The financial details and disclosures of any Home Owner’s Association benefit from periodic review. You will want to ensure that the managing entities are properly reporting all HOA financial transactions and review all relevant accounts for consistency and transparency. Applying standard accounting practices to the financial records of an HOA to determine that all financials are correctly disclosed is known as an audit. During an HOA financial statement audit, any investigator will need to thoroughly examine all applicable financial statements and discuss who controls the spending and record-keeping internally and discuss internal controls with the management company. Simply put, the purpose of an audit is to confirm that the numbers look good, and match with HOA spending and expenses. An assessment of annual costs, vendor contracts, financial reserves, and company savings accounts is typically included within a standard audit as well.

A successful HOA audit is dependent on well-kept records and financial statements that are readily available and easily accessible. Generally Accepted Accounting Practices, or GAAP, serve as the standard framework that commitment CPAs follow when conducting audits, and the GAAP establishes a base standard for a tax professional’s behavior. Following this framework, your CPA will clarify your HOA’s cash flow and profit-and-loss statements. The CPA’s goal in completing an audit is to gain valid assurance that the entity’s financials, viewed at large, are without material misstatement, or egregious errors. For an HOA, or any audited business, the audit will reach its conclusion when the CPA issues a report expressing their opinion of the financials presented. A successful audit ends with a report stating that all statements are presented fairly and in clear accordance with the reporting requirements. Any major weaknesses within an organization’s financial structure should be disclosed as well. Of course, regular audits conducted internally for the sake of thoroughness and detailed record-keeping are encouraged, and can help build a positive financial history. 

Most states require an annual audit for HOAs, especially if your total revenue is beyond a certain figure. In California, an annual audit is required for any fiscal year that the gross income of the association exceeds $75,000, and these specific stipulations vary state-to-state. State tax law also dictates acceptions to this rule, or instances where HOAs with a gross income lower than $75,000 may still require a yearly audit. If there is a change in management, or any unusual payment activity, an audit may be mandated. If your HOA has over $500,000 worth of annual assessments, you will be required to submit to an annual audit in the state of California. According to some state regulations, HOA boards can choose when their required annual review takes place, so long as it is conducted 120 days after the end of the year. In this case, HOAs are also required to provide all board members with an audit report within 120 calendar days of the audit’s completion.

It is important to define the different types of financial services that may be relevant to, or required of, an active HOA. There are audits, which is the standard term for a thorough assessment of financial records and cash flow, reviews, and compilations. Compilations are the least specific, since a compilation is merely a presentation of financial data without any insight or verification from the CPA. Reviews go into management investigations and analytical reviews applied to financial data and resources. There is also a simple type of financial procedure called the Agreed-Upon Procedures Engagement, which focuses solely on areas of financial data that are prone to error, or suspected to be problematic. Depending on the nature of your current HOA, an audit may or may not be the most practical option for validating your finances. Audits provide the highest level of assurance, when compared to reviews and compilations, and conducting an audit ensures the most detailed analysis and the greatest control. 

An HOA should seriously consider an audit if they have received sizable amounts of money, if new employees and members are joining the group and managing money, if management has changed or shifted, or if there is legitimate concern regarding fraud, embezzlement, or potential money laundering. While state laws typically require annual audits, HOA guidelines may stipulate a yearly audit as well. Regular audits keep your finances healthy and help businesses catch fraudulent activity early. 

Typical information requirements for an HOA audit include board minutes, full bank statements, investment details, contracts for hired labor and solicited services, budgets, insurance information, invoices, and any relevant 1099s. 

If fraud is suspected, legal counsel should be contacted and solicited, and a forensic accountant should be enlisted as well. Forensic accounting can be a major asset to your HOA and its required audits, and a forensic accountant is imperative if fraud is a potential threat to your association’s finances. A forensic account will verify vendors, even if there is no legal requirement for an annual audit, and can help satisfy any homeowners requests for quarterly financial reporting or clarification. If any board members suspect that administrative staff, or anyone that manages the HOA’s finances, is hiding money in the business accounts or improperly managing the financial accounts, they can enlist the expert services of a forensic accountant. 

HOAs qualify for specific tax benefits unique to their type of organization. Form 1120-H is the legal name of the U.S. Income Tax Return for Homeowners Associations, and its completion allows the HOA to exclude any exempt function income and revenue from the gross income amount. For your Home Owners Association to qualify, 60% of the gross income should be exempt function income, as described above, and at least 90% of annual expenses should be directly related to the business. To honor the requirements of 1120-H, no private shareholder or individual should receive financial benefit from the HOA’s earnings, and a minimum of 85% of the housing units within the HOA should be for residential living. Should your HOA be unable to meet these requirements, you will need to file Form 1120 and comply with regular corporate tax practices and rates.

Any financial review or audit will entail a review of 1099s and contracts issued by the HOA to independent contractors and repair people. Since your HOA is subject to taxation due to association dues acting as income, you will need to provide solicited vendors with a 1099 form and complete the relevant paperwork with the IRS. By issuing 1099s to your hired vendors, you may be able to write off any and all hiring costs by documenting these expenses with Form 1099-MISC. Send this form to the person you have paid (beyond $600) for service, then have the HOA file away the form in the proper manner. Then, the association is able to offset the taxes owed for that amount. Paying out less taxes means the HOA can retain more money and eliminate a potential loss. Send out 1099s diligently, and don’t put it off until the end of the year. Proper contracting practices reflect well on your HOA, and assure board members that standards are being adhered to. 

Compiling your financial records and generally preparing for an annual audit can be overwhelming. You want to give your board members and HOA finances the proper respect, care, and attention, and identify any fraud or funny business before it escalates. That’s why you need to use Dimov Tax to gather all relevant financial data and ensure a smooth and successful audit. Whether you’re complying with state requirements or simply taking stock of your current finances, we can help facilitate a thorough audit, review, or compilation for your HOA. Find out which financial analysis fits your current needs, and let Dimov Tax guide you through the audit process successfully!