Can a board transfer surplus out of the operating account?

Q. Our homeowners association had an operating surplus at the end of the year in 2012. The declaration provides that any excess over actual operating expenses at the end of a year is to be credited to the assessment installments due in the next year. The board transferred the operating surplus into our capital reserve account just before the end of 2012, thereby eliminating the operating surplus. Is this permitted?

A. It is permitted, if properly done. It may not have been properly done here, though. The IRS has taken an interest in associations in Northern Illinois. The IRS has started auditing associations and taking a look at how operating account surpluses are handled. Under certain circumstances, the IRS could find that the surplus operating funds are taxable income. Operating surpluses that are properly transferred to the association’s capital reserve account are not taxed. This is true, as long as the reserve fund is not over-funded. However, the board must be authorized to transfer the surplus to the capital reserve account via the adoption of a resolution described in IRS Revenue Ruling 70-604. This resolution is adopted by the members of the association at a members’ meeting. It is not adopted by the board.

If the board does not follow the proper procedure to transfer the operating surplus, it may have to credit the surplus to the following year’s assessments as described in the declaration. The surplus may also be taxable income to the association; however, this may depend on what income tax return form the association uses.

I would suggest that the board speak with an accountant familiar with condominium and community associations.

Q. A board member in the condominium association was elected for a two-year term. The board member resigned from the board about six months into the first year of the two-year term. What is the procedure to fill the vacancy?

A. The association’s bylaws are required to describe the method of filling vacancies on the board. The bylaws must include authority for the remaining members of the board to fill the vacancy by two-thirds vote. However, the vacancy filled by the board is filled until the next annual meeting of unit owners, and not for the entire remaining unexpired portion of the term of the board member who resigned.

Let me apply this to your association. The board could fill the vacancy until the next annual meeting. At the next annual meeting, the owners would vote for a member of the association to fill the still remaining one year period left on the term of the board member who resigned.

Even if the board votes to fill the vacancy, there is a process for the owners to submit a petition to the board requesting a meeting of the owners. The purpose of the meeting would be to fill the vacancy for the entire unexpired portion of the term of the board member who resigned. This petition would have to be signed by 20 percent of the owners. If such a petition is received, the board would have to call what is essentially a special election to fill the vacancy.

Q. I am a member of the board of our incorporated common interest community association. I travel frequently for my business, and I cannot attend all of the board meetings. Can I give my proxy to another board member to vote on my behalf?

A. Because each board member has a fiduciary duty that cannot be delegated, no director can act by proxy on any matter. A board member who cannot be physically present at a board meeting can participate in, and act at, any meeting of the board through the use of a conference telephone, or other communications equipment. However, all persons participating in the meeting must be able to communicate with one another. This is best accomplished by a speaker phone.

Q. I am new to the board of a homeowners association. I am completing the annual report to be filed with the Illinois secretary of state. The form refers to a registered agent. What is a registered agent?

A. Each corporation must maintain a registered agent and a registered office in the state of Illinois. The registered agent typically receives service of process on behalf of the association in lawsuits to which the association is made a party. The registered agent would also receive the annual report form from the secretary of state. I suggest that the association’s attorney serve as registered agent, given the legal nature and significance of the documents issued to the registered agent.

Ÿ David M. Bendoff is an attorney with Kovitz Shifrin Nesbit in Buffalo Grove. Send questions for the column to him at CondoTalk@ksnlaw.com. The firm provides legal service to condominium, townhouse, homeowner associations and housing cooperatives. This column is not a substitute for consultation with legal counsel.