The IRS has released Announcement 2012-14, which permits issuers of
student loan bonds that involved loan-swapping to request by July
31, 2012 a closing agreement involving a potentially substantial
settlement payment to the IRS in order to preserve the tax-exempt
status of such bonds.
Certain issuers of student loan bonds reallocated loans
originally funded by a particular bond issue to another bond issue
when calculating compliance with arbitrage restrictions on the
spread between the yield on bond-financed loans and the applicable
bond yield. The IRS has determined that such reallocations by an
issuer among its own portfolios did not constitute actual sales or
dispositions of the swapped loans and therefore were ineffective
for tax law purposes. The reallocations therefore will be
disregarded. If an issuer cannot satisfy its burden of proof in any
audit that the bonds involved are not taxable arbitrage bonds if
such reallocations are ignored, the applicable bonds are at risk of
being declared taxable.
Various issuers of bonds that have been audited and/or that are
at risk of taxability due to the IRS's position on
loan-swapping have filed material event notices on EMMA regarding
the applicable taxability risk. The Announcement outlines the terms
of closing agreements available to issuers of such bonds that have
not yet been audited by the IRS. It does not apply to bonds for
which an audit is already underway. Presumably such bonds may
receive harsher treatment than that available under the
The main terms of the closing agreements offered by the IRS
1. An issuer seeking to enter into a closing agreement must
request a settlement with respect to all of the outstanding
qualified student loan bond issues (1) from which it reallocated
student loans to another issue for reasons other than certain
technical requirements under IRS rules and (2) to which it
reallocated those loans. As drafted, this requirement appears to
compel an issuer to enter into closing agreements, and pay
settlements, as to all bond issues involving loan swaps, including
those the issuer believes are not at risk of being declared
taxable, in order to obtain relief on those bond issues that are at
2. Prior to the IRS's execution and delivery of the closing
agreement, the applicable issuer must pay to the IRS a settlement
amount consisting of the sum of (a) forty percent (40%) of the
taxpayer exposure on each issue of bonds subject to the closing
agreement and (b) an amount equal to the excessive arbitrage profit
on the applicable bonds from the issue date to the beginning of the
first year included in the calculation of taxpayer exposure.
Taxpayer exposure is generally calculated for a period beginning
with the year that is three or four years prior to the settlement
date and ending at maturity (or any earlier redemption date) on the
applicable bonds, and equals the present value of 29% times the
interest paid or to be paid on the bonds during that period. A 40%
payment of full taxpayer exposure may involve a sizable sum,
depending on the amount of bonds outstanding and the projected
period they will remain outstanding.
The IRS Announcement indicates that the IRS will generally
process the closing agreement request and send a closing agreement
to the issuer for its execution within 60 days after the IRS's
receipt of a completed application for the closing agreement. Upon
execution of such agreement by the issuer and the payment of the
applicable settlement amount, the IRS will execute the closing
agreement. The closing agreement preserves the tax-exemption of the
applicable bonds notwithstanding the loan-swapping practices, but
does not preclude the IRS from auditing or challenging the
tax-exemption of the applicable bonds for other reasons.
The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.
Specific Questions relating to this article should be addressed directly to the author.
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