AZHOC - Arizona Homeowners Coalition
Voice for homeowner rights and justice.


Have yet another question and this has to do with surplus funds from your HOA budget. Dennis and I have been discussing it. I’ve discussed it with my Association’s CPA and I guess now the Association has contacted a Tax attorney who has disagreed totally with the Association CPA. Yes…it’s a mess. The issue is surplus funds from previous years and what do you do with them. Background: My community has not had an Annual meeting that stayed open for more than a nanosecond because we vote using ARS 10-3708 so we haven’t been able to establish a quorum using absentee ballots for the Annual meeting. Thus, no member voting on anything. For several years our budget has had excess monies. Some years it’s allocated by the Board – after I remind them. Other years it’s just sat out there in limbo. (and no it does not show up on the tax returns) For 2016 and 2017 we had $53,876 in excess funds – never allocated. I spoke in length with the Association CPA who had no idea that the Members were not able to attend an annual meeting or decide where excess funds would go or what type of form the Association would use to file the taxes. The CPA and I discussed IRS Revenue Ruling 70-604. We do have a management company who has been here running the place (literally) since 2000. Entrenched. We do have a Finance Committee. Cadden Mgtmt brings in a budget and that is typically what is forwarded to the Board. My reason in speaking with the CPA is to find out if excess funds could be put into Reserves. It seems that CAI directs all HOAs to do that. Then we discussed Revenue Ruling 70-604. I asked the CPA to give me direction. He felt that putting them into Reserves was okay. I disagreed. I felt it had to go to operations or back to owners. I then asked him to please do further research. I gave him my email and asked him to please prove me wrong. His answer was that he was incorrect and surplus funds do not go to reserves. Goes back to Owners or to operations. Please share what you do with excess funds. Would love to hear from any Tax Attorney (that isn’t hired by the Management Company( that can give us some direction. Thanks so much!

1 Response

  1. Dennis Legere

    I’ll provide my perspective on this issue not for Joan’s benefit we have had this discussion all day, but rather for all of you. While the association has the authority to raise whatever funds they need to pay the expenses they have no authority to abuse that power and repeatedly overcharge homeowners in assessments. Associations Budgets have to have some contingency considerations to address unexpected needs and often result in excess income at the end of the year. In my opinion not as an attorney of CPA that the associations fiduciary responsibility to the members is to do one of three things with those excess funds. Refund it back to the homeowners, pay it forward to defray assessment in the subsequent year, to transfer that money to the reserve fund the defray the need for additional assessments for long term capital maintenance. Doing nothing with the money and letting it sit in a non-designated slush fund is nothing short of simple theft.

    What the association does with that money depends on the tax method they chose and how they pay taxes on those funds. HOA and Condominiums have a very rare luxury. They get to chose between two tax reporting methods.

    The first and most frequently used is as a special HOA treatment using form 1120-H. The Association gets to choose this every year but must meet three specific qualification requirement to use this method. With that process they get to pay no taxes on exempted income and only pay taxes on non-exempt income , but at 30% for the first $50K. What is included in exempted income is Capital contributions , but they also have very specific rules and controls over what qualifies as a Capital Contribution. If the association sets up and manages the reserve funds properly and provides proper notice to the membership in advance that they intend to move any excess funds at the end of the year to the reserve account , then and only then can they legitimately move that money into the reserve account. In my humble non legal opinion Joan’s association in doing nothing with the money and filing a 1120- H, without reporting profit and paying taxes on that profit (excess exempt income) violated the IRS tax code, and they could be subject to an audit and substantial tax liability, fines and penalties, as well as a breach of the association’s fiduciary responsibility to the homeowners.

    The association can also chose to file their taxes as a normal corporation and pay 15% tax on any non-exempt income and any excess exempt income. This is a much more complicated process but provides substantial tax savings if used properly. With this process comes a specific tax ruling issued in 1970 identified as 70-604. What that ruling says is that to exempt excess funds for the fiscal year they must have a vote of the members decide if the association should return the excess money to the members or roll it forward to the next fiscal year to defer assessments. Ruling 70-604 only applies to association filing a 1120 tax form and provides no option for the reserve fund roll over. With this process the part of the annual assessment that is dedicated to the reserve fund must also satisfy the “Capital Contributions” test and criteria.
    With all this said the association can still ignore all of this and simply pay the tax on the excess funds and illegitimate capital improvements, the IRS will be fine with that but the board will have breached their fiduciary duties to both the association and the members and could be individually held liable for those actions. The indemnification clauses in the governing documents do not protect the board members from criminal acts or intentional acts that were not accomplished in good faith.

    I do hope as Joan asked that any other informed member weigh in on this subject because it has ramification for all homeowners in HOA’s and Condo’s across the country.

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