The Internal Revenue Service has issued guidance clarifying that state student loan programs can use tax-exempt bonds to fund parent loans for students and that tax-exempt bonds can be used for a broad range of refinancings that help student loan borrowers take advantage of lower rates.

Notice 2015-78, issued on Friday, is the first broad public guidance on student loan bonds since they were added to the federal tax code in 1986, apart from guidance on arbitrage-related issues. This guidance in the five-page notice can be applied prospectively to student loans made on or after Feb. 11, 2016 and may be applied to earlier loans.

The IRS guidance will apply to at least 16 state and nonprofit organizations that use tax-exempt bonds from states to fund student loan programs in 15 states. During fiscal 2015, which spanned from July 1 to June 30, the 16 organizations made more than 77,000 student loans totaling $964 million to more than 72,000 borrowers. Collectively their existing portfolios contain 1.12 million student loans totaling $8.5 billion for 517,000 borrowers.

Muni market participants praised the guidance.

"We could not be happier with the guidance they've provided," said Debra Chromy, president of the Education Finance Council. The EFC "is still digesting it, but at first blush it looks like they've responded to what we asked for," she said.

The EFC pressed the Treasury Department and Internal Revenue Service to provide the student loan bond guidance in letters it sent to them on Feb. 10 and April 30, respectively.

Officials from state student loan organizations and lawmakers, including Sen. Chuck Grassley, R-Iowa, sent the Treasury and IRS letters making some of the same requests.

The guidance was also sought because of a private letter ruling the IRS issued last year that was favorable but limited in concluding that an unidentified authority could issue tax-exempt bonds and use the proceeds to fund loans to refinance outstanding loans in a consolidation loan program. The PLR covered a narrow type of refinancing and caused market participants to worry the IRS would not favorably treat other kinds of refinancings. It also did not address whether tax-exempt bonds could be used to fund parent loans.

Under current law, state and nonprofit organizations can have tax-exempt bond-financed student loan programs as long as they are approved by the state and the loan size doesn't exceed the student's cost of attendance, taking into account other financial assistance. Also there must be a nexus between the students and the loans. The student must be either, a resident of the state from which the volume cap for the student loan bonds was provided, or enrolled in an educational institution located in the state.

The IRS said in its notice that parents who are borrowing for the benefit of their children, as well as students, are eligible for tax-exempt bond financed student loans. It said that a student or parent borrower of an original student loan is also eligible for tax-exempt bond funded refinancings.

The notice said a refinancing meets the student nexus requirement either at the time of the original loan or at the time of the refinancing, with the latter covering situations in which the student may have moved.

A refinancing meets the size requirements if the original loan met the loan size requirements and the stated amount of the refinancing does not exceed the sum of the refinanced loan's outstanding stated principal amount and any accrued but unpaid interest as of the date of the refinancing.

The IRS made clear that tax-exempt bonds can be used for refinancings of other types of original loans such as those that are federally-guaranteed or private, as long as they meet the same requirements as for state loans.

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