Rev. Rul. 75-537

Advice has been requested concerning the Federal income tax treatment of student loan interest payments made by the Department of Health, Education, and Welfare under the circumstances described below.

A student obtained a student loan under the terms and conditions of the Higher Education Act of 1965, 20 U.S.C. sections 1001-1144 (1966), as amended by Public Law 93-269, section 2, 93rd Cong., 2d Sess. The Act requires that interest be paid by the Commissioner of Education to makers of loans to qualified students. The lender has a contractual right to receive from the Commissioner of Education the total amount of the interest on the unpaid principal amount of the loan which accrues prior to the beginning of the repayment period of the loan.

The purpose of the interest subsidy program is to assure the greater availability of educational loans from private sources. It applies to loans that meet the Act's standards concerning prepayment and payment of principal and interest. To qualify the loan, the lender must agree not to try to collect from the borrower the amount of interest payable as a subsidy. Once the conditions of the loan meet the standards of the Act, the contractual right to payment of the interest to the lender is established.

Section 61 of the Internal Revenue Code of 1954 provides, in part, that gross income means all income from whatever source derived, except as otherwise provided.

Section 117 of the Code provides, subject to certain qualifications and limitations, that gross income of an individual does not include any amount received as a scholarship at an educational institution.

Section 1.117-3 of the Income Tax Regulations defines scholarship to mean an amount paid or allowed to, or for the benefit of, a student, whether an undergraduate or graduate, to aid such individual in pursuing studies. The term includes the value of contributed services and accommodations, and the amount of tuition, matriculation, and other fees that are furnished to or remitted to a student to aid in pursuing studies. The term also includes any amount received in the nature of a family allowance as part of a scholarship.

The terms of the Act and the legislative history of the Act indicate that the interest subsidy payments are amounts paid for the benefit of the student to aid such individual in pursuing studies.

Accordingly, interest subsidy payments made by the Commissioner of Education to a lender, for that portion of interest that the lender agrees not to collect from the borrower, under the Higher Education Act of 1965, sections 1001-1144, as amended, are scholarships within the meaning of section 117(a) of the Code and excludable from the borrower's gross income. Such amounts may not be deducted under section 163 by the borrower since the borrower does not have an obligation to pay the interest. Furthermore, such amounts are not reportable on Form 1099, U.S. Information Return.