I receive more questions about Revenue Resolution 70-604 than I do about all other tax matters combined. One of the questions that continually comes up is: “How do we inform and educate our members so they can vote on this important decision?”
I recommend putting some descriptive words on the ballot so that members have a basic understanding of the Income Resolution. Below is an example of such wording.
Revenue Resolution 70-604 is a tax ruling only. The purpose of this decision is to allow a homeowners association to avoid taxes on any excess member income (as defined in the Internal Revenue Code) that may inadvertently arise in a given tax year. The ruling establishes that the members of the Association meet to make the election. The ruling applies to any excess income from members. The ruling allows only two options; refund excess income from members to members or apply the excess to the following year’s assessments.
The Board of Directors has determined that it is impractical to attempt to repay excess member income due to the administrative issues involved and the fact that excess member income may be needed as working capital to pay for ongoing operating expenses of the Asociation. Therefore, the Board of Directors requests that you approve an election pursuant to Revenue Rule 70-604 to apply any excess member revenue toward the following year’s dues. This does not mean that fees will be reduced for next year, since the budget is already prepared and approved. Since expenses typically increase from year to year, any excess member income is likely to be absorbed by increased expenses.
Your failure to approve this election may mean that the Association will be subject to additional federal income taxes for the current year, causing all members’ contributions to increase.
My advice to the Association and the board of directors is that the ballot be written with only one option, which is to apply the excess income of the members towards the evaluations of the following year, and that a yes or no vote be presented to the members. .
The above wording explains why the Board of Directors is presented with only one option. Keeping silent on this issue and explaining both options would force members to make a decision that could result in a majority of members voting to refund any excess member income. This creates a difficult situation for the board, as such excess revenue may represent working capital that is necessary to operate on an ongoing basis. Without adequate working capital, the board would be forced to borrow funds on short notice or make a special assessment of members for working capital.
For the hundreds of associations with whom I have discussed this topic in the past, you will probably remember that I have stated that, in my opinion, upon which I have received the verbal concurrence of the national office of the IRS, Revenue Ruling 70-604 as worded, that requires member approval is generally in conflict with the governing documents of most associations and with state law. To the best of my knowledge, the bylaws in all states vest the authority to make financial decisions regarding the disbursement of the Association’s funds in the hands of the elected board of directors. The general membership does not normally have the authority to make such a determination. Therefore, state law is generally in conflict with Revenue Resolution 70-604.
So how do you resolve this apparent conflict? In my opinion it is relatively simple, although it requires little work. First, go ahead and have members approve the election at the annual meeting, or at any other meeting or format where a valid membership vote occurs. Second, have the Board of Directors meet and ratify the election approved by the members. By handling the Revenue Regulation 70-604 approval process in this manner, you first meet the requirements of the IRS, and second, you meet the requirements of state law.
Can you bypass member approval and just have the Board of Directors make the choice? In my opinion, yes it can. However, to do so is to invite a challenge from the IRS. And that’s a battle you don’t need to fight. It is so simple to get member approval to make the election that it is best to simply get member approval and avoid a potential fight with the IRS.