WASHINGTON — The South Texas Higher Education Authority Inc. has proposed paying the Internal Revenue Service $438,243 under the voluntary closing agreement program to settle tax law issues over $255.8 million of student loan bonds it issued in 2007.

The proposed settlement was disclosed in an event notice the authority filed with the Municipal Securities Rulemaking Board’s EMMA system on Monday.

If the IRS accepts the proposed payment, it would eliminate any liability for the authority under Section 148 of the Internal Revenue Code for yield-reduction payments or rebate amounts and would ensure the bonds retain their tax-exempt status, according to the notice.

“The authority cannot guarantee that the IRS will accept the settlement amount offered … or that the authority and the IRS will be able to agree to the terms of a settlement agreement,” the notice said, adding the IRS has not responded to the offer.

Earlier this year, the IRS unveiled a VCAP program for student loan bonds after the Pennsylvania Higher Education Assistance Agency paid $12.3 million to settle tax law violations made in connection with $250 million of student loan bonds, the first public settlement in this area.

Student loan bond issuers had until July 31 of this year to apply for relief under the VCAP program, which was designed for issuers that violated tax rules by reallocating student loans to bonds other than the ones used to finance them.

Several tax experts, who did not want to be identified, said approximately 10 student loan issuers proposed settlements under the VCAP program before the deadline.

In the initial March program announcement, the IRS said it would process the VCAP requests within 60 days. However, sources said this has been updated and the Service is likely to resolve the requests by the end of 2012.

One tax lawyer was surprised at how small the proposed settlement amount was from the authority, compared to the settlement PHEAA paid last year.

“It’s puzzling how they got such a small amount,” the lawyer said. “You would expect it to be in the millions. If it’s a small problem and not in the millions, why are they bothering with it at all?”

Under the VCAP program, issuers agree to pay a settlement amount equal to 40% of the taxpayers exposure on each issue of bonds based on the issuer’s existing records and according to a formula. They also agree at the date of the closing agreement to discontinue the practice of reallocating student loans from one bond issue to another.

Some bond lawyers had expressed concern that the formula for the VCAP may be too cost prohibitive and could ultimately cripple student loan issuers.

A bond lawyer said that one of the main reasons an issuer does not file under the VCAP is because the settlement will likely be in the millions and an issuer will take their chances with an audit.

If the IRS rejects the settlement proposal, it can withdraw the VCAP request and audit the issuer.

The authority issued the Series 2007 bonds to provide funds to purchase student loans guaranteed under the Higher Education Act, refund five series of bonds outstanding under another indenture and make a deposit into a reserve fund, according to bond documents.

RBC Capital Markets was underwriter. Fulbright & Jaworski LLP was bond counsel. The attorney general of Texas also provided a legal opinion.

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