For the second time in two months, the Internal Revenue Service has disclosed it is broadening an audit of student loan securities, focusing on the position that student loans should not be reallocated to different bond issues.
The Pennsylvania Higher Education Assistance Agency said in a material-event notice filed on the Municipal Securities Rulemaking Board’s EMMA system that the IRS has formally opened an audit with respect to the agency’s outstanding tax-exempt auction-rate securities on top of an existing one of an ARS issue. The IRS has not requested additional information, the agency said.
The IRS opened its audit of the PHEAA in May 2008, focusing on $150 million of student loan revenue ARS issued in 2002. Last August, the IRS announced all of the debt would need to be included if the agency wants to settle the student loan dispute.
The PHEAA said the ARS had an original principal amount of $7.4 billion, but only $205.3 million remain outstanding.
Last year, the IRS said it was investigating the consolidation-loan rebate fees and if the loans were reallocated to different bonds. The rebate fees should not be considered as qualified expenses for rebate purposes.
All Federal Family Education Loan lenders are required to pay these fees to the Education Department whenever student loans are consolidated.
Now the PHEAA said the IRS is no longer pursuing an investigation of the loan rebate fee.
“It appears that the IRS is no longer contesting the treatment of the consolidation loan rebate fee paid by PHEAA to the Department of Education as a qualified expense,” the Pennsylvania agency said, referring to a July 21 IRS letter. The IRS’ change in position “is not likely to affect the final outcome of its examination,” it added.
However, the IRS “continues to assert that if issuers reallocate in situations not involving the sale, discharge, or other disposition of the student loans, then the reallocation should be disregarded and the yield restriction analysis should be conducted on the basis of the initial allocations,” the agency said.
Earlier this summer, the IRS took the same position involving a different student loan issuer.
In July, the Vermont Student Loan Assistance Corp. disclosed the IRS is expanding an audit that was started in 2009. The IRS told the Vermont agency that it would no longer contest the consolidation loan rebate fee, but was focusing on the loan-swapping concern.
In both cases, the bonds are auction-rate securities.
The Pennsylvania agency said the IRS has not issued a proposed adverse ruling and has not demanded a monetary sum to settle the audit. If the PHEEA’s ARS are found to be taxable, it could appeal the IRS decision or enter into a closing agreement.
The agency also said the IRS examination could “negatively affect the market price of the PHEAA’s [ARS] whatever the final outcome.”
A potential closing agreement with the IRS to keep the ARS tax-exempt “will reduce moneys available for distribution” to bondholders, the agency said.
Officials with the agency were not available to comment on Friday.
Obermayer, Rebmann, Maxwell & Hippel LLP of Philadelphia was bond counsel for the 2002 deal the IRS initially audited, according to bond documents. Cozen O’Connor was underwriter’s counsel.
There were five underwriters on the deal: UBS PaineWebber Inc., now UBS AG; Wachovia Bank NA, now part of Wells Fargo & Co.; Siebert Brandford Shank & Co.; and NatCity Investments Inc., Bear, Stearns & Co., and RRZ Public Markets, now part of JPMorgan.
