1120-H 90% Confusion

Hi,

Looking for a little help on the 90% rule. Some quick numbers to set up an example:

Exempt Income: $36,000
Qualified Expenses: $16,000
Leftover that we put aside for a rainy day: $20,000

Investment income from our rainy day account for 2007: $1,600
Taxes paid to .gov in 2006: $465

When reading the instructions, it says NOT to include investments or transfers for future costs.

Does this mean that we have to spend at least 90% of our $36,000 each year on expenses?

Does this mean that we will have to pay taxes on that $20,000?

This is my first time preparing the tax return. Looking at past tax returns, previous filers have included the leftover money in a "Reserve for Replacement" account as an expense of the association.

If this is incorrect, we have MANY MANY years of tax returns to ammend!!!!!!!!!

Thanks in advance for any advide.

Thanks Roger. I guess I remain confused about the instruction for Item C (90% Test) where it says...

"...do not include investments or transfers of funds held to meet future costs. An example would be transfers to a sinking fund to replace a roof, even if the roof is association property"

What is the difference between that and our "Reserve for Replacement" line item?

We have over $80,000 in our reserve account now since we have been very conscientious of expenses.

Thanks again!

My understanding of the 90% rule(and the 60% rule)agrees with what RogerB has said. The IRS regulations may explain things a little better. Attached is a portion of them.