[Congressional Record Volume 151, Number 145 (Friday, November 4, 2005)]
[Senate]
[Pages S12406-S12407]
From the Congressional Record Online through the Government Publishing Office [www.gpo.gov]

      By Ms. SNOWE (for himself and Mr. Schumer):
  S. 964. A bill to amend the Internal Revenue Code of 1986 to modify 
the determination and deduction of interest on qualified education 
loans; to the Committee on Finance.
  Ms. SNOWE. Mr. President, every year, the cost of higher education 
and vocational education increases dramatically. College tuition and 
fees have been rising more rapidly than household income over the past 
two decades. The divergence is particularly pronounced for low-income 
households. The sad result is that with every year more students and 
families are forced to decide whether they can afford higher education 
while knowing their choice is limited by price. It is imperative that 
Congress work to make higher education more accessible to all.
  Our Nation must make a solid commitment to ensure that every 
individual has the opportunity to pursue higher education, and our 
policies should reflect this commitment. Education has always been the 
great equalizer in our society that provides every American the same 
opportunity to succeed. That is why today I, along with Senator 
Schumer, am introducing legislation that would provide for a simpler, 
more borrower-friendly method for reporting and deducting capitalized 
interest and origination fees in connection with qualified education 
loans.
  In May 2004, the Treasury Department issued final regulations with 
respect to the student loan interest deduction under the tax code. 
Among other things, these Treasury regulations provide that the 
``original issue discount rules'' (OID) shall apply for purposes of 
students claiming this deduction. In particular, they would apply to 
the portion of the student loan that relates to federally mandated 
student loan origination fees and the capitalized interest that does 
not accrue on the loan while the student attends school (i.e., the 
government essentially pays this interest for the student on the loan 
during the years the student attends school).
  OID rules are complicated and confusing. In general, these rules 
attempt to prevent taxpayers from claiming inflated interest deductions 
stemming from debt obligations. When a borrower issues a debt 
obligation at a discount, that is the note's face amount exceeds the 
amount that the lender advances to the borrower, the amount of the 
discount represents additional interest on the obligation. The OID 
rules reflect Congress' attempt to square the tax treatment of this 
unstated or disguised interest into conformity with economic reality.
  The OID rules, then, ``limit'' a borrower's tax deduction because 
whereas the tax code generally permits borrowers to deduct the interest 
they pay on debt obligations, such as student loans, the tax code 
generally prevents borrowers from deducting any OID they might pay on 
such debt.
  For example, assume that a corporation issues thirty-year bonds with 
a face value of $1,000 each and, according to their terms, paying 10 
percent interest each year. Assume, though, that the corporation 
actually sells these bonds to investors for $850 because the 10 percent 
interest rate is below market rates. Under these facts, there is $150, 
$1,000 - $850, that the corporation essentially is ``re-classifying'' 
as interest that it will pay to the investor; that is, the investors 
would not be satisfied with a 10 percent return upon giving the 
corporation $1,000 so that the corporation essentially treats a portion 
of the principle, $150, as interest.

[[Page S12407]]

  The tax code classifies this $150 as OID. The $150 of OID serves the 
same function as the stated annual interest of $100, 10 percent of 
$1,000. As such, the $150 of OID is an additional cost to the 
corporation in borrowing $850 from the investor, and it is additional 
compensation that the corporation pays to the lender for lending that 
amount. The only differences to the parties are that the corporation is 
not required to pay the OID of $150 until the bond matures and that the 
investor does not receive the discount in cash until then, unless the 
bond is sold in the interim.

  As I noted earlier, the OID rules prevent borrowers from deducting 
the entire amount of ``interest'' they pay to a borrower on a loan. 
Specifically, in the previous example, although the parties treat the 
loan principle as being $850, the application of the OID rules treats 
the loan as $1,000, which is significant because it means the IRS 
classifies the $150 of OID as not being interest. In turn, the borrower 
cannot deduct this $150 payment to the borrower because it is a return 
of principle on the loan rather than interest.
  Consequently, applying OID rules to student loans would have several 
negative effects. First, with respect to students, they would not be 
able to deduct the entire amount of ``interest'' they pay to their 
lender. In general, whereas the tax code generally permits students to 
deduct student loan interest, subject to certain limitations, it does 
not permit taxpayers to deduct OID. The Treasury regulations, then, 
will reduce the cash flow of students who are repaying student loans by 
limiting their student loan interest deduction.
  In addition, applying the OID rules will have an enormous impact on 
the compliance burden. Indeed, the interaction of the OID rules and the 
loan provisions of the Higher Education Act greatly magnifies the 
complexity of rules that lenders must follow. As such, lenders and 
servicers will be forced to create accounting systems, at enormous 
expenses that ultimately will be passed on to student borrowers, to 
enable them to track and report the origination fees and capitalized 
interest in accordance with the OID rules. Furthermore, given that 
there is no track record of applying the OID rules to student lenders, 
there is no guarantee that they can preform these tasks accurately.
  Congress enacted the OID rules to prevent taxpayers, mostly large 
corporations, from altering the terms of loan agreements to claim 
inflated interest deduction. Clearly, applying them to student loans is 
unreasonable and frankly unintended.
  To remedy this problem, my legislation would permit lenders to 
account for the OID treatment of student loans under the ``immediate 
accrual method, which colloquially is referred to as the ``bucket 
method.'' Under this approach, the origination fee would accrue as soon 
as it is charged to or paid by the borrower, and capitalized interest 
would accrue under the terms of the promissory note. Accrued 
origination fee and capitalized interest would go into a ``bucket'' as 
soon as they accrue, until such time as the borrower begins to make 
payments on the loan. Amounts in the ``bucket'' would be applied 
against principal payments until the bucket is empty. Capitalized 
interest and origination fees would be reported to and deductible by 
the eligible taxpayer in the year in which they are paid.
  My legislation would, as I stated, provide for a simpler, more 
borrower-friendly method for reporting and deducting capitalized 
interest and origination fees in connection with qualified education 
loans. Consequently, it would not reduce the need to engage in the 
burdensome task of calculating the OID on loans, and the student 
borrowers would be able to deduct more of the interest they pay.
  This bill is good policy and common sense. Senator Schumer and I look 
forward to working with Finance Committee Chairman Grassley and Ranking 
Member Baucus in seeking swift action to resolve this issue.

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