What Are Excess Operating Funds and Will They Affect Our Nonprofit Status?

What Are Excess Operating Funds and Will They Affect Our Nonprofit Status?

Question- Our Association has been fortunate over the past years and has accumulated excess operating funds. Since we are a nonprofit corporation are these excess funds taxable? Will this cause us to lose our nonprofit status? If we can have excess operating funds, what is considered to be reasonable?

Answer- First off, congratulations for being in a good financial position! It is important to have some excess operating funds in order to be able to withstand contingencies that may occur in the future.

Your association is a nonprofit corporation. However, it is different from a nonprofit charitable or educational corporation. The association was formed for the “mutual benefit” of the owners and enjoys certain tax privileges, but not the tax exemptions generally considered by other nonprofit corporations. Your excess operating funds will not affect your nonprofit status. Neither are these excess funds taxable, though they may cause the Association to pay a higher tax rate on its interest income, which is taxable. (The tax options available to homeowners associations are separate issues and are too complex to go into detail at this time).

As far as what is “reasonable”, that is a question that would depend on the specifics of your association. If you are an older condominium project or a high rise development with lots of amenities you may need more accumulated funds than a small planned unit development with minimal common areas. However, CAI does issue some standards and in my experience over the past 15 years, I have developed some guidelines that I use to advise my clients. These guidelines are as follows:

Guidelines for Excess Accumulated Operating Funds
CAI – (as stated in the M-206 Financial Management Course)

Minimum - 2 – 5 % of annual gross assessments
Very Good - 10-15% of annual gross assessments

My Firm

Minimum - 1 month’s operating expenses
Maximum - 3 month’s operating expenses

It is my opinion that any excess funds over three months of operating expenses should be justified; that is, the board should document their reasoning for the need of these excess monies. Otherwise, the excess funds possibly should be transferred to the replacement fund. This decision, however, should be made after discussing your association’s unique financial position with the board, your manager, your accountant and your reserve professional. In certain circumstances, you may want to get legal advice, also.
The association in this question has the “problem” of excess monies. For those associations which do not have at least ½ to 1 month of operating expenses in excess accumulated operating funds, this should be a goal at budget time. Without this “cushion” of excess monies, the Association may find itself in the undesirable position of having to have a special assessment, borrow from reserves and/or delay work on a project.