Oregon HOAs and Corporate Minimum Tax

In January of 2010, voters in Oregon approved ballot measure 67, which increased the corporate minimum tax from $ 10 to $ 150.  Most voters at the time were likely unaware that this would not just apply to for-profit corporations but also applied to HOAs, which are also corporations.  Since the approval went into effect with tax year 2009, this left many HOAs unprepared for the massive increase in their tax liability, especially those with fewer homes to share the burden.  And, for the past three tax years, HOAs have paid the new corporate minimum.

But there is good news!  The Certified Public Accountants (CPAs) that work with HOAs have been asking the state to look into this since its approval and in spring of 2012, the Policy Systems and Estate Unit did.  In February of this year, the Oregon Department of Revenue changed its interpretation to allow HOAs to be exempt from the increased corporate minimum tax and issued Oregon Revenue Bulletin 2013-01. For tax years 2012 and beyond, HOAs will no longer need to file Oregon Form 20 (unless the HOA has taxable income) and pay the corporate minimum tax, although HOAs should still file a copy of their federal tax form (Form 1120-H) with the state.  Finally, those HOAs that did incorrectly file Form 20 and paid $ 150 in any or all of those tax years (2009, 2010 and/or 2011) can request a refund from the state by submitting an amended return.  There is a looming deadline for the 2009 amended forms; they must be filed by April 15, 2013.

All Oregon HOAs must still file federal tax returns (either 1120 or 1120-H), which are due by March 15th of each year (for HOAs that use the calendar year as their fiscal year).

For more information about Oregon Department of Revenue’s decision, refer to the Oregon Revenue Bulletin 2013-01 (https://www.oregon.gov/DOR/forms/FormsPubs/orb201301_800-012.pdf) or contact your HOA’s CPA.

Reserve Studies

Oregon Statutes 94 and 100 require boards of all but the oldest condominiums and planned unit developments to, “annually... conduct a reserve study or review and update an existing study to determine the reserve account requirements”  (ORS 94.595(3)(a) and ORS 100.175(3)(a)).  But what is a reserve study, who can do one, and it is really that important?

What is a reserve study? A reserve study is essentially a financial planning tool, a roadmap for the board to follow.  When done properly, it provides a way for the board to ensure sufficient funds will be available to fund major maintenance, repair or replacement of all items of common property* that will normally require such work over the next one to 30 years.

While there is no one proper format for a reserve study, each one should, at the bare minimum, have the following:

a.  Listing of common property/items of HOA maintenance responsibility.  This list should include the item, its year of installation, its anticipated lifespan, and the cost for this item at the end of its useful life.

b.  Listing of reserve income/expenses from current year through year 30.  This is usually a spreadsheet with income for each year as well as reserve expenses for each year, with a total showing the net anticipated balance at the end of each year.

There are many other items that may be included with a reserve study.  These typically include definitions of terms, assumptions about inflation, interest or other income, written evaluations of the components by the experts who assessed them, and sometimes also photographs and detailed information about each common property item.  In addition, most reserve studies also include a maintenance plan.

A maintenance plan is a critical component of a reserve study.  While it is not required to be updated annually, it is intended to be used in conjunction with the reserve study to help the reserve items last for their anticipated lifespans.  To give an example, let’s say the roof on your building is expected to last for another 25 years.  To help ensure that the roof actually lasts that long, the maintenance plan will call for periodic (probably at least annual) inspections of the roof and the removal of moss, cleaning of gutters (to avoid water backing up under the roof), etc.  Failing to clean the moss off the roof may not only void any warranty it has but will certainly shorten its lifespan.

Who should perform a reserve study?  Statute does not currently specify who may or may not produce a reserve study, but that does not mean that the board should just hire anyone.  Since the reserve study is a financial planning tool, it should be done by someone with knowledge of the maintenance, repair and replacement needs of the association’s common property or someone who has experts who can provide this knowledge.  Experts would include individuals/firms with the Reserve Specialist designation, a professional designation from Community Association Institute, the national community management organization (to learn more about this designation, please see:  http://www.caionline.org/reservespecialist).  There are several local reserve study providers who have this designation; follow this link for more information:  http://www.caioregon.org/Reserve-Studies-~232872~17084.htm.

Board members sometimes ask about self-performing reserve studies.  Even if one or more of the board members has construction/maintenance industry experience or education, it is not prudent for the board to try to take on this responsibility themselves.  There is simply too much potential risk if an error is made.  In good conscience, I cannot recommend it.

How important is it to update a reserve study every year?  Actually, it is extremely important that the reserve study is updated annually, and not just because statute says so.  The reserve study is a snapshot of the reserve income and expense over the next 30 years, and so each reserve study has a different window of 30 years.  So the 2011 reserve study should show income and expenses from 2012 through 2032, while the 2012 one shows 2013 through 2033.  If there is a big expenditure that happens in 2013 (say the roofs need to be replaced that year) and the board only relies on the figure from the 2011 budget (which doesn't show that big roof expense because it’s not required to since it happens in 31 years), the board is going to find itself seriously underfunded when it has to replace the roofs or whenever it does update its reserve study.  If the study had been updated in 2012 and the roof expense caught, the board would have much more time to consider how to get their funding to the proper level.  Even though it’s not an insignificant expense to have a reserve study prepared, it’s a small price to pay in the long run to help ensure the community has the proper funds to do what’s needed and avoid special assessments.

One final thought about reserve studies:  boards shouldn’t wait until they’re trying to put their annual budgets together to have a reserve study done.  Boards should plan to have the reserve study in hand at least four months prior to the beginning of the fiscal year (so if the fiscal year is the calendar year, that means by September 1).  Waiting on a reserve study to determine the amount to contribute to the reserves for the next year may delay the adoption of the budget, so the board should even consider contacting reserve study professionals now for quotes and getting the ball rolling for next year.

________________

* The term "common property" is being used to designate any items within the community that the association has maintenance responsibility over, regardless of who actually owns the item.

Should Board Members Receive Compensation?

This question is posed to me again and again:  why, if a board member spends his/her personal time to do association business, cannot he or she be compensated for that time?Both ORS 94 and 100 provide that the bylaws for an association should include any compensation for the directors.  In my experience, though, the bylaws as written do not allow for any compensation to directors (that is, renumeration for their time and effort).  So why, if ORS 94 and 100 do not outright ban compensation to directors, do the documents almost always do so?  I believe that the primary reason that HOA and condominium board of directors are not compensated for their time is due to the fiduciary duty each director is obligated to observe.  Directors owe fiduciary duties of fair dealing, good faith and loyalty to the association.  If directors are getting paid for their time, then there is a question about whether or not they are acting in good faith or only in their own self-interest.What if a director is not compensated in cash directly but instead in some other form?  Even if the board members are simply not required to pay their dues, this is indeed compensation and I would argue is in direct violation of their fiduciary duty.  After all, that lack of income will result in a budget shortfall, and allowing a known reason for a budget shortfall is not acting in good faith.

I’m sure some will argue as to why any owner would want to serve on the board without compensation.  The reason, besides the annoying answer that “It’s the right thing to do,” is that board members get to make 95% (or more) of the decisions for all owners in their community, and those that serve on the board should be motivated by knowing they are making the best possible choices for the benefit of all members of the association, including their own.  Serving on the board is also the absolutely best way for an owner to understand the inner-workings of the association and seeing the struggles and challenges to be faced.  All owners should take a turn at serving on their boards at some point during their tenure in that community.  It does mean giving up some free time, but having a properly running community can be well worth it.

So compensation for board members?  Unlikely.  Owners should serve on boards for the experience and to keep their community running smoothly and properly.  Seems like that should be compensation enough, no?

Owners Who Don't/Won't Pay

When meeting with boards, one of the things that I inevitably hear they are struggling with is what to do about the owners that simply don’t pay.  This has always been a problem and with the downturn in the economy it’s just gotten worse.  While there is no sure fire way to make everyone pay on time, the board can certainly take some steps to encourage owners to pay while allowing recourse for those who don’t.  Boards should first look to their governing documents to find out what is already laid out for delinquencies.  When are the assessments due and how long is the grace period?  Are there provisions for late fees or interest?  If so, the board already has a good backbone for enforcement.  If not, there are provisions in ORS 94 and ORS 100 that allows associations to impose reasonable late fees and interest against account that are past due.  Also per ORS, owners are personally liable for all assessments imposed.When the board has the basic information, the next step is to formally adopt a payment resolution that provides all of this information in a written form to all owners.  For more information about this resolution, please see my article entitled, “Resolutions!” posted on November 10, 2011.  It is prudent to have an expert in this field prepare the resolution for the board (the HOA’s attorney or community manager are best suited to this task).  This resolution, once adopted, should be sent to all owners of record before any new enforcement steps are undertaken.

At this point, the best thing the board (or the management company) can do is follow the steps outlined in the resolution exactly.  If the assessments are due on the 1st day of each month and late if not received by the 10th day of that month, then within the next few days follow up should be done.  At minimum, a statement should be send (via first class mail) showing the assessment, late fee, and any other penalties that the payment resolution provides for.  This statement should also include contact information - phone number, e-mail address - in addition to the payment remittance address, in case the owner has a question about the delinquency.  Owners are entitled to understand their account and any charges on it, so it’s better to make it easier for them to get their questions answered.

If owners continue not to pay, eventually the board will have to get a law firm involved.  Boards should talk to their law firm to determine if they do collections, and if so how they are compensated for their work.  Some firms bill as they go, so the association pays the legal charges up front and then is reimbursed those costs by the delinquent owner when s/he brings the account current.  Other firms will do the work and not charge the association anything up front but simply collect it from the owner as part of the delinquency.  Both arrangements have their advantages and disadvantages, so if the board doesn’t already have a relationship with a law firm (which it should; it’s better to know an attorney and not need him/or then suddenly discover one is needed and have no idea who to contact), both options should be explored to determine which will be best for the association.

Before the delinquent owner and his/her account are turned over to the law firm for collections, however, it is prudent to make one last attempt to collect the debt.  Management companies like to call this a ten-day demand letter, and that’s exactly what it is:  a letter that gives the owner ten days to pay his/her account in full before it is turned over to the attorney.  This letter should always include the following language, “This letter is an attempt to collect a debt and any information obtained will be used for that purpose.”  I also think it is prudent to include in the letter an opportunity for the owner to get on a payment plan, just in case s/he cannot pay the full amount due.  This payment plan cannot simply be, “I’ll pay when I can.”  A payment plan is a specific, written agreement, entered into by the owner and the association, that puts forth concrete deadlines that the owner must meet as well as the consequences for the failure to meet those requirements.  For example, let’s say an owner is behind by $500 (including assessments, late fees, interest, etc.).  A reasonable payment plan would be for that owner to pay the regular assessments on time and before the end of the month each month pay an additional $50.  This payment plan would bring him/her current within 10 months.  Once the payment terms have been worked out and are agreeable to both parties, a written agreement should be mailed (or e-mailed) to the owner, signed, and returned to the association.  This agreement should also detail what will happen if the owner fails to make a payment as agreed upon (or goes into foreclosure); in that case, normally the account is immediately turned over to the law firm for collections.  Likewise, the association should have a deadline on when the signed payment resolution should be returned by (10 days is generally considered reasonable) and the date it goes into effect.  These things are necessary to protect the association's interests.

Boards should remember that, even though their fellow owners are their friends and neighbors, they are charged with a fiduciary duty, which in this context means that personal feelings and relationships can’t be allowed to get in the way of doing what is right for the association, and holding all owners responsible for returning their assessments.

Year End Responsibilities

Many associations have their fiscal year as the calendar year (January 1 - December 31).  If that is the case with your association, it’s time to start getting the year end financial work done.  What does that mean?  Well, like any business, an HOA is responsible for providing 1099s, filing its taxes and preparing and distributing an annual financial statement.  Depending on the amount of income, a financial review may also be required.  Let’s look at each of these issues in turn.

Form 1099-MISC.  Most HOAs will have to file at least a few of these forms.  Any vendors paid for services of more than $600 (with the exception of corporations; these are mostly exempted from this requirement) should receive a Form 1099-MISC from the HOA.  All law firms must also have a Form 1099-MISC, whether or not they are a corporation.  There are very specific rules and instructions for the completion of these forms, which can be reviewed at this link:  http://www.irs.gov/pub/irs-pdf/i1099msc.pdf.  If you have additional questions, contact a CPA.

Federal Taxes.  HOAs, although sometimes mistakenly thought as non-profit corporations (truly, they’re really not-for-profit, which is not the same from the government’s standpoint), must annually file taxes with the IRS.  HOAs file either Form 1120 or Form 1120-H.  Federal taxes are due March 15 for HOAs on a calendar fiscal year (a month earlier than personal returns are due).  There is generally a significant tax benefit to HOAs who qualify for and file Form 1120-H, but in addition to other qualifications, an HOA must annually adopt IRS Revenue Ruling 70-604 at the annual meeting.  This ruling allows HOAs to roll over any excess member income to the next tax year without being taxed on that income.  This should be done every year at the annual meeting (it should be a standing agenda item) and must be done by the owners (the board cannot approve this ruling on the owners’ behalf).  For more information on this, see this fascinating article by Gary A. Porter, a CPA:

http://www.revenueruling70-604.com/index.php?option=com_content&view=article&id=3&Itemid=14

For more information about Form 1120-H, see http://www.irs.gov/pub/irs-pdf/i1120h.pdf.

Oregon State Taxes.  Most Oregon HOAs are no longer required to file Form 20 (as of the 2012 tax year).  HOAs that may need to do so are ones that have non-trivial income from interest and other non-member-assessments.  For more information, see my article from March 1, 2013 entitled, "Oregon HOAs and Corporate Minimum Tax."

I do not recommend that HOAs, even small, self-managed ones, have a board member take on the liability of filing the HOA’s taxes, either federal or state.  Instead, have a CPA familiar with HOAs take over that potential liability for you.

Annual Financial Statement.  Regardless of income received in the year, each year the board is responsible for having an annual financial statement, consisting of at least a balance sheet and an income/expense statement, prepared and a copy distributed to each owner within 90 days of the end of the fiscal year.

Annual Review.  Oregon statutes now require that an association who has income in excess of $75,000 must have a review by an independent CPA.  Many boards know about this clause but misunderstand it.  To determine if the HOA is subject to this requirement, total income for the year must be evaluated, not just income from owner assessments.  So if there was a special assessment applied or if the HOA received an insurance settlement, these funds are also considered income and for the purposes of determining the review must also be added to total income for the fiscal year.  Likewise, any income for the HOA, whether from coin op (laundry facilities), rental of HOA-owned parking spots or otherwise, must be included in this total to determine if the income exceeds $75,000.  If it does, an HOA must have the review done unless 60% of the owners vote not to do the review.  This vote only applies for a single fiscal year and must be repeated each year the owners do not want to have the review done (Note that it is the owners who must make this affirmation, not just simply the board.  From this fact alone, and with the inherent difficulty most associations face simply trying to reach quorum, I suggest boards simply comply with the statute and have the review done).

For more information, please consult a CPA.  CPAs familiar with HOA rules and regulations may be found through the CAI-Oregon website:  http://www.mydigitalpublication.com/publication/?i=71867.

For more information about requirements in statute, please also see:

Condominiums (ORS 100.480):  http://www.leg.state.or.us/ors/100.html
Planned Unit Developments (ORS 94.670):  http://www.leg.state.or.us/ors/094.html

Financials 101

If meetings are the backbone of a community, the place that all decisions of the board are made (as required by Oregon statute), then financials are the muscles that help hold those decisions in place.  It is critical that each and every board member read and understand the financials provided every month.  Without the review and an understanding of the association’s fiscal state, how can the board determine if the business of the association can proceed normally?

Each month, the management company (or the association’s treasurer, if the community is self-managed) should produce a financial report for the previous month.  While each management company may provide different items in its package, a basic financial report (at minimum) must include these reports:

Balance Sheet.  This report provides a snapshot of the current financial health of the association.  It shows how much cash the association has as of the end of the current period and is generally broken down into different asset accounts (such as checking/operating and money market/reserves) and also shows the current liabilities, which are also broken down into separate accounts (such as reserves and retained earnings).  If the association has a loan, this should also be reflected on the balance sheet.

Budget Comparison/Income and Expense.  This report may have different names but ultimately it should show current income and expenses versus budgeted income and expenses as well as yearly income and expenses versus budgeted amounts.  Boards should scrutinize this closely to see where the actual expenditures are exceeding the budgeted amount and determine why this is occurring.  The reason for the variances could be quite reasonable (for example, water usage tends to be greater in the summer due to irrigation requirements) or it could be the frequency of the payments (maybe two monthly insurance bills were paid in the same month) or it could be that the board simply didn’t budget enough for that expense in the current fiscal year.  More important than the number itself is obtaining an understanding of why the variance occurred so as to help determine what, if any, action needs to be taken.

Income Received.  Again, this report has many different names, but whatever it’s called it should be a listing of owners, their payment amounts and dates the payments are received.  If there is other income received (let’s say from a coin-op washer and dryer in the basement of the building), that should also show up on this report as a receivable.  About the only income you wouldn’t expect to see on this report is interest from a financial institution.  (Note:  this report generally has confidential information on it and as such should not be shared with any non-board-member owners.)

Expenses Incurred.  This report may be called “Check Register” or may have any number of other names, but it is a listing of all of the checks written in the month, including the number, the payee, the amount paid, and the expense account they were paid to.  Many management companies also try to provide a note with some additional description (for example, an invoice paid to the landscaper for monthly contract maintenance may have the month paid noted).  The checks should be sequentially numbered and any voided checks should also show up on this report.

Delinquencies.  This should include the name and amount owed for all owners with a past due balance as of the end of the period.  Usually this includes a breakdown of current, 30 days, and 60-90 days.  This report is sometimes also called “Aged Receivables” or “Receivables” and is also confidential and must not be shared with any owners who are not board members.

Bank Statements and Reconciliations.  The board should receive a copy of the bank statements and the reconciliations for each bank account.  While the balances shown on the balance sheet may not match the bank account ending balances, they should match the ending balances shown on the reconciliation.  (The reconciliation - and the balance sheet - takes into consideration checks that have been written but not yet cashed.)

It is not required to be provided, but I believe managed associations deserve to have their managers review the financials and provide some sort of recap.  I find that going through the financials in order to write up my report helps me notice trends and potential issues before they become full-scale problems (such as chronic overspending in a budgeted line item) as well as helps me to correct any minor errors in the financials (an invoice for insurance accidentally coded to building maintenance, for example).

So now that you know what should be in your financial package each month, what do you do if you’ve looked it over and still have questions?  Ask them!  Too many board members are unnecessarily bashful about asking questions either because they feel they should know the answer already or maybe they assume another board member will ask the same questions.  As a manager, though, I want my boards to ask me if they have questions.  If you don’t understand the financials, you should ask to sit down with the manager and go through them (if you are self-managed, you should ask to sit down with the treasurer).  A good manager will take the time to help you understand your financial report and its implications.  It’s not a nuisance or an inconvenience to us, even though of course we are busy people, because part of our job is to help you do your fiduciary duty, and how can you do that if you don’t understand the HOA’s finances?

(If you are unsure what fiduciary duty means, here is a link to the Wikipedia article:  http://en.wikipedia.org/wiki/Fiduciary_duty)

Board members are entrusted with making responsible decisions on behalf of the owners that elected them.  A proper understanding of the association’s finances is critical to being able to do so.  Board members must each take the time to review and understand them as well as seek assistance when needed.  There is no shame in asking questions.

Resolutions!

Resolutions are one of my favorite tools for boards to use to address routine, common problems and procedures.  CAI describes a resolution as “...a motion that follows a set format and is formally adopted by the board...(they) may enact rules and regulations or formalize other types of board decisions.”  Simply put, resolutions are decisions by the board on topics that are commonly encountered in the day to day business affairs of the association.  Resolutions cannot contradict the rules and restrictions in the governing documents (or state or federal laws) but are instead considered an extension of them.

Resolutions must follow a set format:  citation of authority to adopt the resolution, which may include sections of state or federal statutes or of the governing documents; purpose, which explains why the board is adopting this resolution; scope and intent, which is who this resolution affects and for how long; and finally the specifications, which explains what those affected by the rule are expected to do.*

There are four resolutions that I think all boards should adopt:  payment resolution, insurance and maintenance resolution, architectural review resolution and rules enforcement resolution.  It can also be prudent to have a resolution to explain how resolutions are made and adopted, but it is unclear if that is truly necessary or not.  So what do these resolutions do?  Let’s take each of them in turn.

Payment Resolution.  The payment resolution, which may have several different names, is all about monies due to the association.  This resolution details the frequency of regular assessments, the due date, the grace period (how many days after the due date the payment is still considered not late), the late fee (which may be a dollar figure or a percentage of the assessment), as well as any other fees or penalties for failure to pay.  This resolution also details what actions are taken and in what time frame when an assessment is not received by the end of the grace period.  Typical steps you’ll see in this resolution is notice to the owner at 30 and 60 days, with a demand letter being sent around 90 days (provided this conforms with the governing documents).  It should also detail when an owner’s account will be turned over to a collections attorney (usually an amount or a minimum number of days without payment).  Things like NSF charges, attorneys' fees, etc., are generally also mentioned in this document, so that there’s no question the HOA has the right to recover these costs.

Insurance and Maintenance Resolution.  This resolution is especially critical for condominiums and those planned unit developments where the HOA and the owners share maintenance responsibility for the homes/units.  This two-fold resolution helps owners, the board, and the insurance agent to clarify the items that are the responsibility of the association (versus what each owner is responsible for) in accordance with the governing documents.  In addition to giving an overview of owner versus HOA maintenance responsibilities, it also explains insurance coverages, deductibles, and the procedures for filing an insurance claim.  When the association has its first insurance claim, the board will be glad to have this resolution in place.

Architectural Review Resolution.  Most governing documents give the board the authority to set up an architectural review committee (commonly called ARC or ACC) to help review and approve potential changes to the community.  Developers like to put this clause in their documents (and many owners like to see it in them) because an ARC can help ensure that the standards of the development are upheld and potential neighbor concerns are considered.  This resolution is generally a formalization of the procedures mentioned in the governing documents but may also include specific restrictions (such as no fences may be more than 6’ in height or all homes must use cedar shake or tile roofing).  It also usually includes a form that details the process and information to be provided for consideration.

Rules Enforcement Resolution.  The governing documents for your community most likely include some restrictions on use that may address such issues as rentals, trash cans and recycling bins, recreational vehicles, etc.  This resolution expands on those restrictions by putting into place the procedure to follow when a violation occurs.  Without such a resolution, and the accompanying fine schedule, a board may not be able to enforce the restrictions in its documents.  This resolution usually also includes a recap of the rules for quick reference.  Any board that wants to enforce its rules should adopt this resolution.

One important thing to note about all of these resolutions:  they cannot be contrary to your governing documents nor to state or federal laws.  So if your documents say that a boat cannot be in sight in the community, the board should not adopt a resolution that states that an owner can keep a boat in his/her driveway overnight.  The resolution should match the governing documents.  Likewise, if the governing documents allow owners a 30 day grace period to submit their dues payments, the board cannot opt to reduce that to 10 days in its resolution.

It is also a good idea to have any resolution being considered for adoption by the board be reviewed by legal counsel to ensure there are no invalid clauses nor anything imprudent contained with them, especially if the person drafting them does not have experience doing so.  Even though I’ve written countless resolutions (maybe 75 or so over the years), I still encourage my boards to run them past their legal counsel if they want to do so.

Finally, resolutions must not only be adopted by the board but must also be provided to all owners before they go into effect.  It is not sufficient to post them on the HOA's website; all owners must be notified and receive a copy of the resolutions (electronic or physical) before the board undertakes any enforcement of them.

Resolutions are incredibly powerful and somewhat underutilized tools of the board.  If your community does not have these resolutions in place, please consider which may be appropriate for you.

* This section is based entirely on the text on pages 52-53 of the M-100:  The Essentials of Community Association Management from CAI.