Can an HOA keep a budget surplus at the end of the year?
By OurHOA · General information · Revised
What a board can do with money left over at year end: refund it, credit next year's dues, or move it to reserves, plus the annual tax election that decides.
Find out whether it is actually a surplus first
Most year-end surpluses in small associations turn out to be something else once someone looks. Four impostors account for nearly all of them. Unspent reserve contributions are not operating surplus; that money was collected for a restricted purpose and is already spoken for. Prepaid assessments, the owner who sends twelve months in January, are a liability until the month they cover arrives, and an association keeping its books on a cash basis will show them as income in the wrong year. Unpaid invoices for work already done, the December landscaping bill that arrives in January, belong to the year the work happened, so an apparent surplus can vanish once accruals are booked. And a receivable is not cash: an association can show a surplus on paper while three owners are 90 days delinquent. Before the board decides anything, ask the treasurer for the year-end balance sheet alongside the income statement, with reserve and operating funds shown separately and a list of accounts payable and prepaid assessments. The number that can actually be given back is unrestricted operating cash left after every obligation of that year is recorded, and it is usually smaller than the first draft suggests.
Your governing documents answer before the tax code does
Read the declaration and bylaws before reading anything else, because plenty of them settle the question outright. Some require that any excess of assessments over expenses be applied to the following year's assessments. Some require a refund to owners in proportion to their assessment share. Some give the board discretion to allocate excess to reserves. A few say nothing at all, which leaves the board with the general rule for nonprofit mutual benefit corporations: the association is not a business distributing profit to shareholders, and a return of excess assessments is a return of the members' own money rather than a dividend. That framing matters for how you document it. If the documents are silent and the board wants to refund, the resolution should describe the payment as a return of excess assessments allocated on the same basis assessments were levied, not as a distribution or a bonus. If the documents are silent and the board wants to carry the money forward, that is generally the easier path and the one most associations take.
The four things a board can realistically do with it
Refund the excess to owners in cash. This is the cleanest answer conceptually and the least popular in practice, because a $60 check to each of 80 homes costs real administrative effort and gets spent rather than noticed. It is also the wrong move when the association is underfunded on reserves. Credit it against the following year's assessments. Most associations choose this: the excess reduces what each owner is billed next year, which achieves the same economic result as a refund with far less work, and it is the option the tax rules are built around. Transfer it to reserves. This is usually the most valuable use of the money in a community whose reserve study shows a funding gap, but it is also the option most likely to need a specific authorization, either in the documents or from the membership, because it converts unrestricted cash into restricted cash. Leave it in the operating account as working capital. Defensible when the association has no cushion for a slow collection month, and indefensible as a permanent habit, because an association that runs a surplus year after year and keeps it is systematically overcharging its members. Whichever the board picks, put the choice and the dollar amount in the minutes.
The 70-604 election, and the two things it will not do
Revenue Ruling 70-604 is the federal tax provision every HOA treasurer eventually hears about and few hear about accurately. It addressed a condominium management corporation that assessed its owners to manage, operate, maintain and replace the common elements, and held that excess assessments over the amounts used for those purposes are not taxable income to the corporation when they are returned to the owners or applied to the following year's assessments, on the reasoning that the excess has in effect been returned to them. Three details decide whether an association actually gets that treatment. It is a decision of the members rather than of the board, made at a meeting of the owners, and the ruling's facts turn on the owners deciding to have the excess returned or applied against the next year's assessments. It is annual, so a vote taken once in 2019 does not carry a 2026 return. And it matters only if the association files a regular corporate return on Form 1120, because an association that elects to file Form 1120-H under Internal Revenue Code section 528 already excludes exempt function income, which covers member assessments. Our guide on whether an HOA has to file a tax return walks through that choice between the two forms. The two things the election will not do are just as important. It does not let an association pile up excess assessments year after year outside of income; the IRS position is that the ruling does not permit accumulation beyond amounts actually applied to the following year. And applying the excess forward is not a permanent escape: excess applied to a future year's assessments is treated as gross income and as exempt function income in that later year. Put the election on the annual meeting agenda as a standing item, word the motion to cover the fiscal year just ended, and keep the minutes with the tax file.
Moving a surplus into reserves is the choice that gets challenged
Boards reach for this one because it is the financially responsible answer, and it is the one an angry owner is most likely to question the following year. Two cautions. The first is authority. Sweeping operating surplus into the reserve fund converts money the members arguably had a claim to into money that can only be spent on reserve components, and in Florida, for example, reserve funds and the interest on them stay in the reserve account and are used only for authorized reserve expenditures unless another use is approved in advance by a majority vote at a meeting at which a quorum is present. California Civil Code section 5510(b) works the same way from the other direction, barring the board from spending reserve funds on anything other than the major components the reserve was established for. Money that goes in is not easy to get back out, which is a feature until it is a problem. The second caution is tax. An association filing Form 1120 cannot treat a transfer to reserves as if it were the 70-604 election; the two are different acts with different requirements, and a transfer alone does not remove the excess from member income. Internal Revenue Code section 277 is the background rule for membership organizations: deductions attributable to furnishing services and other items of value to members are allowed only to the extent of income derived that year from members, and any excess deductions carry forward to the succeeding year. That carryforward is why a well-run association with a genuinely lumpy expense year often owes nothing anyway. The safe sequence is to take the member vote on the election, then make the reserve transfer by separate board resolution, and to have a CPA who works with community associations look at the return in any year the numbers are unusual.
A closing timetable for the treasurer
Work backward from the tax filing deadline rather than forward from the last board meeting, because the member vote has to happen before the return is filed and annual meetings are easy to schedule too late. Close the books within 30 to 45 days of year end and produce a balance sheet, an income statement with budget-to-actual columns, and a list of payables, receivables and prepaid assessments. Identify the unrestricted operating excess as a specific dollar figure rather than a description. Put the election and the disposition on the annual meeting notice with enough detail that owners know what they are voting on, and record the vote count in the minutes. Then act on the decision inside the same quarter: issue the credits or the checks, or make the reserve transfer, and show the movement on the next financial statement so owners can see the money went where the vote said it would. Tell members the result in plain numbers, including the per-home effect, because the most common reason a board gets accused of hiding money is that it handled a surplus correctly and never said so. If the association carries a surplus for a second consecutive year, treat that as a signal to re-forecast the budget rather than as good news: consistent overcollection means the assessment is set above what the community actually costs to run, and owners are entitled to have that corrected.
Sources
- Rev. Rul. 70-604: excess assessments returned to owners or applied to the following year's assessments
- IRS: About Form 1120-H, U.S. Income Tax Return for Homeowners Associations
- 26 U.S.C. 277: deductions of membership organizations and the carryforward of excess deductions
- Florida Statutes 720.303(6): reserve funds stay in the reserve account absent advance member approval
- California Civil Code 5510(b): permitted uses of reserve funds
These guides are general education for HOA boards and residents, not legal, tax, or financial advice. Rules vary by state and by your community's governing documents - check with a professional for your situation.