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Education Dept. Expresses Concern Over Reporting Requirements for Student Loan Interest Payments

APR. 30, 1998

Education Dept. Expresses Concern Over Reporting Requirements for Student Loan Interest Payments

DATED APR. 30, 1998
DOCUMENT ATTRIBUTES
  • Authors
    Longanecker, David A.
  • Institutional Authors
    U.S. Department of Education
  • Cross-Reference
    Notice 98-7, 1998-3 IRB 54; For a summary of the notice, see Tax

    Notes, Dec. 29, 1997, p. 1452; for the full text, see Doc 97-34302

    (13 pages) or H&D, Dec. 24, 1997, p. 3803.
  • Code Sections
  • Subject Area/Tax Topics
  • Index Terms
    education, tuition, returns
    student loans, interest deduction
  • Jurisdictions
  • Language
    English
  • Tax Analysts Document Number
    Doc 98-13996 (7 pages)
  • Tax Analysts Electronic Citation
    98 TNT 93-28
====== SUMMARY ======

The U.S. Department of Education has expressed concern about the application of the reporting requirements for student loan interest payments to defaulted student loans. According to the department, reporting the interest on defaulted student loans that it and other guarantors currently hold will cost over $13 million. To avoid that administrative cost, it recommends (1) making the 60-month period for defaulted loans begin on the date of default on the loan; and (2) specifying that reportable interest on defaulted loans includes only those payments that the department or other guarantors apply to interest that accrued before either one acquired the loan.

====== FULL TEXT ======

Internal Revenue Service

 

Attn: CC:DOM:CORP:R

 

Room 5228 (IT&A:Br1)

 

P.O. Box 7604

 

Ben Franklin Station

 

Washington, D.C. 20044

Dear Mr. McGreevy:

[1] The Department of Education is submitting the attached comments on proposed regulations implementing reporting requirements for student loan interest under 6050S of the Internal Revenue Code as requested in Section B of Notice 98-7. These comments are offered solely on the reporting requirements, and the Department proposes only that these considerations govern the reporting requirement, regardless of the manner in which the taxpayer's deduction is computed.

[2] The new requirement poses particular problems with respect to defaulted student loans made under the Federal Family Education Loan Programs (FFELP). The specific areas of concern are the calculation of the covered period for interest payments and the treatment of payments to the Department on loans with defaulted or capitalized interest. Details of those concerns and the Department's recommendations are provided in the attached.

[3] We appreciate the opportunity to submit comments and would hope they will be given serious consideration when preparing the final regulations. The Department of Education will make every effort to ensure that these reporting requirements are met. If you have any questions or would like to discuss these comments, please contact Thomas J. Pestka, Director, Debt Collection Service, at (202) 708- 8462.

Sincerely,

David A. Longanecker

 

The Assistant Secretary

 

UNITED STATES DEPARTMENT OF

 

EDUCATION

 

Washington, D.C.

COMMENTS ON REGULATIONS IMPLEMENTING REPORTING REQUIREMENTS FOR

 

STUDENT LOAN INTEREST UNDER SECTION 6050S OF THE INTERNAL

 

REVENUE CODE

[4] The following comments are submitted by the Department of Education in response to the invitation for comments in IRS Notice 98-7 regarding standards for requirements for reporting interest payments on education loans. The Notice invites comments on how these regulations should address the calculation of the 60-month period in which interest payments must be reported, and how payments should be identified as payments of interest, especially where interest has been capitalized on the loan. The Department offers these comments solely on the standards for the reporting requirement as they apply to loans it holds, not on the manner in which the taxpayer's deduction for education loan interest is computed.

[5] As amended by section 201 of the Taxpayer Relief Act of 1997, Pub. L. 105-34, (the "Act"), section 6050S(a)(2) of the Internal Revenue Code (IRC or the Code) requires the holder of a qualified education loan who receives interest aggregating $600 or more for any calendar year to report that interest to the IRS and to the taxpayer. This requirement is effective, under section 202(e) of the Act, with respect to "any loan interest payment due and paid after December 31, 1997, and [to] the portion of the 60-month period" beginning when interest payments are first required to be made on the loan. IRC section 221(d), as amended by section 202 of the Act.

[6] The new requirement poses particular problems with respect to reporting concerning defaulted student loans made under the Federal Family Education Loan Programs (FFELP) under title IV, Part B of the Higher Education Act of 1965, as amended, 20 U.S.C. sections 1071 -- 1087-4. Since 1965, FFELP has helped provide students with access to and choice in postsecondary education. From its inception through fiscal year 1997, this program has provided over $235 billion in loans to postsecondary students and parents. FFELP loan volume is expected to exceed $24 billion in fiscal year 1998. Under FFELP, banks and other eligible lenders provide loan capital but assume minimal risk as the Federal Government provides the ultimate loan guarantees that cover most loan default and other write-off costs. Lenders also may receive special allowance interest subsidies that are based upon a Government Treasury-bill rate plus an amount that will provide the lender a guaranteed rate of return in order to ensure their participation in the program. Some 4,800 lenders participate in FFELP, with the 100 leading lenders providing approximately 84 percent of total FFELP dollars. The top ten lenders alone account for about 40 percent of total FFELP volume.

[7] State and private nonprofit guaranty agencies ("guarantors") act as intermediaries between FFELP lenders and this Department, which provides the Federal guaranty. There are 36 active guaranty agencies. Guarantors insure loans (which in turn are reinsured by the Federal government) and are expected to provide collection efforts on delinquent loans, as well as on defaulted ones. The guarantors may assign defaulted loans to the Department if they are unable to collect them. The Department currently holds three million defaulted FFELP loans; State and non-profit guarantors hold a similar number. This group of defaulted FFELP loans constitutes one of the largest groups of Federally-financed consumer credit debt. Because the Department took assignment of the loans it holds from various guarantors only after the loans had been in default for some time, and received payments on only some of this portfolio, we estimate that some 275,000 debtors made payments to the Department during the past year on about 385,000 loans that defaulted within the past 60 months. The portfolio of FFELP loans held by the guarantors is generally newer, and a much higher percentage of loans held by the guarantors may have been credited with payments within that same 60- month period. Reporting qualifying interest on these defaulted loans in the manner proposed in Notice 98-7 poses very significant reporting problems for defaulted loans held by the Department and the guarantors that are not likely to arise for current loans held by banks and secondary markets, and, under the Direct Loan Program, the Department itself. The Department estimates that attempting to report interest on the FFELP loans it holds as suggested in the Notice will cost over $13 million.

[8] To avoid this undue administrative cost, the Department proposes that the statutory reporting requirement be implemented in a manner that is consistent with the data currently available on these loans. Specifically, the Department proposes that the IRS regulations adopt two principles for reporting interest on these loans: first, that the 60-month period for FFELP loans held by the Department and the guarantors be deemed to commence on the date of default on the loan, and second, that reportable interest on these loans include only those payments applied by the Department or the guarantor to interest that accrues after either acquired the defaulted loan, rather than also those payments applied to capitalized interest that accrued before either acquired the loan. For the reasons explained here, we believe that these standards are consistent with current IRS rules and offer the most uniform and reliable method of measuring both factors without undertaking substantial, burdensome and very costly changes in FFELP recordkeeping and reporting requirements that cannot be accomplished in the foreseeable future.

CALCULATION OF COVERED PERIOD FOR INTEREST PAYMENTS ON FFELP LOANS IN

 

DEFAULT

[9] As interpreted in IRS Notice 98-7, the holder of a defaulted loan may compute the "covered period" of sixty months in any of three ways, including counting from the date the loan went into default, if the holder knows or has reason to know the date of default but does not know or have reason to know the date on which the loan went into repayment. Periods for which the payee knows that the loan was in a grace period, or period of deferment or forbearance should be excluded from the computation of the covered period. The Department proposes that, for defaulted loans, the regulations should direct that the covered period for reporting purposes commence on the date of default, as proposed in paragraph (b) on page 7 of the Notice, but without the conditions included in that same paragraph.

[10] The date of default is a practical and reasonable point from which to compute the covered period because, as a general rule, no additional forbearances or deferments may be granted after that date and any required grace period has by that date expired. 34 C.F.R. section 682.210(a)(8). /1/ Guarantors regularly record and transmit to the Department in computerized format the default date on loans they acquire, and this date is both available in the Department's database and, we believe, reasonably reliable as there recorded. By contrast, it would be much more difficult to determine the repayment date. Although data on the date on which the loan entered repayment status sometimes is kept in the guarantors' and the Department's computerized records, more often this data is maintained in paper form, and would require a review of several records in order to obtain an accurate calculation of the repayment date. Thus, the current recordkeeping system is not sufficient to permit the Department to compute the date on which repayment obligation commenced in a reliable manner using only its computerized records, and retrieving the source documents is an uncertain, time-consuming and costly project. For these reasons, the Department recommends that the regulations incorporate the position taken in paragraph (b), page 7 of the Notice that would allow the commencement of the period to be computed from the date of default, but without the qualifying provision that would allow the holder to do so only if the holder has no reason to know the date of repayment.

[11] Department analysis of FFELP data shows that the majority of defaulted loans entered default immediately after the initial six- month grace period or shortly thereafter. This is yet another reason why the condition in paragraph (b), page 7 of the Notice is not necessary to achieve a reasonably accurate computation of the covered period for this portfolio of defaulted loans. Although under this suggested approach the relatively small number of borrowers who defaulted later would likely be able to claim significantly larger interest deductions than properly allowed, the Notice position already recognizes that some flexibility is needed to accommodate the information limits faced by holders of defaulted loans. In sum, when viewed for the portfolio as a whole, the Department's proposal to use default date in computing the covered period for all defaulted loans should produce results that do not vary materially from those derived from an examination of actual repayment start dates. That variation does not appear to exceed the range contemplated as acceptable and realistically achievable reporting under the flexible standards already contained in the Notice.

TREATMENT OF PAYMENTS TO THE DEPARTMENT ON LOANS WITH DEFAULTED OR

 

CAPITALIZED INTEREST

[12] The second standard that the Department urges be adopted in the regulations is that the reporting requirement for defaulted FFELP loans held by guarantors or the Department should include only those payments received by either for interest that accrues after payment of the default claim on the loan guarantee. A brief description of the role and obligations of the guarantors under the FFELP may help clarify the basis of the problem posed by this requirement for the Department and those guarantors as well as the proposed resolution. /2/ Under FFELP, State and non-profit guaranty agencies guarantee repayment of principal and interest on education loans made by banks and other financial institutions; in the event of default, the agencies reimburse the lender/holder for unpaid principal and accrued interest owed on the loan, which must be accelerated prior to a claim on the guaranty. 20 U.S.C. section 1078(b)(1)(G), (c)(1)(A). The guaranty extends to outstanding principal, unpaid interest that accrues during the period of delinquency that culminates in a default (180 days) and, within limits, to interest accrued while a default claim is being submitted to and considered by the guarantor. 34 C.F.R. section sections 682.406(a)(6), (8). The lender must apply payments to costs, then to interest, and last to principal. 34 C.F.R. section 682.209(b)(1). Lenders may capitalize interest that accrues during in-school and deferment and forbearance periods. 34 C.F.R. section 682.202(b).

[13] After payment of a default claim to a lender by a guarantor, FFELP regulations require the guarantor to "capitalize" unpaid interest due the lender at the time the guarantor pays a default claim. 34 C.F.R. section 682.410(b)(4). The principal of the guarantor's claim or receivable for that loan obligation then includes any amount paid pursuant to its guaranty to the lender, whether for unpaid principal, for interest capitalIzed by the lender, or for interest that accrued but went unpaid while the loan was still held by the lender ("defaulted interest"). FFELP regulations require the guarantor to charge interest to the defaulted borrower on this new principal balance. 34 C.F.R. section 682.410(b)(3). Because neither the FFELP regulations nor the statute have required guarantors to record whether payments they receive were applied to a portion of the principal that arose from unpaid interest that accrued on the loan while held by the lender, guarantors have not developed the capability to identify readily payments applied to defaulted or lender-capitalized interest. All of the defaulted FFELP loans now held by the Department were assigned from guarantors to whom the Department had paid reinsurance. These guarantors have provided the Department only limited accounting data on those loans, and the Department therefore has no practical way to identify which portion of any payments it now receives on these debts is being applied to a portion of the debt based on defaulted or lender-capitalized interest.

[14] The guarantor is not merely an assignee of the defaulted loan. By payment of the default claim, the guarantor acquires under common law a separate legal claim against the debtor with respect to that loan obligation, which encompasses a claim for reimbursement for the fall amount spent to honor the guaranty. /3/ Payment on the amount of that reimbursement claim, regardless of the elements of the lender's claim from which it originated, is then due in full immediately from the debtor. If not paid promptly by the debtor, the guarantor's claim, like any other claim for money damages, accrues interest, and FFELP regulations require the guarantor to assess and recover from the debtor the interest that accrues on the principal of that claim. Because the guarantor holds a distinct legal right to payment with respect to that loan obligation, the interest received by the guarantor, and by the Department which accedes on assignment to the rights of the guarantor, should be computed in way that comports with that distinct legal right to payment.

[15] Plainly, for defaulted FFELP loans acquired by the Department or a guarantor, that portion of a borrower payment received by the Department or the guarantor within the 60-month qualified period and applied to interest that accrued AFTER the guarantor paid the guaranty claim and acquired the debt is reportable interest under section 6050S(a)(2). The legislative history of the Act offers no specific clarification on the treatment of payments received and applied by the guarantor or the Department to a principal balance that includes amounts paid for losses from interest that accrued BEFORE the guarantor paid the claim, whether unpaid defaulted interest or interest capitalized by the lender. However, principles established in IRS regulations and in pertinent case law strongly suggest that the those payments should not be reportable under section 6050S as interest by the guarantor or the Department. For example, section 103 of the Code includes interest received by the taxpayer in the taxpayer's income. Regulations implementing this section provide that interest payments on a loan are allocated to interest accrued and unpaid on the date of payment as determined under rules similar to those applicable to accrual of original issue discount. 26 C.F.R. section 1.446-2(c), (e)(1). The latter rules provide that "interest [that] has been defaulted or . . . accrued but . . . not paid . . . [or] in arrears at the time of purchase is not income and is not taxable as income if subsequently paid." 26 C.F.R. section 1.61-7(c). This rule recognizes that payments to a taxpayer applied to interest already included within a debt obligation when purchased by that taxpayer constitute no more than a recovery of capital, and not income to the taxpayer, unlike payments applied to interest accrued after purchase. Assuming that the Code does not intend to require two different definitions of income and therefore impose two very different reporting standards on guarantors, the reporting obligation of the guarantor under new section 6050S(a)(2) should mirror the reporting applicable to guarantors generally and others who purchase instruments on which interest has accrued and is in default.

[16] Conversely, section 163 of the Code allows some interest paid by a taxpayer to be a deductible expense. Regulations governing computation of interest referred to above, 26 C.F.R. section 1.446-2, would appear equally applicable to determining whether payments made by a taxpayer were deductible as interest payments. Case law interpreting section 163 as applied to interest deduction claims by guarantors appears to mirror the standard used to identify those interest payments that constitute income to the guarantor. Amounts owing on the obligation guaranteed, including amounts owed as accrued interest, may not be deducted as interest expenses by the taxpayer/guarantor. /4/ Interest accrued and paid by the guarantor after default by the original obligor, so long as the guarantor has then become, for all practical purposes, the primary obligor on the debt, may be deducted as an interest expense by the guarantor.5 These same principles, the Department submits, should control the reporting requirements for interest on FFELP loans held by guarantors and the Department: payments received and applied to a defaulted loan debt that includes capitalized or defaulted interest should no more be reportable under section 6050S(a)(2) than they would be recognized as income under section 103 to a taxable guarantor.

[17] The Department submits that this approach not only confirms to current requirements applicable to guarantors generally in similar contexts, but farther stresses that identification of the portion of its debt balances that include defaulted or lender- capitalized interest would be an extremely difficult and costly operation. As noted earlier, the Department's current computerized records do not show or permit reliable calculation of the amount of such interest included within the principal of the loan balances assigned to it by the various guarantors. At present, identification of that amount can be accomplished only by securing and examining guarantor records, and in many instances, lender and loan servicer records, for each individual loan. We estimate that this loan by loan research for the 385,000 loans held by the Department on which some payment has been received this past year would cost $12.4 million. /6/ In addition, because the Department's computer record systems do not now have the capacity to include this data as developed by staff research, a further expense of $1 million would be incurred to modify those computer record systems to incorporate this data so as to issue reports to the debtors and the IRS containing this new data. We estimate that this system modification would not be available until December 1999. Any change by the Department to FFELP recording and reporting requirements that would provide this data in usable computerized form, even if promulgated promptly, would not take effect until July 1, 1999. 20 U.S.C. section 1089(c). Reporting interest payments as they are currently recognized by the Department, on the other hand, would require little if any change to the Department's system. We believe that guarantors would experience comparably costly difficulties in reporting interest payments in any other manner.

CONCLUSION

[18] The obligation to report interest on education loans should be implemented in manner that neither impinges on the taxpayer's right to deduct interest payments, nor costs the taxpaying public unnecessary expenses through unworkable administrative requirements. These proposals meet both these objectives. Taxpayers now face the duty to support claims for interest payments; those who owe defaulted FFELP loans held by the Department or a guarantor and wish to claim as deductible interest payments in amounts that may differ from those reported by the Department or guarantor remain free to do so under these proposals. The Department submits that the IRS regulations should adopt these proposals because the proposals are narrowly focused to allow the reporting duty to be met in a way that is relatively inexpensive, that is feasible with currently-available records, and that comports with the way tax law treats payments received by guarantors in other contexts.

FOOTNOTES

/1/ Forbearance may be allowed after default, but only where the borrower agrees to resume payments to the lender. 34 C.F.R. section 682.211(d). Those payments, if made, would cure the default, and in that case the date of default recorded by the guarantor would be the date of subsequent default.

/2/ These comments address only the reporting responsibilities of guarantors and the Department, not those of the lenders, which differ both legally and practically. Lenders (banks and other financial institutions, including secondary markets such as the Student Loan Marketing Association) hold and service current loans either as originating lender or as assignee of the loans, and can be expected to have in operation the computerized bookkeeping systems that permit ready identification of the portion of borrower payments applied to interest, including capitalized interest.

/3/ U.S. v. Tilleraas, 709 F.2d 1088 (6th Cir. 1983), U.S. v. Frisk, 675 F.2d 1079 (9th Cir. 1982), U.S. v. Bellard, 674 F.2d 330 (5th Cir. 1982).

/4/ Rider Corp v. C.I.R., 725 F.2d 945 (3rd Cir. 1984); Golder v. C.I.R., 604 F.2d 34 (9th Cir. 1979); see Hynes v. C.I.R., 74 TC 1266 (1980).

/5/ Stratmore v. C.I.R., 785 F.2d 419 (3rd Cir. 1986).

/6/ This portfolio includes debts owed by some 275,000 debtors; the total expense cited here rests on our estimate that the cost of salaries, document production and management, and overhead expenses for researching payments will be $45.00 for each debtor.

END OF FOOTNOTES

DOCUMENT ATTRIBUTES
  • Authors
    Longanecker, David A.
  • Institutional Authors
    U.S. Department of Education
  • Cross-Reference
    Notice 98-7, 1998-3 IRB 54; For a summary of the notice, see Tax

    Notes, Dec. 29, 1997, p. 1452; for the full text, see Doc 97-34302

    (13 pages) or H&D, Dec. 24, 1997, p. 3803.
  • Code Sections
  • Subject Area/Tax Topics
  • Index Terms
    education, tuition, returns
    student loans, interest deduction
  • Jurisdictions
  • Language
    English
  • Tax Analysts Document Number
    Doc 98-13996 (7 pages)
  • Tax Analysts Electronic Citation
    98 TNT 93-28
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