Tax Code Updates

Nonprofit and state-based education loan providers utilize tax-exempt bond financing (in the form of Qualified Student Loan Bonds, or QSLBs) to fund low-cost education and refinancing loans to students. Proceeds from these loans enable EFC members to offer extensive free programs aimed at college access, student success, and financial literacy. Federal rules restrict the yield of the student loans financed with tax-exempt bond financing to no more than the yield of the bond plus two percent. EFC members, as a result, offer students and families in their state much lower loan rates than what the applicants could expect from for-profit student loan companies. This is particularly true for those students and families with average to low credit scores. In addition, nonprofit and state-based student loan programs do not impose an origination fee, and these programs regularly feature benefits not widely available in the for-profit marketplace like income-driven repayment plans and loan rehabilitation.

The Problem

Every state receives an Internal Revenue Code (IRC) Section 146, private activity bond (PAB) volume cap, and the QSLBs issued by EFC members count against this cap. The result is that EFC members must then compete against other entities that are also addressing worthwhile activities under the PAB cap, such as affordable housing. Consequently, EFC members are frequently shut out from the marketplace, or they see their tax-exempt issuance significantly reduced. In 2023, QSLBs amounted to less than 1 percent of all PAB issues. The volume cap restriction translates to higher college costs for students nationwide.

The Solution

Congress should amend Section 146 of the Internal Revenue Code by adding QSLBs as another type of bond that is exempt from states’ PAB volume cap. Doing so would expand the availability of QSLBs and, in turn, lower the cost of nonprofit student loan programs that help families access and pay for college.

More than $18.3 billion in education loans have been funded from the proceeds of tax-exempt QSLBs. Over the life of their individual programs, state-based nonprofit organizations have issued these tax-exempt bonds, resulting in collective savings for borrowers of more than $1.2 billion compared to if the loans had been funded using the proceeds of taxable bonds. For example, a student borrowing $40,000 over four years could have saved more than $2,100 through the use of tax-exempt Qualified Student Loan Bonds compared to taxable bonds.

According to a 2024 EFC analysis, one member organization’s student loans funded by tax-exempt bonds had interest rates 4.8 percentage points lower than those offered by large for-profit lenders. This lower rate would save the typical borrower over $9,500 across a 15-year repayment term

Interest income from QSLBs is subject to the Alternative Minimum Tax (AMT). Treatment of QSLB interest as a preference item under the AMT reduces investor interest and increases borrowing costs for students. The AMT increases borrowers’ interest rates anywhere from 25 to 60 basis points depending on the year. Congress has exempted certain PABs (e.g. housing projects) from the AMT in recognition that the tax was suppressing investor demand for those bonds.

Congress should add QSLBs to the list of PABs exempt from the AMT, which will have the effect of decreasing QSLBs rates by roughly 50 basis points. This will increase QSLB attractiveness to investors and result in lower student loan rates for borrowers.

Section 127 of the Internal Revenue Code allows employers to exclude from gross income up to $5,250 in employer-provided educational assistance to their employees. However, “educational assistance” in this section will no longer include payments on qualified education loans after 2025. EFC recommends Congress indefinitely extend this provision.

Extending this provision indefinitely will:

1.) Help college graduates achieve financial stability;

2. ) Continue to fuel economic growth;

3.) Encourage more employer-provide education assistance by giving businesses long-term certainty about the availability of this incentive; and

4.) Boost the number of borrowers who are actively repaying their student loan debt, most of which is backed by taxpayers through the federal Direct Loan program.

Section 529 of the IRC levies a tax penalty on individuals who use their qualified tuition plan funds to pay for shorter-term education programs and workforce-related credentials. Career and financial success are not limited to individuals with college degrees. Families that responsibly save for college should not be forced to use their savings solely for a degree, and they should not be penalized when the student elects to pursue a shorter-term credential.

Congress should let families use their 529 plans to cover workforce-related credential programs tax-free. This would expand opportunities for students who elect to pursue either a shorter-term credential or advancement within a chosen career field by removing an obstacle that prevents hardworking families from using their own money to invest in themselves and fill good-paying jobs. By allowing 529 plans to cover workforce-related credential programs, Congress can boost economic growth, expand educational opportunities, encourage human flourishing, and help students reach their fullest potential. 

Pell Grant recipients who use a portion of their award on expenses other than tuition, fees, and course materials must report this part of their grant to the Internal Revenue Service as taxable income. To maximize their American Opportunity Tax Credit (AOTC) credit, Pell Grant recipients must engage in a sophisticated calculation process to determine the optimal amount of Pell money to include as taxable income. This task is particularly burdensome for these individuals, as they usually lack access to advanced tax preparation resources.

Congress should make Pell Grants entirely tax-free and remove the requirement for students to subtract their Pell Grants from expenses eligible for the AOTC. This legislative change will simplify the tax process, allow students to retain more of their critical financial aid, and reduce the financial burden that threatens students’ success.