WASHINGTON - The Internal Revenue Service has ruled that loans that will be made with bond proceeds and used to refinance outstanding student loans will qualify as student loans that can be financed with tax-exempt bonds.
The IRS came to this conclusion in a private-letter ruling that is dated Aug. 1 but was not released until Friday. The ruling did not identify the issuer by name and was signed by Johanna Som de Cerff, senior technician reviewer in the IRS chief counsel's office.
The issuer is an authority that provides financial assistance to help qualified students obtain higher educations. The authority plans to issue bonds and use the proceeds in a "consolidation loan program," which will refinance one or more of a borrower's outstanding student loans into a single loan, according to the ruling
"The primary purpose of the consolidated loan program is to reduce the interest rate on the student loan notes of the authority's current borrowers as the authority refinances its outstanding bonds at lower interest rates," the IRS said.
The loans being refinanced were originally financed with tax-exempt bond proceeds. The original loans were also made to students under a state-approved program of general application, and they met the size limitation described in federal tax law. The state allocated volume cap for the original bonds, and at the time that the original loans were made, the students were either state residents or attending colleges in the state. However, the students may no longer live in the state.
Under federal tax law, qualified student-loan bonds are private-activity bonds that can be tax-exempt. Bonds can be qualified student loan bonds if the proceeds of the issue are used directly or indirectly to make or finance student loans under a state-approved program of general application. The loans have to meet certain criteria, one of which is called the "nexus test." Under this test, the loans have to be made to residents of the state whose volume cap was allocated to the bonds, or to those attending educational institutions in the state.
The authority requested a ruling from the IRS that the refinancing loans that will be made with the proceeds from proposed new bonds will meet the criteria for loans that can be financed by qualified student loan bonds.
Because the new bonds would be refunding previous bonds, the proceeds of the refunding bonds and the proceeds of the prior bonds will be considered to be used for the same purpose. Therefore, since the original loans met the nexus test, the refinancing loans will also meet the test, the IRS said.
Bond lawyers found the IRS' ruling as it pertains to the nexus test to be useful.
"The ruling helpfully held, in effect, that the residency test is applied as of the date of the original loans, not the date of the new consolidation loans or the new refunding bonds," said Tom Vander Molen, a partner at Dorsey & Whitney LLP in Minneapolis.
The authority represented that refinancing loans could be used to refinance accrued or capitalized interest in addition to the original loans' principal. The IRS said that the loans can be used to refinance interest without the interest being treated as a new loan that has to meet another nexus test. Vander Molen said that this finding makes sense because refunding bonds can normally pay off accrued interest in addition to the principal of the refunded bonds.
Dave Caprera, an attorney at Kutak Rock LLP in Denver, agreed that the nexus part of the ruling is helpful and that it is useful that the IRS is allowing interest on the original loan to be refinanced.
Additionally, "it is unclear from the ruling if the IRS required the issuer to trace the refunding bond proceeds specifically to the bonds to which the original loans being consolidated had been allocate," Caprera said. "This is significant because IRS enforcement has found it problematic when issuers don't trace which bond issue specifically finances a loan."
