WASHINGTON - Bonds issued to finance student loans will not become taxable if their issuer takes action to cease being a qualified scholarship funding corporation, the Internal Revenue Service said.
The IRS reached this conclusion in a private-letter ruling that was dated April 7 but was not made public until Friday. The ruling, which did not name the issuer, was signed by James Polfer, chief of the tax-exempt bond branch of the IRS chief counsel's office.
Bond lawyers said the IRS' conclusion was correct.
"I think the IRS reached the right result," said Tom Vander Molen, a partner at Dorsey & Whitney in Minneapolis.
The issuer in the ruling is a 501(c)(3) organization that is also a qualified scholarship funding corporation under section 150(d)(2) of the Internal Revenue Code. This type of corporation is a nonprofit that is operated exclusively to acquire student loan notes incurred under the Higher Education Act of 1965.
The organization issued bonds and was the obligor of the securities for the entire time they were outstanding. The bonds were fully redeemed using cash from student-loan payments and sales, and the issuer no longer has any outstanding tax-exempt bonds, according to the ruling.
The organization is proposing to expand its charitable purposes to include offering scholarships and grants to students. The expansion would mean the organization could no longer be a qualified scholarship funding organization. The organization does not plan to issue any more tax-exempt bonds in the future. It asked the IRS to rule that its proposed actions would not cause interest on the bonds to become taxable.
Under federal tax law, qualified scholarship funding bonds are treated as tax-exempt state and local bonds. A qualified scholarship funding bond is a bond issued by a qualified scholarship funding corporation.
The IRS said that the organization's bonds will not become taxable because the issuer was a qualified scholarship funding corporation for the entire time while the bonds were outstanding.
"Based on the information submitted and representations made, we conclude that issuer's proposed actions will not cause the interest on the bonds to fail to be excludable from gross income," the IRS said.
If an issuer ceases to be a qualified scholarship funding organization and has bonds outstanding, the bonds can remain tax-exempt if the issuer meets certain requirements. The IRS said these requirements don't apply in this circumstance because the organization seeking the ruling has redeemed all of its bonds.
Bond lawyers said the IRS' conclusion was sound. They noted that the ruling is very similar to a PLR issued in 2011.
Qualified scholarship funding corporations are looking for new activities because all new federally insured student loans now have to be originated by the federal government, Vander Molen said. The corporations had issued new-money bonds to finance student loans under the Federal Family Education Loan Program, which was created by the Higher Education Act of 1965, but no new loans can be made under this program as a result of a 2010 law.
Ed Oswald, a partner at Orrick, Herrington and Sutcliffe in Washington, said that the issuer in the recent PLR might have requested the ruling because the bonds were paid off recently enough that the IRS could still ask bondholders to pay taxes on interest on the bonds if they were found to be taxable in an audit.
Also, perhaps the issuer wanted the IRS to bless its proposed actions "out of caution" in light of the fact that the Service created a special voluntary closing agreement program for issuers of student loan bonds, Oswald said.
