There are many nuances to the definition of a qualified education loan. Some student loans do not satisfy the requirements for a student loan to be a qualified education loan.
Qualified education loans are eligible for the Student Loan Interest Deduction and qualified distributions from a 529 college savings plan to repay up to $10,000 in student loan debt. Qualified education loans are also excepted from bankruptcy discharge.
Qualified education loans include all federal education loans, including Federal Stafford loans, Federal Perkins loans, Federal PLUS loans and Federal Consolidation loans. Qualified education loans also include many private student loans, but not all private student loans.
Let’s dive in and understand the true definition of a qualified education loan.
Definition Of A Qualified Education Loan
The Taxpayer Relief Act of 1997 [P.L. 105-34] introduced the concept of a qualified education loan by amending the Internal Revenue Code of 1986 [26 USC 221(d)(1)].
Qualified education loans are defined in the IRC as:
“indebtedness incurred by the taxpayer solely to pay for qualified higher education expenses.”
Qualified higher education expenses are defined as the cost of attendance, as defined in the Higher Education Act of 1965 [20 USC 1087ll] “as in effect on the day before the date of enactment of the Taxpayer Relief Act of 1997.” The Taxpayer Relief Act of 1997 was enacted on August 5, 1997.
So, the definition of a qualified education loan does not include any changes in the definition of the cost of attendance on or after August 5, 1997.
The cost of attendance includes tuition and required fees, and allowances for room and board, books, supplies and equipment, transportation, miscellaneous personal expenses, dependent care costs, study abroad costs, disability-related expenses and loan fees.
Subsequent changes to the statutory definition of cost of attendance apply to a student’s eligibility for federal student aid, but not to the definition of a qualified education loan. For example, a qualified education loan cannot be used to pay for the rental or purchase of a personal computer, room and board for students who are enrolled less than half-time, and the one-time cost of obtaining professional licensure or certification.
These changes were enacted by the following legislation on or after August 5, 1997 and therefore are excluded from the definition of a qualified education loan:
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Changes To Cost Of Attendance |
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The Higher Education Amendments of 1998 (P.L. 105-244, 10/7/1998) |
Added an allowance for the rental or purchase a personal computer. Repealed the previous specific minimums for room and board costs. |
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The Deficit Reduction Act of 2005 (P.L. 109-171, 2/8/2006) |
Added an allowance for room and board expenses for students who are enrolled on a less-than-half-time basis. Added an allowance for the one-time cost of obtaining first professional credentials or licensing for students in a program that requires professional licensing or certification. |
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The Higher Education Opportunity Act of 2008 (P.L. 110-315, 8/14/2008) |
Added an allowance for room and board costs incurred by students who live in housing on a military base or for which they receive a basic military allowance for housing. |
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The FAFSA Simplification Act, which was included in the Consolidated Appropriations Act, 2021 (P.L. 116-260, 12/27/2020) |
Added transportation between campus, residences and place of work, among other changes. |
The cost of attendance is determined by the college financial aid office, not the borrower or lender.
The total amount of qualified higher educational expenses may be reduced by the higher education expenses used to justify certain tax-free education benefits, such as tax-free interest on education savings bonds, the American Opportunity Tax Credit and Lifetime Learning Tax Credit, employer-paid educational assistance, veterans educational assistance, tax-free scholarships and fellowships, and tax-free distributions from college savings plans (e.g., 529 plans, prepaid tuition plans and Coverdell education savings accounts).
Benefits Of Qualified Education Loans
The definition of a qualified education loan is used to determine eligibility for the student loan interest deduction [26 USC 221], the qualified 529 plan distribution to repay up to $10,000 in student loan debt [26 USC 529(c)(9)], and whether a student loan is excepted from bankruptcy discharge [11 USC 523(a)(8)(B)].
The Student Loan Interest Deduction provides an above-the-line exclusion from income for up to $2,500 in interest paid on qualified education loans. Borrowers can claim the student loan interest deduction even if they don’t itemize.
529 college savings plans may be used to repay up to $10,000 in qualified education loan debt of the beneficiary or the beneficiary’s siblings. This is a lifetime limit per borrower. The distribution may be used to pay for principal and/or interest. The beneficiary may be changed to a relative of the old beneficiary, such as to the student’s parents, to repay the qualified education debt of other borrowers. For example, a parent could use a qualified distribution from a 529 plan to repay Federal Parent PLUS loans by changing the beneficiary from the student to the parent.
The U.S. Bankruptcy Code provides an exception to bankruptcy discharge of qualified education loans unless the exception would impose an undue hardship on the borrower and the borrower’s dependents. This provision was added by the Bankruptcy Abuse Prevention and Consumer Protection Act (BAPCPA) of 2005 [P.L. 109-8].
Characteristics Of Qualified Education Loans
The requirement for qualified education loans to have been incurred solely to pay for qualified higher education expenses precludes mixed-use loans (i.e., loans used for purposes in addition to qualified higher education expenses), per the regulations at 26 CFR 1.221-1(e)(4) example 6 and 26 CFR 1.221-2(f)(4) example 6. Thus, if a loan is obtained to pay for qualified higher education expenses and for other purposes, the loan is not a qualified education loan. Credit card debt, home equity loans and HELOCS are not considered to be qualified education loans.
The use of the word “solely” is an indication that Congress intended the indebtedness to be an indivisible whole. Generally, if Congress had wanted to allow qualified education loans to be partially qualified and partially not qualified, it would have used language like “in whole or in part” or “to the extent” as it does elsewhere in the Internal Revenue Code of 1986, Higher Education Act of 1965 and the U.S. Bankruptcy Code, and it would not have used the word “solely.”
The student on whose behalf a qualified education loan is borrowed must be the borrower, the borrower’s spouse or a dependent of the borrower, per 26 USC 221(d)(1)(A). If the student is not claimed as a dependent by the borrower, and the student is neither the borrower nor married to the borrower, the loan is not a qualified education loan. Thus, a Federal Parent PLUS loan or a private parent loan is not considered qualified education loans if the borrower did not claim the student as a dependent when the loan was borrowed.
Qualified education loans must have been borrowed to pay for the education of an eligible student,per 26 USC 221(d)(1)(C) and 26 USC 221(d)(3). An eligible student must be enrolled on at least a half-time basis [26 USC 25A(b)(3)(B)] and seeking a degree, certificate or other recognized educational credential [26 USC 25A(b)(3)(A) and 20 USC 1091(a)(1)] at an eligible institution of higher education [26 USC 221(d)(2)]. An eligible educational institution includes colleges and universities that are eligible for Title IV federal student aid [26 USC 25A(f)(2), 20 USC 1088(a), (b) and (c), now in 20 USC 1002].
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An eligible educational institution may 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 which offers postgraduate training.” Such medical, veterinary, pharmacy and dental internship and residency programs do not charge tuition and fees, and so do not lead to qualified education loans.
Eligible students may not be simultaneously enrolled in an elementary or secondary school, per 20 USC 1091(a)(1).
Qualified education loans may not be owed to a person who is related to the taxpayer, per 26 USC 221(d)(1), 26 USC 267(b) and 26 USC 707(b)(1). Family members include only “brothers and sisters (whether by the whole or half blood), spouse, ancestors and lineal descendants” per 26 USC 267(c)(4).
Qualified education loans do not include loans from qualified employer retirement plans, such as a 401(k) or 403(b) plan, per 26 USC 221(d)(1).
The qualified higher education expenses must have been paid or incurred within a reasonable period of time, per 26 USC 221(d)(1)(B). A reasonable period of time is defined in the IRS regulations at 26 CFR 1.221-1(e)(3)(ii)(B) and 26 CFR 1.221-2(f)(3)(ii)(B) as 90 days before or after the qualified education loan was borrowed.
Qualified education loans may include loans that are used to refinance qualified education loans.
Cost Of Attendance Cap
If a private student loan in combination with other financial aid exceeds the cost of attendance, it is not a qualified education loan. That is because only loans that pay for qualified higher education expenses, like the cost of attendance, meet the statutory definition.
If a private student loan is school-certified, the college financial aid office ensures that the private student loan does not, alone or in combination with other aid, exceed the cost of attendance. If the private student loan amount is too high, the college will certify the loan for a lower amount.
The other main type of private student loan is a direct-to-consumer loan. Unlike school-certified loans, direct-to-consumer loans are not reviewed or approved by the college or university. College financial aid administrators are generally not aware of the loan amount on a direct-to-consumer loan. However, the amount of a federal education loan may not exceed the cost of attendance minus other aid received. Direct-to-consumer loans are considered part of “other aid received” and would result in reductions in federal education loan amounts if the loan amounts were known to the college.
For example, the statutory language at 20 USC 1078-8(c) specifies that the amount of a Federal Stafford Loan “shall be calculated by subtracting from the estimated cost of attendance at the eligible institution any estimated financial assistance reasonably available to such student” and prohibits colleges from certifying a student’s eligibility for a Federal Stafford Loan in excess of this amount.
The statutory language at 20 USC 1078-2(b) specifies that Federal PLUS Loans cannot be made in excess of the student’s estimated cost of attendance, minus other financial aid as certified by the eligible institution.
The term “other financial aid” includes the financial aid specified in 20 USC 1078(a)(2)(C), namely, the Federal Pell Grant, the Federal Supplemental Educational Opportunity Grant, Federal Work-Study, Federal Perkins Loans, and other scholarship, grant or loan assistance, but excludes National Service education awards (e.g., AmeriCorps) and veterans education benefits.
The statutory language at 20 USC 1087vv(j) defines “estimated financial assistance not received under this subchapter” (subchapter referring to Title IV federal student aid) as including “all scholarships, grants, loans, or other assistance known to the institution at the time the determination of the student’s need is made, including national service educational awards or post-service benefits under title I of the National and Community Service Act of 1990 (42 U.S.C. 12511 et seq.), but excluding veterans’ education benefits.”
The regulations likewise cap the amount of federal education loans for a period of enrollment at the cost of attendance minus the student’s estimated financial assistance for that period.
Estimated financial assistance is defined at 34 CFR 682.200 and 34 CFR 685.102 as the “estimated amount of assistance for a period of enrollment that a student (or a parent on behalf of a student) will receive from Federal, State, institutional, or other sources.” Estimated financial assistance is identified as including loans in addition to scholarships, grants, work-study and other forms of student financial aid. In addition to a specific reference to loans, estimated financial assistance also includes “any educational benefits paid because of enrollment in a postsecondary education institution, or to cover postsecondary education expenses.” Loans are not necessarily limited to federal education loans.
What Is Not A Qualified Education Loan
Loans with the following characteristics are not qualified education loans.
- Enrollment Status.Loans where the student is enrolled on less than a half-time basis are not qualified education loans.
- Cost of Attendance Cap.Loans that exceed the college’s cost of attendance in combination with other financial aid.
- Expenses Not in Cost of Attendance.Loans used to pay for a computer, an automobile (as opposed to the incremental cost of transportation), test prep classes, uniforms or the cost of obtaining first professional credentials and licensing are not qualified education loans. The transportation allowances specified by the college or university as part of their official cost of attendance are usually much smaller than the purchase price of an automobile.
- Costs Not Required by the College. The cost of attendance includes books, supplies and equipment required by the college. For example, if the student borrowed money to pay for photography equipment but the equipment was not required by the college, the loan is not a qualified education loan, even if the student is pursuing a degree in photography.
- Loans for Prior-Year Balances.Loansusedto pay for prior-year balances are not qualified education loans because the higher education expenses are not paid or incurred “within a reasonable period of time before or after the indebtedness is incurred.” Most loans to cover prior year balances involve expenses that were incurred more than 90 days previously.
- The School Is Not an Eligible Institution.Loans used to pay for expenses at colleges that are not accredited, which have not signed a Program Participation Agreement with the U.S. Department of Education or which are otherwise not eligible for Title IV federal student aid are not qualified education loans. For example, loans made to a student who is enrolled at a coding bootcamp are not considered to be qualified education loans.
- Loans Borrowed from a Relative. Loans obtained from a relative, such as a spouse, brothers and sisters (including half brothers and sisters), parents, grandparents, children, grandchildren, ancestors and descendants, are not qualified education loans.
The following types of loans are generally not qualified education loans.
- Continuing Education Loans.Continuing education loans are not qualified education loans because the student is not seeking a degree or certificate. Also, in most cases the student is enrolled on less than a half-time basis.
- Career training loans.Generally,career training loans are not qualified education loans because the student is seeking professional and technical training, but not necessarily seeking a degree, certificate or other education credential. These loans are generally made to students who are enrolled at non-degree-granting schools. The student is also often enrolled on less than a half-time basis. Many career schools, also known as technical, vocation and trade schools, are not Title IV institutions, so loans to students at such schools are not qualified education loans.
- K-12 Education Loans.K-12 education loans are not qualified education loans because the student is not enrolled in college and the loans are used to pay for elementary and secondary education costs, not higher education costs. Dual enrollment programs are also not eligible.
- Retirement Plan Loans. Loans from qualified retirement plans, such as a 401(k) loan, are not qualified education loans. Retirement plan participantsmay borrow up to half the vested account balance from a 401(k), 403(b) or government retirement plan, but not IRAs, with a 5-year repayment term. Loans from a qualified employer plan are not considered to be qualified education loans, due to an explicit exclusion from the definition of a qualified education loan.
- Non-Education Debt. Credit cards, auto loans, mortgages, personal loans and signatures are not qualified education loans because they are mixed-use loans and are not restricted to paying for qualified higher education expenses.
- Bar Study Loans. Bar study loans, which are borrowed to pay for living costs while a law school graduate studies for the bar, are not qualified education loans because they are used to pay for costs that are incurred after graduation (thus not incurred during a period of enrollment) and because the costs covered by a bar study loan are not part of a college’s cost of attendance. The borrower is not an eligible student is the borrower has already graduated. The expenses are not qualified higher education expenses.
- Residency and Relocation Loans. Residency and relocation loans are borrowed by medical school graduates, dental school graduates and veterinary school graduates to pay for costs after graduation from medical school, dental school, pharmacy school and veterinary school. Residency and relocation loans are not qualified education loans because they are used to pay for costs that are incurred after graduation and because these costs are not part of a college’s cost of attendance.
