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Federal District Court Case on RR 70-604

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What Happened to Option 3: The Check is In the Mail?

On the Issue of Transparency and the IRS Tax Problem

The August board adopt's then ignores a key IRS ruling

The August board meeting was a revelation of sorts, as much for what was disclosed about the association’s IRS compliance as for what was not disclosed. In simplest terms, serious questions were raised about past compliance with IRS regulations. Those unanswered questions raised the ominous specter of monies owed to the government as a result of the failure of the association to follow well established IRS rules in the filing of their annual tax return, Form 1120.

For the first time in the association’s history, we were introduced to something new, IRS Revenue Ruling 70-604, which is not new. Unfortunately, we are told that RR 70-604 has been frequently misapplied or ignored altogether by tax practitioners and boards in completing the annual tax return Form 1120. As a result, the association may be at risk of a serious tax liability they could have avoided had they complied with RR 70-604 in the past. The importance of RR 70-604 in avoiding a potential tax liability problem cannot be understated too much.

Although RR 70-604 is short and simple for even lay persons like the average homeowner to understand, our board has taken exception to key provisions for reasons that elude us. We know the board is now keenly aware of achieving compliance with RR 70-604 because of the actions approved at the August board meeting. In making their judgments on this matter, the board has determined that the cumulative untaxed carryovers from 2002 through 2008 amounts to $4.755 million. The problem for the board is how to treat that amount insofar as IRS is concerned. The problem for the unit owners is in deciding whether the board acted properly in their attempts to comply with RR 70-604.

In making their decision on what to do, the board made the following decisions and considered two options, as presented at the board meeting and at the August Tax Planning Workshop:        

Given the above choices, to pay the taxes owed or to disburse the funds as indicated above, the board voted for the spend and allocate option, that is, Option 2. The board is currently in the process of implementing Option 2, although specific details may change somewhat to fit ongoing circumstances and priorities.

There is no doubt that homeowners will likely appreciate the board’s decision to enhance our lifestyle with this or that board-selected project.

But aside from the goodies (capital projects) the board has determined we will need in allocating these surplus funds, there is a lingering issue of whether the board acted properly and in full faith in light of RR 70-604. The board tells us that they did. However, there is abundant literature on the subject of applying RR 70-604 that would cast doubt on the options that were put before the board to consider. While the board was offered but two options to consider, there was actually a third and unstated option, Option 3. Option 3 was the forbotten or unmentionable option, i.e., YOUR EXCESS ASSESSMENT CHECK IS IN THE MAIL.

What is Option 3? Well, if you take a brief moment to read RR 70-604, you will get a completely different picture of what compliance means from what the board voted to approve. While IRS tax compliance seems to be the goal of the board, the board's August decisions actually contradict that goal in major respects. For example, most people already understand full well that state law provisions like NRS 116 in no way preempt the application of federal law, although the board would have us believe that they do in the application of federal tax law. So, you might ask, why would the board assert that the board has authority to act in behalf of the association? For the simple reason that the board wants to make certain tax-related decisions that directly contradict and ignore major provisions contained in RR 70-604.

What provisions of RR 70-604 does the board wish to ignore? For the purpose of treating that untaxed carryover of $4.755 million, virtually all of their provisions. RR 70-604 provides that when there is a surplus of income over expenses in any given year, which could result in a potential carryover to the following year, the board has two choices and ONLY two choices:

There are no other options or choices open to the board other than to return excess income to the unit owners. The IRS ruling held that if the money is returned, the excess income over and above expenses are not taxable income since such excess has been returned to the unit owners. If those surplus funds were not returned to the unit owners, the association could be held liable for the taxes owed. So, what did our board decide? They decided to ignore the rules set forth in RR 70-604 and to ignore the wishes of the unit owners as set forth in the following paragraph.

Getting back to the reason the board asserted their authority to act for us under NRS is another provision of RR 70-604 the board chose to ignore in its entirely. That provision is the all important “who decides” issue. According to RR 70-604, it is abundantly clear that the decision on what to do with the surplus funds is made by the unit owners at a meeting of unit owners. There is really no other way to interpret this language:

A meeting is held each year by the stockholder-owners of the corporation, at which they decide what is to be done with any excess assessments not actually used for the purposes described above, i.e., they decide either to return the excess to themselves or to have the excess applied against the following year's assessments.

And what is it that they the unit owners must decide? “. . . they decide either to return the excess to themselves or to have the excess applied against the following year’s assessments.” It could not be anymore clear than that.

Except for the 4th quarter assessment holiday approved by the board, it would seem the board has chosen to ignore key portions of RR 70-604. Whether Sun City’s unit owners care about such technicalities of tax law is another matter. After all, instead of our longer term homeowners receiving a check along with that 4th quarter debit amounting to a combined total of up to $900 in 2009, less to shorter term owners, there will be some nice board-selected projects for some of us to enjoy and ponder over. Interestingly, of the $4.755 million covered by RR 70-604, the board is planning to divert only $1.5 million of that amount to enhance our lifestyle.

Ron Johnson, 24 August 2009, Rev 9/26

Here are a number of tax articles on RR 70-604 by Gary Porter, CPA, to address these issues in greater detail. Mr. Porter is a nationally recognized expert on the application of IRS rules to common interest communities and associations like Sun City.

  1. Revenue Ruling 70-604 - The Complete Guide
  2. Revenue Ruling 70-604 - The Latest Word
  3. IRS Reconsiders Revenue Ruling 70-604
  4. Is Revenue Ruling 70-604 Still Alive?
  5. Timing of the Revenue Ruling 70-604 Election
  6. The Association IRS Audit