Deduction for Interest on Qualified Education Loans

DEPARTMENT OF THE TREASURY
Internal Revenue Service 26 CFR Part 1 [REG-116826-97] RIN 1545-AW01

TITLE: Deduction for Interest on Qualified Education Loans

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Notice of proposed rulemaking and requests to
videoconference the public hearing.

SUMMARY: This document contains proposed regulations relating to the
deduction for interest paid on qualified education loans.

The proposed regulations reflect changes to the law made by the
Taxpayer Relief Act of 1997, the Internal Revenue Service
Restructuring and Reform Act of 1998, and the Omnibus Consolidated
and Emergency Supplemental Appropriations Act, 1999.

The proposed regulations affect taxpayers who pay interest on
qualified education loans. This document also provides notice that a
public hearing will be held on the proposed regulations and that
persons outside the Washington, DC, area who wish to testify at the
hearing may request that the IRS videoconference the hearing to
their sites.

DATES: Written or electronically generated comments must be received
by April 21, 1999. Requests to videoconference the hearing to other
sites must be received by March 22, 1999.

ADDRESSES: Send submissions to CC:DOM:CORP:R (REG-116826-97), room
5226, Internal Revenue Service, POB 7604, Ben Franklin Station,
Washington, DC 20044. Submissions may be hand delivered Monday
through Friday between the hours of 8 a.m. and 5 p.m. to:
CC:DOM:CORP:R (REG-116826-97), Courier's Desk, Internal Revenue
Service, 1111 Constitution Avenue, NW., Washington, DC.
Alternatively, taxpayers may submit comments electronically via the
Internet by selecting the A Tax Regs @ option on the IRS Home Page,
or by submitting comments directly to the IRS Internet site at
http://www.irs.ustreas.gov/prod/tax_regs/comments. html. The IRS
will publish the time and date of the public hearing and the
locations of any videoconferencing sites in an announcement in the
Federal Register.

FOR FURTHER INFORMATION CONTACT: Concerning the regulations, contact
John P. Moriarty, (202) 622-4950 (not a toll-free number);
concerning submissions of comments, the hearing, and/or to be placed
on the building access list to attend the hearing, contact Michael
L. Slaughter (202) 622-7190 (not toll-free numbers).

SUPPLEMENTARY INFORMATION

Background

This document contains proposed amendments to the Income Tax
Regulations (26 CFR part 1). Section 202 of the Taxpayer Relief Act
of 1997 (Public Law 105-34 (111 Stat. 778)(TRA 97)) added section
221 of the Internal Revenue Code to allow a deduction from gross
income for certain interest paid on qualified education loans. On
November 17, 1997, the IRS published Notice 97-60 (1997-46 I.R.B. 8)
to provide guidance on the higher education tax incentives enacted
by TRA 97, including the deduction for interest paid on qualified
education loans.

Section 6004(b) of the Internal Revenue Service Restructuring and
Reform Act of 1998 (Public Law 105-206 (112 Stat. 685)) (RRA 98) and
section 4003(a) of the Omnibus Consolidated and Emergency
Supplemental Appropriations Act, 1999 (Public Law 105-277 (112 Stat.
2681)) (Omnibus Act 99) made technical amendments to section 221.
TRA 97 also added section 6050S to the Internal Revenue Code, which
requires the filing of information returns by certain persons who
receive payments of interest that may be deductible as interest on a
qualified education loan. In 1998, the IRS published two notices
describing the information returns that are required under section
6050S for 1998 and 1999. On January 20, 1998, the IRS published
Notice 98-7 (1998-3 I.R.B.

54), which describes the information reporting required under
section 6050S for 1998. On November 16, 1998, the IRS published
Notice 98-54 (1998-46 I.R.B. 25), which modified Notice 98-7 to
reflect a technical amendment made by RRA 98 and extended the
application of Notice 98-7, as so modified, to information reporting
required under section 6050S for 1999.

Explanation of Provisions

Section 221 allows taxpayers who are legally obligated to pay
interest on qualified education loans a federal income tax deduction
for their interest payments. The deduction is an adjustment to gross
income and, therefore, is available to eligible taxpayers regardless
of whether they itemize deductions.

The deduction is limited to $2,500 for taxable years beginning after
2000. For taxable years 1998, 1999 and 2000, the limits are $1,000,
$1,500 and $2,000, respectively. Consistent with the income
limitations in section 221(b)(2), the proposed regulations provide
that the deduction is phased-out for taxpayers with modified
adjusted gross income between $40,000 and $55,000 ($60,000 and
$75,000 for taxpayers filing a joint return) for the taxable year.
For taxable years beginning after 2002, these amounts will be
adjusted for inflation.

No deduction under section 221 is allowed in a taxable year to an
individual who is properly claimed as a dependent on another
taxpayer's federal income tax return for the taxable year. In
addition, a taxpayer who is married as of the end of a taxable year
is allowed a deduction under section 221 only if the taxpayer and
the taxpayer's spouse file a joint return for the taxable year.

Consistent with section 221(e)(1), the proposed regulations define a
qualified education loan to mean any indebtedness incurred by the
taxpayer solely to pay qualified higher education expenses on behalf
of a student enrolled at least half-time in a program leading to a
degree, certificate, or other recognized educational credential. The
student must be the taxpayer, the taxpayer's spouse, or the
taxpayer's dependent at the time the indebtedness is incurred. In
addition, the qualified higher education expenses must be incurred
within a reasonable period of time before or after the indebtedness
is incurred. The requirement that the indebtedness be incurred
solely to pay qualified higher education expenses was added by RRA
'98.

Accordingly, mixed use loans are not qualified education loans.

Similarly, revolving lines of credit (e.g., credit card debt)
generally are not qualified education loans, unless the borrower
uses the line of credit solely to pay qualified higher education
expenses.

Consistent with section 221(e)(1), the proposed regulations provide
that a loan made by an individual who is related to the borrower,
within the meaning of section 267(b) or 707(b)(1), is not a
qualified education loan. For example, a loan from a parent or
grandparent of the borrower is not a qualified education loan. In
addition, consistent with a technical amendment to section 221(e)
contained in the Omnibus Act < 99, the proposed regulations provide
that loans made under any qualified employer plan (within the
meaning of section 72(p)(4)) or made pursuant to any contract
referred to in section 72(p)(5) are not qualified education loans.
The proposed regulations also provide that loans that are not issued
or guaranteed as part of a federal postsecondary education loan
program nonetheless may be qualified education loans.

The proposed regulations provide that whether or not qualified
higher education expenses are paid within a reasonable period of
time before or after the indebtedness is incurred depends on all the
facts and circumstances. However, the proposed regulations provide
two safe harbors. The first safe harbor treats any education loan
that is issued as part of a federal postsecondary education loan
program as meeting the reasonable period requirement. The second
safe harbor treats qualified higher education expenses as paid or
incurred within a reasonable period of time before or after the
indebtedness is incurred if the expenses relate to a particular
academic period and the proceeds of the loan are disbursed within a
period that begins 60 days prior to the start of that academic
period and ends 60 days after the end of that academic period. The
proposed regulations do not require actual tracing of loan proceeds
to the payment of qualified higher education expenses.

The proposed regulations define an eligible educational institution
by reference to section 25A to mean any college, university,
vocational school, or other postsecondary educational institution
that is described in section 481 of the Higher Education Act of 1965
(20 U.S.C. 1088) as in effect on August 5, 1997, and certified by
the U.S. Department of Education to be eligible to participate in a
student aid program administered by that department. This category
includes generally all accredited public, nonprofit, and proprietary
postsecondary institutions.

Consistent with section 221(e)(2), the proposed regulations provide
that, for purposes of the qualified education loan interest
deduction, eligible educational institutions also include
institutions that conduct an internship or residency program leading
to a degree or certificate awarded by an institution of higher
education, a hospital, or a health care facility that offers
postgraduate training.

Qualified higher education expenses are generally the same as the
cost of attendance as determined by the eligible educational
institution for purposes of calculating a student's financial need,
in accordance with section 472 of the Higher Education Act of 1965,
20 U.S.C. 1087ll, as in effect on August 4, 1997. Such expenses
generally include tuition, fees, room, board, books, equipment, and
other necessary expenses, such as transportation. However, for
purposes of calculating qualified higher education expenses, the
amount of such expenses must be reduced by educational assistance
that the student receives and excludes from gross income under
section 117 (qualified scholarships), section 127 (employer-provided
educational assistance), section 135 (redemption of U.S. savings
bonds), and section 530 (distributions from education IRAs). In
addition, such expenses must be reduced by a veterans' or member of
the armed forces' educational assistance allowance under chapter 30,
31, 32, 34 or 35 of title 38 United States Code, or under chapter
1606 of title 10, United States Code, and any other educational
assistance that is excludable from the student's gross income (other
than as a gift, bequest, devise or inheritance within the meaning of
section 102(a)).

The qualified education loan interest deduction generally is
available only for interest payments made during the first 60 months
in which interest payments are required on the qualified education
loan. The proposed regulations provide that the 60- month period
commences with the month in which a loan first enters mandatory
repayment status and continues to elapse regardless of whether
payments are actually made, unless the repayment period is suspended
for a period of deferment or forbearance. The 60-month period may
expire at different times for different loans of the same borrower.

The date on which a qualified education loan enters repayment status
is determined by reference to the loan agreement or the federal
regulations governing the applicable federal postsecondary education
loan program.

The proposed regulations provide that a deduction is allowed for a
payment of interest that was required to be made in one month but
that actually is made in a subsequent month prior to the expiration
of the 60-month period. A deduction is not allowed for a payment of
interest that was required to be made in one month but that actually
is made in a subsequent month after the expiration of the 60-month
period.

The proposed regulations provide that a qualified education loan and
all refinancings of that loan are treated as a single loan for
purposes of calculating the 60-month period.

Consistent with section 221(d), as amended by RRA < 98, the proposed
regulations provide special rules for calculating the 60-month
period for consolidated loans or collapsed loans. These rules
generally mirror the guidance contained in Notice 98-7 and provide
that the 60-month period begins on the most recent date on which any
of the underlying loans entered repayment status.

See Conf. Rep. No. 599, 105th Cong., 2d Sess., at 339 (1998).

If a qualified education loan entered repayment status prior to
January 1, 1998 (the effective date of section 221), the taxpayer is
not entitled to deduct any interest paid during that portion of the
60-month period occurring prior to January 1, 1998. A deduction is
allowed only for interest due and paid during that portion, if any,
of the 60-month period remaining after December 31, 1997.

General tax principles apply in determining what is deductible
interest for purposes of section 221. However, to assist taxpayers,
the proposed regulations specifically provide that loan origination
fees and capitalized interest are interest and are deductible under
section 221 as the stated principal amount of the qualified
education loan is repaid.

Proposed Effective Date

These regulations are proposed to be effective for interest paid
after the date they are published in the Federal Register as final
regulations. Taxpayers may rely on these proposed regulations for
guidance pending the issuance of final regulations. If, and to the
extent, future guidance is more restrictive than the guidance in
these proposed regulations, the future guidance will be applied
without retroactive effect.

Special Analyses

It has been determined that this notice of proposed.10 rulemaking is
not a significant regulatory action as defined in EO 12866.
Therefore, a regulatory assessment is not required.

It also has been determined that section 553(b) of the
Administrative Procedure Act (5 U.S.C. chapter 5) does not apply to
these regulations, and, because the regulations do not impose a
collection of information on small entities, the Regulatory
Flexibility Act (5 U.S.C. chapter 6) does not apply. Pursuant to
section 7805(f) of the Internal Revenue Code, this notice of
proposed rulemaking will be submitted to the Chief Counsel for
Advocacy of the Small Business Administration for comment on its
impact on small business.

Comments and Requests for a Public Hearing Before these proposed
regulations are adopted as final regulations, consideration will be
given to any comments that are submitted timely to the IRS. The IRS
and Treasury Department request comments on the clarity of the
proposed rules and on how they can be made easier to understand. All
comments will be available for public inspection and copying.

A public hearing will be scheduled in the Internal Revenue Building,
1111 Constitution Avenue, NW., Washington, DC. The IRS recognizes
that persons outside the Washington, DC, area may also wish to
testify at the public hearing through videoconferencing.

Requests to include videoconferencing sites must be received by
March 22, 1999. If the IRS receives sufficient indications of
interest to warrant videoconferencing to a particular city, and if
the IRS has videoconferencing facilities available in that city on
the date the public hearing is to be scheduled, the IRS will try to
accommodate the requests.

The IRS will publish the time and date of the public hearing and the
locations of any videoconferencing sites in an announcement in the
Federal Register.

Drafting Information

The principal author of these regulations is John P. Moriarty of the
Office of the Assistant Chief Counsel (Income Tax and Accounting).
However, other personnel from the IRS and Treasury Department
participated in their development.

List of Subjects in 26 CFR Part 1

Income taxes, Reporting and recordkeeping requirements.

Proposed Amendments to the Regulations Accordingly, 26 CFR part 1 is
proposed to be amended as follows:

PART 1--INCOME TAXES

Paragraph 1. The authority citation for part 1 is amended by adding
an entry in numerical order to read as follows:

Authority: 26 U.S.C. 7805 * * *

Section 1.221-1 also issued under 26 U.S.C. 221(d). * * *

Par. 2. Section 1.221-1 is added under the undesignated
centerheading A Additional Itemized Deductions For Individuals @ to
read as follows:

�1.221-1 Deduction for interest on qualified education loans.

(a) In general. An individual taxpayer is allowed a deduction under
section 221 from gross income for certain interest paid during the
taxable year on a qualified education loan. The deduction is allowed
only with respect to interest paid on a qualified education loan
during the first 60 months that interest payments are required under
the terms of the loan. See paragraph (e) of this section for rules
relating to the 60-month rule.

(b) Eligibility--(1) Taxpayer must be legally obligated to make
interest payments. A taxpayer is allowed a deduction under section
221 only if the taxpayer is legally obligated to make interest
payments under the terms of the qualified education loan.

(2) Claimed dependents not eligible--(i) In general. An individual
is not allowed a deduction under section 221 for a taxable year if
the individual is a dependent (as defined in section 152) for whom a
deduction under section 151 is claimed on another taxpayer's federal
income tax return for the same taxable year (or, in the case of a
fiscal year taxpayer, the taxable year beginning in the same
calendar year as the individual's taxable year).

(ii) Examples. The following examples illustrate the rules of this
paragraph (b):

Example 1. Student not claimed as dependent. Student A pays $750 of
interest on qualified education loans during 1998.

Student A's parents do not claim her as a dependent for 1998.

Assuming all other relevant requirements are met, Student A may
deduct the $750 of interest paid in 1998 under section 221.

Example 2. Student claimed as dependent. Student B pays $750 of
interest on qualified education loans during 1998. Only Student B is
legally obligated to make the payments. Student B's parent claims
him as a dependent and a deduction under section 151 is allowed with
respect to Student B in computing the parent's 1998 federal income
tax. Neither Student B nor Student B's parent may deduct the $750 of
interest paid in 1998 under section 221.

(3) Married taxpayers. If a taxpayer is married as of the close of
the taxable year, a deduction under this section is allowed only if
the taxpayer and the taxpayer's spouse file a joint return for that
taxable year.

(c) Maximum deduction. In any taxable year, the amount allowed as a
deduction under section 221 may not exceed the amount determined in
accordance with the following table:

Taxable year beginning in: Maximum Deduction
                     1998  $1,000
                     1999  $1,500
                     2000  $2,000
                     2001 
           and thereafter  $2,500

(d) Limitation based on modified adjusted gross income--(1) In
general. The deduction allowed under section 221 is phased out
ratably for taxpayers with modified adjusted gross income between
$40,000 and $55,000 ($60,000 and $75,000 for married individuals who
file a joint return). Taxpayers with modified adjusted gross income
of $55,000 or above (or $75,000 or above for joint filers) are not
allowed a deduction under section 221.

(2) Modified adjusted gross income defined. The term modified
adjusted gross income means the adjusted gross income (as defined in
section 62) of the taxpayer for the taxable year increased by any
amount excluded from gross income under section 911, 931, or 933
(relating to income earned abroad or from certain U.S. possessions
or Puerto Rico). Adjusted gross income must be determined under this
section after taking into account the exclusions, deductions and
limitations provided for by sections 86 (social security and tier 1
railroad retirement benefits), 135 (redemption of qualified U.S.
savings bonds), 137 (adoption assistance programs), 219 (deductible
IRA contributions) and 469 (limitation on passive activity losses
and credits).

(3) Inflation adjustment. For taxable years beginning after 2002,
the amounts in paragraph (d)(1) of this section will be increased
for inflation occurring after 2001 in accordance with section 1(f)
(3). If any amount adjusted under this paragraph (d)(3) is not a
multiple of $5,000, the amount will be rounded to the next lowest
multiple of $5,000.

(e) 60-month rule--(1) General rule. A deduction for interest paid
on a qualified education loan is allowed only for payments made
during the first 60 months that interest payments are required on
the loan. The 60-month period begins on the date the qualified
education loan first enters repayment status and ends 60 months
later, unless the period is suspended for periods of deferment or
forbearance within the meaning of paragraph (e)(3) of this section.
The 60-month period continues to elapse regardless of whether the
required interest payments are actually made. The date on which the
qualified education loan first enters repayment status is determined
under the terms of the loan agreement or, in the case of a loan
issued or guaranteed under a federal postsecondary education loan
program, under applicable federal regulations. For special rules
relating to loan refinancings, consolidated loans, and collapsed
loans, see paragraph (h)(1) of this section.

(2) Loans that entered repayment status prior to January 1, 1998. In
the case of any qualified education loan that entered repayment
status prior to January 1, 1998, no deduction is allowed under
section 221 for interest paid during the portion of the 60-month
period described in paragraph (e)(1) of this section that occurred
prior to January 1, 1998. A deduction is allowed only for interest
due and paid during that portion, if any, of the 60-month period
remaining after December 31, 1997.

(3) Periods of deferment or forbearance. The 60-month period
described in paragraph (e)(1) of this section is suspended for any
period when interest payments are not required on a qualified
education loan because the borrower has been granted deferment or
forbearance (including postponement in anticipation of
cancellation). However, in the case of a qualified education loan
that is not issued or guaranteed under a federal postsecondary
education loan program, the 60-month period will be suspended under
this paragraph (e)(3) only if the borrower satisfies one of the
conditions for deferment or forbearance established by the U.S.
Department of Education for federal student loan programs under
Title IV of the Higher Education Act of 1965, such as half-time
study at a postsecondary educational institution, study in an
approved graduate fellowship program or in an approved
rehabilitation program for the disabled, inability to find full-time
employment, economic hardship, or the performance of services in
certain occupations or federal programs. The 60-month period is not
suspended if, under the terms of the loan--

(i) Interest continues to accrue while the loan is in deferment or
forbearance; and

(ii) The taxpayer has the option of paying the interest currently or
requesting that the interest be capitalized, and the taxpayer elects
to make current interest payments.

(4) Late payments. A deduction is allowed for a payment of interest
that was required to be made in one month but that actually is made
in a subsequent month prior to the expiration of the 60-month
period. A deduction is not allowed for a payment of interest that
was required to be made in one month but that actually is made in a
subsequent month after the expiration of the 60-month period.

(5) Examples. The following examples illustrate the rules of this
paragraph (e). In the examples, assume that the institution is an
eligible educational institution, the loan is a qualified education
loan, and the student is legally obligated to make interest payments
under the terms of the loan:

Example 1. Payment prior to 60-month period. Student C obtains a
loan to attend College V. The terms of the loan provide that
interest accrues on the loan while C earns his undergraduate degree
but that C is not required to begin making payments of interest
until six full calendar months after he graduates. Nevertheless, C
voluntarily pays interest on the loan while attending College V. C
is not allowed a deduction for interest paid while attending College
V because the payments were made during a month prior to the start
of the 60-month period.

Example 2. Deferment option not exercised. The facts are the same as
Example 1, except that Student C makes no payments on the loan while
C is enrolled at College V. C graduates in June, 1999 and is
required to begin making monthly payments of principal and interest
on the loan in January, 2000. The 60- month period described in
paragraph (e)(1) of this section begins in January, 2000. In August,
2000, C enrolls in graduate school on a full-time basis. Under the
terms of the loan, C may apply for deferment of the loan payments
while C is enrolled in graduate school. However, C elects not to
apply for deferment and continues to make monthly payments on the
loan during graduate school. Assuming all other relevant
requirements are met, C may deduct interest paid on the loan during
the 60-month period beginning in January, 2000, including interest
paid while C was enrolled in graduate school, but elected not to
defer payment.

Example 3. Late payment, within 60-month period. The facts are the
same as Example 2, except that, after the loan enters repayment
status in January, 2000, Student C makes no interest payments until
March, 2000. In March, 2000, C pays interest required to be paid for
the months of January, February, and March, 2000. Assuming all other
relevant requirements are met, C is allowed a deduction for the
interest paid in March for the months of January, February, and
March because the interest payments were required under the terms of
the loan and were paid within the 60-month period, even though the
January and February interest payments may be late.

Example 4. Late payment during deferment but within 60- month
period. The terms of Student D's qualified education loan require
her to begin making monthly payments of interest on the loan in
January, 2000. The 60-month period described in paragraph (e)(1) of
this section begins in January, 2000. D fails to make the required
interest payments for the months of November and December, 2000. In
January, 2001, D enrolls in graduate school on a half-time basis.
Under the terms of the loan, D is eligible for deferment of the loan
payments due while D is enrolled in graduate school. The deferment
is granted effective January 1, 2001. In March, 2001, while the loan
is in deferment, D pays the interest due for the months of November
and December, 2000. Assuming all other relevant requirements are
met, D is allowed a deduction for interest paid in March, 2001 for
the months of November and December, 2000 because the interest
payments were made paid prior to the expiration of the 60-month
period, even though the November and December interest payments were
late and were made while the loan was in deferment.

Example 5. 60-month period. The facts are the same as Example 4
except that Student D graduates from graduate school in December,
2004 and is required to begin making monthly payments of interest on
the loan in June, 2005. As of January, 2001, when the loan entered
deferment status, 12 months of the 60-month period had elapsed
(January-December, 2000). As of June, 2005, when the loan re-enters
repayment status, there are 48 months remaining in the 60-month
period for that loan.

Example 6. 60-month period. The terms of Student E's qualified
education loan require him to begin making monthly payments of
interest on the loan in November, 1999. The 60-month period
described in paragraph (e)(1) of this section begins in November,
1999. In January, 2000, E enrolls in graduate school on a half-time
basis. As permitted under the terms of the loan, E applies for
deferment of the loan payments due while E is enrolled in graduate
school. While awaiting formal notification from the lender that his
request for deferment has been granted, E pays interest due for the
month of January, 2000. In February, 2000, E receives notification
from the lender that deferment has been granted, effective as
January 1, 2000.

Assuming all other requirements are met, E is allowed a deduction
for interest paid in January, 2000, prior to his receipt of the
notification, even though the deferment was granted retroactive to
January 1, 2000. As of February, 2000, there are 57 months remaining
in the 60-month period for that loan.

Example 7. Reduction of 60-month period for months prior to January
1, 1998. The first payment on a qualified education loan is due on
January 1, 1997. Thereafter, interest is required to be paid on a
monthly basis. The 60-month period for this loan begins on January
1, 1997. However, no deduction is allowed for interest paid by the
borrower prior to January 1, 1998, the effective date of section
221. Assuming all other relevant requirements are met, the borrower
may deduct interest due and paid on the loan during the 48 months
beginning on January 1, 1998 (unless such period is extended for
periods of deferment or forbearance under paragraph (e)(3) of this
section).

(f) Definitions--(1) Eligible educational institution. In general,
an eligible educational institution means any college, university,
vocational school or other post-secondary educational institution
that is described in section 481 of the Higher Education Act of 1965
(20 U.S.C. 1088), as in effect on August 5, 1997, and is certified
by the U.S. Department of Education to be eligible to participate in
student aid programs administered by the Department, as described in
section 25A(f)(2). In addition, for purposes of this section, an
eligible educational institution also includes an institution that
conducts an internship or residency program leading to a degree or
certificate awarded by an institution, a hospital, or a health care
facility that offers postgraduate training.

(2) Qualified higher education expenses--(i) In general.

Qualified higher education expenses means the cost of attendance (as
defined in section 472 of the Higher Education Act of 1965, 20
U.S.C. 1087ll, as in effect on August 4, 1997), at an eligible
educational institution, reduced by the amounts described in
paragraph (f)(2)(ii) of this section. Consistent with section 472 of
the Higher Education Act of 1965, 20 U.S.C. 1087ll, the cost of
attendance is determined by the eligible educational institution and
includes tuition and fees normally assessed a student carrying the
same academic workload, an allowance for room and board, and an
allowance for books, supplies, transportation and miscellaneous
expenses of the student.

(ii) Reductions. Qualified higher education expenses must be reduced
by any amount paid to or on behalf of a student with respect to such
expenses that is--

(A) A qualified scholarship that is excludable from income under
section 117;

(B) A veterans' or member of the armed forces' educational
assistance allowance under chapter 30, 31, 32, 34 or 35 of title 38
United States Code, or under chapter 1606 of title 10, United States
Code;

(C) Employer-provided educational assistance that is.20 excludable
from income under section 127;

(D) Any other educational assistance that is excludable from gross
income (other than as a gift, bequest, devise, or inheritance within
the meaning of section 102(a));

(E) Any amount excluded from gross income under section 135
(relating to the redemption of United States savings bonds); or

(F) Any amount distributed from an education individual retirement
account described in section 530 and excluded from gross income.

(3) Qualified education loan--(i) In general. Qualified education
loan means indebtedness incurred by a taxpayer solely to pay
qualified higher education expenses that are--

(A) Incurred on behalf of a student who is the taxpayer, the
taxpayer's spouse, or a dependent (as defined in section 151) of the
taxpayer at the time the indebtedness is incurred;

(B) Paid or incurred within a reasonable period of time before or
after the indebtedness is incurred. Qualified higher education
expenses that are paid with the proceeds of education loans that are
part of a federal postsecondary education loan program are deemed to
meet this requirement. For other loans, except as provided in
paragraph (f)(3)(ii) of this section, what constitutes a reasonable
period of time is determined based on all the relevant facts and
circumstances; and

(C) Attributable to education provided during an academic period, as
described in section 25A and the regulations thereunder, when the
student is an eligible student as defined in section 25A(b)(3)
(requiring that the student be a degree candidate carrying at least
one-half the normal full-time workload).

(ii) Reasonable period safe harbor. For purposes of paragraph (f)(3)
(i)(B) of this section, qualified higher education expenses are
treated as paid or incurred within a reasonable period of time
before or after the indebtedness is incurred if the expenses relate
to a particular academic period and the loan proceeds are disbursed
within a period that begins 60 days prior to the start of that
academic period and ends 60 days after the end of that academic
period.

(iii) Related party. A loan made by a person who is related to the
borrower, within the meaning of section 267(b) or 707(b)(1), is not
a qualified education loan. For example, a parent or grandparent of
the borrower is a related person. In addition, a loan made under any
qualified employer plan as defined in section 72(p)(4) or under any
contract referred to in section 72(p)(5) is not a qualified
education loan.

(iv) Not federally issued or guaranteed. A loan does not have to be
issued or guaranteed under a federal postsecondary education loan
program to be a qualified education loan.

(4) Examples. The following examples illustrate the rules in this
paragraph (f):

Example 1. Eligible educational institution. University Z is a
postsecondary educational institution described in section 481 of
the Higher Education Act of 1965. University Z has completed the
necessary paperwork and has been certified by the U.S. Department of
Education as eligible to participate in federal financial aid
programs administered by the Department, although University Z
chooses not to participate. University Z is an eligible educational
institution.

Example 2. Qualified education loan. Student F borrows money from a
commercial bank to pay qualified higher education expenses related
to his enrollment on a half-time basis in a graduate program at an
eligible educational institution. All the loan proceeds are used to
pay qualified higher education expenses incurred within a reasonable
period of time after the indebtedness is incurred. The loan is not
federally guaranteed.

The commercial bank is not related to Student F within the meaning
of section 267(b) or 707(b)(1). The fact that Student F's loan is
not federally issued or guaranteed does not prevent the loan from
being a qualified education loan within the meaning of section 221.

Example 3. Qualified higher education expenses. Student G receives a
$3,000 qualified scholarship for the 1999 Fall semester, that is
excludable from F's gross income under section 117. Student G
receives no other forms of financial assistance with respect to the
1999 Fall semester. Student G's cost of attendance for the Fall
semester, as determined by Student G's eligible educational
institution for purposes of calculating a student's financial need
in accordance with section 472 of the Higher Education Act, is
$16,000. For the 1999 Fall semester, Student G has qualified higher
education expenses of $13,000 (the cost of attendance as determined
by the institution ($16,000) reduced by the qualified scholarship
proceeds excludable from gross income ($3,000)).

Example 4. Qualified education loan. Student H signs a promissory
note for a loan on August 15, 1999, to pay for qualified higher
education expenses for the 1999 Fall and 2000 Spring semesters. On
August 20, 1999, loan proceeds are disbursed by the lender to
Student H's college and credited to H's account to pay qualified
higher education expenses for the 1999 Fall semester, that begins on
August 23, 1999. On January 25, 2000, additional loan proceeds are
disbursed by the lender to Student H's college and credited to H's
account to pay qualified higher education expenses for the 2000
Spring semester, that began on January 10, 2000. Student H's
qualified higher education expenses for the two semesters are paid
within a reasonable period of time, as the first loan disbursement
was made within 60 days prior to the start of the Fall 1999 semester
and the second loan disbursement was made during the Spring 2000
semester.

Example 5. Mixed-use loans. Student I signs a promissory note for a
loan which is secured by I's personal residence. Part of the loan
proceeds will be used to pay for certain improvements to I's
residence and part of the loan proceeds will be used to pay
qualified higher education expenses of I's spouse. Because the loan
is not incurred by I solely to pay qualified higher education
expenses, the loan is not a qualified education loan.

(g) Denial of double benefit. No deduction is allowed under this
section for any amount for which a deduction is allowed under
another provision of Chapter 1 of the Internal Revenue Code.

(h) Special rules--(1) 60-month limitation--(i) Refinancing. A
qualified education loan and all refinancings of that loan are
treated as a single loan for purposes of calculating the 60-month
period described in paragraph (e)(1) of this section.

(ii) Consolidated loans. A consolidated loan is a single loan that
refinances more than one qualified education loan of a borrower. For
consolidated loans, the 60-month period described in paragraph (e)
(1) of this section begins on the most recent date on which any of
the underlying loans entered repayment status and includes any
subsequent month in which the consolidated loan is in repayment
status.

(iii) Collapsed loans. A collapsed loan is two or more qualified
education loans of a single borrower that are treated as a single
qualified education loan for loan servicing purposes and are not
separately accounted for by the lender or servicer.

For a collapsed loan, the 60-month period described in paragraph (e)
(1) of this section begins on the most recent date on which any of
the underlying loans entered repayment status and includes any
subsequent month in which any of the underlying loans is in
repayment status.

(2) Loan origination fees and capitalized interest--(i) In general.
Loan origination fees (other than any fees for services) and
capitalized interest are interest and are deductible under this
section.

(ii) Capitalized interest defined. Capitalized interest means any
accrued and unpaid interest on a qualified education loan that is
capitalized by the lender (in accordance with the terms of the loan)
and added to the outstanding principal balance of the qualified
education loan.

(iii) Allocation of payments. Loan origination fees and capitalized
interest are deemed to be paid by the taxpayer when principal is
repaid on the qualified education loan.

Accordingly, the taxpayer may deduct the portion of a stated
principal payment that is treated as the payment of any loan
origination fees or capitalized interest on the loan. See
��1.446-2(e) and 1.1275-2(a) for rules on how to allocate payments
between interest and principal. In general, under these rules, a
payment (regardless of its label) is treated first as a payment of
interest to the extent of the interest that has accrued and remains
unpaid as of the date the payment is due, second as a payment of any
loan origination fees or capitalized interest, until such amounts
have been reduced to zero, and third as a payment of principal.

(3) Examples. The following examples illustrate the rules of this
paragraph (h):

Example 1. Refinancing. Student J obtains a qualified education loan
to pay for an undergraduate degree at an eligible educational
institution. After graduation, Student J is required to make monthly
interest payments on the loan beginning in January 2000. Student J
makes the required interest payments for 15 months. In April 2001,
Student J borrows money from another lender to be used exclusively
to repay the first qualified education loan. The new loan requires
interest payments to start immediately. At the time Student J is
required to make interest payments on the new loan there are forty
five months remaining of the original 60-month period referred to in
paragraph (e)(1) of this section.

Example 2. Collapsed loans. To finance his education, Student K
obtains four separate qualified education loans from Lender B. The
loans enter repayment status on different dates.

After all of Student K's loans have entered repayment status, Lender
B informs Student K that all four loans will be transferred to
Lender C. Following the transfer, Lender C treats the loans as a
single loan for loan servicing purposes; Lender C sends Student K a
single statement that shows the total principal and interest, and
does not keep separate records with respect to each loan. The 60-
month period described in paragraph (e)(1) of this section begins on
the most recent date on which any of Student K's four loans entered
repayment status.

Example 3. Capitalized interest. Interest on Student L's qualified
education loan accrues while Student L is in school, but Student L
is not required to make any payments on the loan until six months
after he graduates. At that time, all accrued but unpaid interest is
capitalized by the lender and is added to the outstanding principal
amount of the loan. Thereafter, Student L is required to make
monthly payments of interest and principal on the loan. For purposes
of section 221, interest includes both stated interest and
capitalized interest. Therefore, in determining the total amount of
interest paid on the qualified education loan during the 60-month
period described in paragraph (e)(1) of this section, Student L may
deduct any principal payments that are treated as payments of
capitalized interest under paragraph (h)(4) of this section.

(i)Effective date. This section applies to interest due and paid
after December 31, 1997, on a qualified education loan.

Deputy Commissioner of Internal Revenue

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