General Tax Due Diligence Questions
The following due diligence questions track the language of I.R.C. 144(b), which sets forth the requirements for qualified student loan bonds.
- __ Is the “applicable percentage” or more of the net proceeds used to finance “student loans”?
- Applicable percentage for purposes of the HEA Program referred to below is 90%. For the alternative program referred to below, the applicable percentage is 95%.
- A student loan is treated as made or financed only if the student is (1) a resident of the State from which the volume cap under I.R.C. 146 for such loan was derived or (2) enrolled at an educational institution located in such State.
- Are the student loans financed under either:
- __ A program of general application to which the Higher Education Act of 1965 applies (a “HEA Program”) (not currently available); or
- __ An “alternative” program, satisfying the following requirements:
- Program of general application approved by the State;
- No loan under the program may exceed the difference between the “total cost of attendance” and other forms of student assistance for which the student borrower may be eligible (see Notice 2015-78); and
- The program is not an HEA Program.
- __ The issue of which the bond is a part must not meet the private business tests of I.R.C. 141(b)(1) and (2) (determined by treating 501(c)(3) organizations as governmental units with respect to their activities that do not constitute unrelated trades or businesses, determined by applying I.R.C. 513(a)).
- __ If the issuer is a nonprofit corporation, the bonds must constitute “Qualified Scholarship Funding Bonds.” I.R.C. 150(d). Bonds are QSFBs if they are issued by a corporation that is (1) a not-for-profit corporation established and operated exclusively for the purpose of acquiring student loans incurred under HEA and (2) is organized at the request of a state or political subdivision of the state. The corporation should be required by its organizational documents or by state law to devote any income to the purchase of additional student loans or to pay over its income to the United States. The corporation must be operated exclusively for acquiring student loans. A corporation that is a servicer is not operated exclusively and is not an eligible issuer. PLR 9407016. However, a corporation is permitted to provide loan-servicing services. PLR 9126019.
Private Business Tests
I.R.C. 144(b)(1), flush language, provides that a bond will not be a qualified student loan bond if the issue of which such bond is a part meets the private business tests of paragraphs (1) and (2) of I.R.C. 141(b) (determined by treating 501(c)(3) organizations as governmental units with respect to activities that do not constitute unrelated trades or businesses, determined by applying I.R.C. 513(a)). This paragraph was added by the 1988 Act. When would this come up? It might come up where the student loan issuer loans the money to a company (a trade or business) – but that would violate other provisions of the Code. It probably arose from certain savings and loan arrangements where an issuer would loan the moneys to a savings and loan organization, which would then make loans to students. Since the moneys were deposited with the savings and loan organization, federal guarantees for the deposits provided “free” security for the bond proceeds.
Loans under the Higher Education Act of 1965
The Higher Education Act of 1965 authorized the Federal Family Education Loan Program (FFELP). FFELP was the second largest of the United States education loan programs and was funded through a public/private partnership administered at the state and local level. Following the passage of the Health Care and Education Reconciliation Act of 2010, the program was eliminated and no subsequent loans were permitted to be made under FFELP after June 30, 2010.
Proceeds of an issue that are used to finance student loans under I.R.C. 144(b)(1)(A) may be invested without regard to yield restriction for an initial temporary period equal to 6 months. Module H of IRS Training Manual. See also I.R.C. 148(c)(2)(A) (Providing that temporary period may not exceed 6 months with respect to proceeds of an issue which are to be used to make or finance loans (other than nonpurpose investments) to two or more persons.) There is a special rule for bonds issued prior to January 1, 1989. [The IRS Training Manual probably means to say that the 6-month temporary period applies to private loans under I.R.C. 144(b)(1)(B), too.] Any “proceeds” received as a result of a repayment of a loan may be invested without regard to yield restriction for a temporary period equal to 3 months. See I.R.C. 148(c)(2)(B) and Treas. Reg. 1.148-2(e)(4)(ii). Yield reduction payments are not available in connection with I.R.C. § 144(b)(1)(B) loans.
Allocation of Gross Proceeds to Loans
Treas. Reg. § 1.148-6(a)(1) states that an issuer may use any reasonable, consistently applied accounting method to account for gross proceeds, investments and expenditures of an issue. Under Treas. Reg. § 1.148-6(d)(2) (allocations for purpose investments), gross proceeds of an issue that are invested in purpose investments are allocated to an expenditure on the date on which the conduit borrower under the purpose investment allocates the gross proceeds to an expenditure – not when the issuer makes the purpose loan. However, under that same subsection, if the gross proceeds are allocated to purpose investments that are a qualified mortgage loan or a qualified student loan, the gross proceeds are allocated to an expenditure on the date on which the issuer allocates the gross proceeds to that purpose investment. In either case under Treas. Reg. § 1.148-6(d)(2) (allocations for purpose investments), those gross proceeds stay allocated to the purpose investment until the purpose investment is sold, discharged or otherwise disposed of. (The Internal Revenue Service has claimed that “other disposition” does not include the sale of a loan from one trust to another trust.)
Loan Size Limitation
See Notice 2015-78 for a discussion of determining the loan size for supplemental loans. “Estimated financial assistance” under section 428 of the Higher Education Act (https://www.law.cornell.edu/uscode/text/20/1078), referenced by Notice 2015-78, means:
- the amount of assistance such student will receive under:
- “subpart 1 of part A” of this subchapter (as determined in accordance with section 1091(b) of this title): Relates to Federal Pell Grants, academic competitiveness grants
- “subpart 3 of part A” of this subchapter: Relates to federal supplemental educational opportunity grants
- “part C of subchapter I of chapter 34 of title 42”: Relates to federal work-study programs
- “part D” of this subchapter: Federal Perkins Loans
- plus other scholarship, grant, or loan assistance, but excluding—
- any national service education award or post-service benefit under title I of the National and Community Service Act of 1990 [42 U.S.C. 12511 et seq.]; and
- any veterans’ education benefits as defined in section 1087vv(c) of this title; and
Payments made by the Secretary of Education pursuant to section 438 of the HEA of 1965 are not taken into account, for purposes of 148(a)(1) (acquiring higher yielding investments), in determining yields on student loan notes. See I.R.C. 148(g).
The purchase of student loans is probably a capital and not a working capital expenditure, according to FSA 001678 (Jan. 31, 2004).
Creation by student loan entity of a secondary market in guaranteed student loans advances the 501(c)(3) charitable purpose of lessening the burdens of government. Purchase of loans with debt does not convert the loans into an unrelated trade or business. FSA 001678 (Jan. 31, 2004).
PLR 201126020, July 1, 2011: Ruling to the effect that the issuer’s proposed actions to cease status as a qualified scholarship funding corporation under section 150(d)(2) will not cause the interest on the bonds to fail to be excludable from gross income under section 103. (HHNNAAA) See also, PLR 201528035, regarding the same issue.
PLR 201447023 (August 1, 2014): Bonds issued to refinance 144(b)(1)(B) student loans satisfy the nexus requirement and can be used to refinance capitalized and accrued interest on the original loans.
Bond Buyer article of February 9, 2016, concerning student loan audits references Alaska Student Loan Corp. and New Hampshire Health and Education Facilities Authority audits.
Other Basic Definitions
Pell Grants: A Pell Grant, unlike a student loan, does not need to be repaid. The maximum yearly grant amount is $5,500. The grant is generally only available to undergraduate students and for not more than 12 semesters. The amount of a grant award depends on financial need, the cost of attendance, status as full-time or part-time student and plans to attend school for a full year or less than a full year. NFP Program: “Not-for-profit servicer program” – A not-for-profit servicer is an “eligible” and “qualified” entity for Title IV student financial aid servicing, in accordance with Section 2212 of the Health Care and Education Reconciliation Act of 2010 (Pub.L. 111-152, 124 Stat. 1029). CFPB: Consumer Financial Protection Bureau, an instrumentality of the government with oversight responsibility for student loans. Recycling and recycling period: Recycling is the use of revenues to make new eligible loans. Recycling is typically permitted during a specified period during which revenues do not need to be used to make redemption payments on the bonds. The length of recycling periods is set, in part, by credit needs. Origination period: Period during which the issuer may use original proceeds of the bonds to finance eligible loans. The origination period may typically be extended.