Sec. 221 final regs. on deducting qualified education loan interest.

• Author: Schell, Wayne M.

In May 2004, Treasury issued final regulations (TD 9125) to clarify the rules on deducting interest on qualified education loam under Sec. 221.

Background

Sec. 221 was enacted by the Taxpayer Relief Act of 1997. The Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) amended its provisions, to (1) increase the income limit for the deduction and (2) eliminate the 60-month period for the deduction and the restriction disallowing a deduction for payments during a deferment. The EGTRRA amendments apply to interest paid on loans after 2001 and before 2011. As a result, in 2011, the pre-2002 rules will again apply, unless the EGTRRA amendments are extended or made permanent.

To accommodate the dual sets of rules, the regulations are divided into two parts, Regs. Sec. 1.221-1 addresses qualified education loan interest paid from 2002-2010, inclusive; Reg. Sec. 1.221-2 applies to such interest paid from 1998-2001 and after 2010. This item focuses on Regs. Sec. 1.221-1.

General Rules

Sec. 221 (a) provides that individuals may deduct interest paid during the tax year on qualified education loans. Sec. 221(d) defines this as a loan obtained to refinance other qualified education loans or to pay qualified higher education expenses (QHEEs) for an eligible student at an eligible educational institution. The "eligible student" can be the taxpayer or his or her spouse or dependent. Under Regs. Sec. 1.2211(e)(3)(i) and (e)(3)(v)(A), the boa rowed funds must be used solely to pay QHEEs or refinance qualified education loans; if any part is used for other purposes, it is not a qualified education loan.

Further, under Sec. 221(d), flush language, and Regs. Sec. 1.2211(e)(3)(iii), qualified education loans do not include loans a taxpayer obtains from related parties (as defined in Sec. 267(b) or 707(b)(1)). Thus, if the student borrows money from his or her grandparent, it is not a qualified education loan; any interest paid thereon would not be deductible. Other loans that do not qualify include those made under a qualified employer plan (under Sec. 72(p)(4)) or a contract identified in Sec. 72(p)(5). Kegs. Sec. 1.2211(e)(3)(iv) provides, however, that qualified education loans need not be issued or guaranteed under a Federal postsecondary education loan program.

QHEEs: Regs. Sec. 1.221-1(e)(2) defines QHEEs as the cost of attendance, including tuition and fees, room and board, books, supplies, transportation and miscellaneous student expenses...