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PHEAA pays $12 million to settle IRS probe

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Tuesday, Dec. 6, 2011

Pennsylvania's state-administered student lender agreed to pay more than $12 million to end an IRS investigation into tax law violations.

The Pennsylvania Higher Education Assistance Agency disclosed the settlement in its most recent quarterly financial report and in a letter to bond dealers and brokers dated Nov. 17.

"Once again, PHEAA receives failing grades for fiscal oversight and common sense," said Eric Epstein, founder of the government reform advocacy group Rock the Capitol. "It is hard to imagine how this settlement makes college education more accessible to students."

Critics targeted PHEAA, created in 1963 by the General Assembly, in recent years for lavish travel spending. That led to the March 2009 firing of then president Michael Hershock -- and a $200,000 settlement by the agency in January for Hershock's wrongful termination lawsuit, according to The Patriot-News in Harrisburg.

The IRS began investigating $150 million in tax-exempt PHEAA bonds in May 2008, according to PHEAA's quarterly report. In December 2010, PHEAA set aside $3 million in preparation for a fine. Then, on July 21 of this year, IRS officials sent PHEAA a letter saying auditors expanded the investigation to include all of the agency's $205.3 million in tax-exempt bonds, the report states.

Two months later, PHEAA settled for $12.3 million, according to the November letter. Spokesman Keith New declined to comment further, citing federal disclosure rules relating to investments.

Epstein called the payment a "gross abuse of public assets."

An IRS spokeswoman declined to comment, citing confidentiality laws.

The IRS investigation revolved around a complex set of federal laws meant to prevent nonprofits from making money from their tax-exempt status by selling bonds just to invest the money. If tax-exempt organizations profit in this manner, they're supposed to turn it over to the government, said Kenneth McCrory, a partner in the Downtown accounting firm ParenteBeard.

PHEAA can charge students an interest rate only 2 percent higher than the rate it pays bondholders, according to federal tax law. So, for example, if PHEAA sold bonds with a 2 percent return for investors, it couldn't charge more than 4 percent interest on the student loans those bonds financed.

The IRS is concerned that student loan agencies are shifting loans around -- taking them from bonds with low interest rates and reassigning them to bonds with higher interest rates -- so they remain below that 2 percent cap, according to The Bond Buyer, an industry publication.

PHEAA is the first student lender to reach an agreement with the IRS for doing this, and its settlement could set an industrywide precedent, according to The Bond Buyer.

Several state legislators who are members of PHEAA's board of directors did not return calls seeking comment.

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