cable expenses) is negative, set the budget to reflect the net, for example:
Cable discount $100,000
Cable expense 110,000
Cable assessment revenue $10,000
Also do not reflect the $10,000 on the income statement but only on the budget detail. Effectively you are reducing the cable assessment fee by the discount.
3) If the net cable income (cable discount less cable expense) is positive and is reported as discussed, the positive amount ($20,000) may be taxable, for example:
Cable discount $120,000
Cable expense 100,000
Net cable income $20,000
4) If the Association does not offset and reduce the cable assessment income by the cable discount, showing the entire cable discount as other income, you may have taxable income on the entire cable discount.
5) If the cable discount agreement is detailed and clearly provides a time line for the period of the discount, you may be able to defer the income to agree to the contract period, for example, if the contact shows a cable discount of $100,000 for five years allocated evenly over the five year period, then $20,000 may be current cable income (the budget should be adjusted accordingly) and $80,000 is recorded deferred income to be recognized at $20,000 per year over the remaining four years. This also can be used to offset cable expense.