QUESTION: Our association's budget keeps interest on the reserves in our reserves. Out of fairness, shouldn't taxes on the interest be paid with reserve funds?
ANSWER: Typically, one would match income with expenses. If taxes on the interest earned by the reserves are paid with that interest and not with reserve funds already allocated to reserve component repairs, it can be done. However, except for borrowing, it would be inconsistent with the Davis-Stirling Act to use monies already allocated to repairs to pay taxes.
Civil Code §4177(a): ["reserve accounts" means] Moneys that the association's board of directors has identified for use to defray the future repair or replacement of, or additions to, those major components that the association is obligated to maintain.
Civil Code §5510(b): The board of directors shall not expend funds designated as reserve funds for any purpose other than the repair, restoration, replacement, or maintenance of, or litigation involving the repair, restoration, replacement, or maintenance of, major components that the association is obligated to repair, restore, replace, or maintain . . .
Caution. Boards that want to pay taxes from the reserve account must be careful to ensure that their reserve funding plan clearly allocates interest to reserves net of taxes. The unallocated interest can then be (i) transferred to operations for payment of taxes or (ii) paid directly to the IRS from the reserve account.
Recommendation: The simplest way to address reserve interest is to move it into operations as income, pay taxes as may be appropriate, and either leave it in operations or allocate the balance to reserves. Boards should work closely with their CPA and reserve analyst to develop a consistent approach to reserve interest allocation and taxes.
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