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March 21‚ 2012
IRS Announces Closing Agreement Program for
Tax-Exempt Student Loan Bonds Subject to Taxability Determination Due to
Loan-Swapping
By Len Weiser-Varon,
Jeremy Spector and Maxwell Solet
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
Announcement.
The main terms of the closing agreements offered by the IRS
are:
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 risk.
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.
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