IRS approves a long-term set-aside for a STEM student-debt program

Plain-English summary

A private foundation proposed setting aside a redacted amount for a program that would reduce student debt for selected workers who committed to living and working in one state in STEM occupations for ten years. A state agency and its supporting organization would administer the program, select participants through multiple application cycles, and make debt-reduction payments after the fifth and tenth anniversaries of each cohort. The foundation explained that the program needed a long funding period because the final cohort's second payment would occur in the program's fourteenth year, and both borrowers and lenders needed confidence that the promised funds would remain available. The IRS approved the set-aside under section 4942(g)(2) and found good cause to extend the payout period. The foundation must record the set-aside as a pledge or obligation and include the set-aside and its income in the calculations required by sections 4942(e) and 4942(f).

Ruling snapshot

• Question: May the private foundation treat funds reserved for a long-term STEM student-debt reduction program as a qualifying set-aside and receive more time to distribute them?
• Outcome: Approved
• Key authorities: IRC §§ 170(c)(2)(B), 4942(e), 4942(f), and 4942(g)(2); Treas. Reg. § 53.4942(a)-3(b); Rev. Rul. 74-450

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
P.O. Box 2508
Cincinnati, OH 45201

Release Number: 201627005 Employer Identification Number:
Release Date: 7/1/2016
Date: April 8, 2016

Contact Person - ID Number:

Contact Telephone Number:

LEGEND UIL: 4942.03-07

P = State
Q = Program Name
R = Organization

S = Year
T = Organization
V = Year

W = Organization
y dollars = Amount

Dear

Why you are receiving this letter

This is our response to your December 30, 2015, letter requesting approval of a
set-aside under Internal Revenue Code section 4942(g)(2) as well as your request
for a 60-month extension to pay out the set-aside. You’ve been recognized as tax-
exempt under section 501(c)(3) of the Code and have been determined to be a
private foundation under section 509(a).

Our determination

Based on the information furnished, your set-aside program is approved under
Internal Revenue Code section 4942(g)(2). Also, we conclude that you have
established good cause to extend the period of time to pay out the set-aside.
Therefore, we approve your request for a 60-month extension to pay out the set-
aside amount.

Description of set-aside request

You are committing y dollars to fund a student debt reduction program for
individuals who commit to living in P and working in a STEM occupation in P for a
period of ten years. This program will be known as the Q Program. The Q Program
will provide debt reduction payments on behalf of a competitively-selected group
of P workers who have student debt and who are employed in the State of P in

disciplines, or other STEM capabilities or requirements. For the purposes of the Q
Program, “STEM” shall refer to Science, Technology, Engineering, and
Mathematics.

The Q Program will be established and administered by an agency of the State of
P, T, with the grant funds ultimately payable to R, T’s supporting organization and
an entity described in Section 501(c)(3) and 509(a)(3)(B)(1) of the Code. R will
make payments from the grant funds exclusively for the purposes of the Q
Program. T will promote and market the Q Program along with a new student loan
consolidation and refinancing program that it plans to launch in S. Although
separate programs, together the two programs will provide student debt
refinancing and consolidation for qualified individuals committing to live and work
in P in STEM occupations. T agrees to promote and market the Q Program
through its network of businesses, educational institutions and financial lending
partners. Upon your request, T will submit to you sample copies of promotional
and marketing materials used in connection with the Q Program, including website
content. The Q Program will build on and leverage the administrative and
operational expertise of T, will enhance T’s ability to market and underwrite
successfully the T student debt refinancing program, and will aid T in attracting
qualified lenders to participate in the program.

Due to the complex, multi-party nature of the Q Program and its unique private
and public sector collaboration, you will designate a y dollars commitment as a
charitable set-aside for V, with funds to be disbursed over an extended period
pursuant to the terms of the program. You request an advance ruling that the
proposed set-aside is a qualifying distribution for V under Section 4942(g) of the
Code. You also request an extension of time beyond five (5) years to distribute to
the R all amounts set aside for the purposes of the Q Program.

The Q Program will be established and administered by T and R. T will be
responsible for the means and methods of administering the Q Program in
conformity with the program requirements agreed to between T, R and you,
including compliance with all applicable laws and regulations. You and T will
establish a seven person Advisory Committee together that will work with T to
provide programmatic leadership to the Q program. The Advisory Committee will
be composed of individuals who collectively represent a broad cross section of
STEM constituencies important to the success of the Q Program. You anticipate
that the Advisory Committee will consist of: your designee, the Executive Director
or a designee of W, a P nonprofit organization dedicated to championing college
and career readiness and increased education attainment among P students, a
professor from a STEM academic discipline employed within the University of P
system, two senior representatives from leading P STEM companies, an
investment professional with experience investing in and capitalizing venture,
start-up, and emerging businesses, and an ad-hoc member to be mutually agree
upon between you and T. T will be required to communicate regularly with you on
the status and progress of the Q Program in conformance with reporting

requirements to be agreed upon between T and you.

The Q Program will be open to individuals who: (i) are either residents of P or will
become residents upon being hired by a P-based employer; (ii) are or will be
employed by a P-based employer in a STEM occupation; and (iii) have a higher
education degree or certification. The Q Program will seek to recruit and enroll
individuals within the State, from across the nation and internationally. Q leaders
will be selected on a nondiscriminatory basis without regard to race, gender, age,
national or ethnic origin sexual orientation, or religion.

Individuals must apply for entry into the Q Program. T will run up to six (6)
application cycles over a rolling three-year period (the “Application Period”),
commencing sometime in S. Q accepted within each application cycle will
represent a different Q Program “Cohort.” Application materials will be created by
T and the Advisory Committee. The materials will clearly state the terms and
conditions of the Q Program, including requirements for participation. Application
materials will likely require:
• The acceptance into the T Refinance Program, which requires the approval
of a refinance loan by a T Refinance Program partner
• The completion and submission of a Program application, written essay,
and a resume
• The participation in an interview
• A statement of intent to live and work in P for ten years
• An employment certification by a P employer

Individuals will be selected to participate in the Q Program based on their record of
scholastic, academic, extra-curricular, technical or other personal achievement,
application materials, interview performance, STEM professional qualifications,
and transformative nature of the industry in which they work. Admitted Q will be
deemed by T, working with the Advisory Committee, to be of high-quality, both
personally and professionally, and to have STEM careers of importance to the P
economy.

Any person who is a “disqualified person” (as defined in Section 4958(t)(I) of the
Code) with respect to you, R, or T, and any person who is a “substantial
contributor” (as defined in Section 4958(c)(3)(C) of the Code) or otherwise
described in Section 4958(c)(3)(B) of the Code with respect to the R, shall be
ineligible to participate in the Q Program. Further, no debt reduction payment shall
be made pursuant to the Q Program if such payment would constitute an “excess
benefit transaction” within the meaning of Code Section 4958 and the regulations
thereunder.

Once an individual is accepted into the Q Program, he or she will remain in the
Program and entitled to debt reduction payments so long as the individual
continues to meet the eligibility requirements including continuing to live and work
in P for a P based employer, making all required payments on refinanced loans

under the T Refinance Program, and satisfying uniform annual reporting
requirements developed by T for the Q Program. If an individual is no longer
eligible for the Q Program due to failure to meet one of the eligibility requirements,
T will take appropriate action to terminate the individual’s participation in the Q
Program and the individual will no longer receive debt reduction payments.

You will pay to R amounts only on behalf of those Q who have satisfied the
requirements of the Q Program. Amounts paid to R will be applied by it exclusively
for the purpose of reducing the outstanding amount of qualifying loans within each
Cohort, and for no other purpose. Amounts to satisfy debt reduction payments for
each Cohort will be made at the times and in the amounts as follows:

i. Within thirty (30) days following the fifth (5th) anniversary of each Cohort
Commencement Date a payment shall be made by you to R in an amount
equal to Fifty Percent (50%) of the then outstanding amount of principal and
accrued and unpaid interest of each qualifying loan within the Cohort; and

ii. Within thirty (30) days following the tenth (10th) anniversary of each Cohort
Commencement Date a payment shall be made by you to R in an amount
equal to One Hundred Percent (100%) of the then outstanding amount of
principal and accrued and unpaid interest of each qualifying loan within the
Cohort.

In advance of a debt reduction payment being made for each Cohort following
Years 5 and 10, T will certify to you: the number of Q within such Cohort receiving
principal payments, the value of each such Q’s reduction payment, and the total
value of all payments for the Cohort. Debt reduction payments will be made to
lenders participating in the T Refinance Program who hold refinanced student debt
of qualifying Q within each Cohort.

To encourage the substantial effort and expenditures by T to develop the
necessary core components of the Q Program, and to satisfy lenders that the debt
reduction payments they are counting on in underwriting Q refinanced student
debt will in fact be there when the debt reduction commitments are due, you agree
to establish a segregated special custody account to be funded with your grant
commitment of y dollars. Funds from the account will be used exclusively to make
debt reduction payments on behalf of Q admitted to the Q Program. The use of the
funds, the conditions for their release in satisfaction of commitments made to Q
and their lenders, and other terms and conditions of the maintenance, investment,
access to, and disbursement of the funds will be set forth in a control agreement
between you, the bank, and R. Under the Control Agreement, R shall have the
right to direct withdrawals from the account, and shall deposit those withdrawals to
a segregated account owned and controlled by R, from which it shall make debt
reduction payments in conformity with the Q Program.

According to certain financial models produced by T, in order to satisfy the
anticipated debt reduction payments for approximately One Hundred Twenty-Eight
(128) Q, the value of the assets on deposit in the account must increase at an

average annual rate of six percent (6%). You agree to maintain assets on deposit
in the account in an amount equal to (i) the original y dollars deposited in to the
account, plus (ii) earnings on the assets in the account equal to six percent (6%)
per annum, less (iii) any withdrawals made to fund debt reduction payments
(“Target Account Value”). At the beginning of each calendar year during the
operation of the Q Program, the value of the assets on deposit in the account as of
December 31 of the preceding year will be determined based upon the year-end
account statement (“Annual Valuation”). In the event the account value as reported
in the Annual Valuation is less than the Target Account Value, then on or before
February 28 of each year, you will contribute additional assets to the account in an
amount sufficient to cause the amount on deposit in the account to at least equal
the Target Account Value. Such additions will be designated on your books and
reported by you as additions to the set-aside. In the event the account value as
reported in the Annual Valuation exceeds the Target Account Value (such excess
value being referred to as “Excess Assets”), you will have the option, but not the
obligation, to withdraw all or any portion of excess assets from the account at any
time or times during the then current calendar year.

The Q Program will conclude following the final Year 10 Cohort debt reduction
payment. In the event that surplus assets remain in the account following the final
debt reduction payment, you reserve the right to withdraw those assets, transfer
those assets to another of your accounts, or redirect the assets in support of any
other charitable program or endeavor, as you may determine. If for any reason the
Q Program is not initiated or terminates prior to its planned expiration, all amounts
deposited by you into the account along with any interest or investment earnings
will be returned to you, subject to the commitment to fund debt reduction
obligations with respect to any then existing Q to whom debt reduction payments
were committed. Also, if for any reason the Q Program, R, or T are found to be
ineligible to receive grants from private foundations under the Code, the funds
granted by you for the program will be returned to you.

The success of the Q Program, and of necessity the success and viability of the T
Refinance Program with which it is partnered, depend heavily both on the
participation of a significant pool of qualified lenders in the T Refinance Program
and on the participation of a significant number of individuals in STEM occupations
with student debt who meet the qualifications of the program. The decision of
qualified lenders to participate in the T Refinance Program for P STEM employees
will depend on such lenders’ assessment of the depth, size and risk profile of the
applicant pool and the likelihood of debt repayment by the applicants and/or by
other sources. Further, any refinancing by a lender must be of a sufficient duration
to make it financially attractive and viable for the lenders, but the expected 15-year
duration of the refinanced student loans also necessarily presents risks to lenders.

You expect that the Q Program will result specifically in greater participation by
lenders and in lower interest rates and more favorable repayment terms for Q (and
likely other R Refinance Program borrowers). Additionally, the existence of the Q

Program will encourage more STEM employees to participate in the refinancing
program than would otherwise, thus enhancing the risk profile of the applicant
pool. At the same time, the Q Program itself will succeed in its charitable mission
of bringing quality STEM employees in high-potential STEM occupations to live,
work, contribute, and invest in P communities and in P’s quality of life for an
extended period of time. However, each constituency, whether lenders or
borrowers, must be assured that the promised debt reduction payments, which will
directly impact the underwriting of the refinanced loans, will be made at the
expected time. Essentially, for underwriting purposes, the existence of the set-
aside and the associated funding of the account will function much like a linked
deposit, a guarantee, or a reserve fund, whereas a mere charitable pledge would
not. You state the use of a set-aside will help materially to ensure maximum
participation by both qualified lenders and borrowers and to ensure the most
favorable underwriting standards. Therefore, you indicate that setting aside in V
your grant commitment on your books, and further, depositing the grant funds in
the account and subjecting it to the proposed Control Agreement, rather than
simply pledging to make a future grant payment to satisfy debt reduction payments
in years 5 and 10 of a Cohort’s participation, will best accomplish the purposes of
the Q Program.

Request for Extension of 60 Month Distribution Period

You requested an extension of the 60-month distribution period for the above
described set-aside in support of the Q Program. You indicated that the charitable
purposes of the Q Program cannot be accomplished if the amounts set-aside must
be distributed within a sixty (60) month period. The long-term objectives of the
program, and the realities of the duration of student loan obligations which
underpin the design and administration of the program, require an extension from
5 years to 14 years to fully meet the demands of the program. You also state the
time period over which its substantial charitable objectives must be cultivated and
measured, the needs of participating STEM employees with student debt, and the
needs and requirements of lenders whose participation is essential to the success
of the program together are also cause for the requested extension.

More specifically, the set-aside must continue for 14 years (with distributions made
over that time period) to ensure the repayment of student loan debt for program
participants, including those in the final Q Program Cohort. T contemplates
admitting candidates to the program over a three-year rolling application cycle. A
debt reduction payment will be made with respect to the first Q Cohort in the sixth
year of the program (being Year 5 of the first Cohort’s participation after admission
to the program). However, as a result of the three-year rolling application cycle,
the first debt reduction payment for the last program Cohort will be in the ninth
year of the program (which would be Year 5 of the final Cohort’s participation). The
second debt reduction payment for the first successful Cohort will be in the
eleventh year of the program, being Year 10 of the first Cohort’s participation, but
the second debt reduction payment for the final Cohort will be in the 14th year of
the program (being Year 10 of the final Cohort’s participation).

The unique nature of the Q student debt reduction program requires a set-aside of
as much as 14 years. The purpose of the Q Program is to attract and retain P
STEM employees, to grow P STEM businesses, and to advance STEM research,
education and investment in P for a period measured in decades, not a few years.
A survey of financial institutions in the student loan refinancing market reveals that
refinanced student loans are frequently of 10, 15 and even 20 year terms. The
typical refinanced student loan has a term of at least 10 years. Such individuals
must have confidence in the total grant commitment when they make the decision
to refinance through the T Refinance Program versus through another lender.

More importantly, the approximately one hundred twenty-eight (128) Q must have
complete confidence in your total grant commitment when they themselves commit
to living and working in P for a decade or more. Achieving the charitable purposes
of the program depends on individuals making this life-course decision. Q must
know that the funds to guarantee the program’s debt reduction payments have
been committed in a secure, identifiable and formal manner for the duration of
their loans, not just pledged and not just set aside for the first five years of the
program. The duration of the set-aside must match the loan terms of, and the
substantial level of commitment made by, participating STEM employees.

Further, the extended duration of a typical refinanced student loan is a reality
lenders must account for in deciding to participate in the Q Program and the T
Refinance Program. Under the T Refinance Program, the life of the refinanced
student loans is expected to be as much as 15 years. The success of the Q
Program depends heavily on the development of long-term contractual
commitments between T and a significant pool of qualified lenders providing loan
funding, underwriting, record keeping, and customer service to the program. It also
depends heavily on those lenders determining that the Q Program and the T
Refinance Program together support more generous repayment terms, lower
interest rates, and other favorable lending terms. Generous, highly competitive
lending terms are imperative to successfully attract a significant pool of STEM
employees willing to commit to living and working for 10 years in P in STEM
occupations.

Obviously lenders underwrite for, and commit to funding and servicing, the entire
life of a refinanced loan. As such, the set-aside period must extend for fourteen
(14) years and cannot be divided in successive five-year installments. A lender
does not underwrite for the first half of a refinanced student loan, and then re-
evaluate and underwrite anew the second half of the refinanced loan. Rather, the
duration of refinanced student debt requires an underwriting, lending, and
customer service process that takes into account, and obligates itself to, the full
life of the loan. To achieve the competitive loan terms and the pool of qualified
lenders needed to make the Q Program a success, your grant commitment must
mirror in duration the expected duration of the underlying refinanced student debt.

You state that none of Section 4942(g)(2), the associated regulations, or the

legislative history to Section 4942(g)(2) of the Tax Reform Act of 1969 prescribes
an outer limit or maximum duration for an extension of a set-aside. The legislative
history expressly states that an extension is appropriately granted when longer
term grants are necessary to support and to ensure the continuity of a particular
charitable program or program related investment. See House Report 91-413,
(Part I), 1st Session 1969-3 C.B. 216, 217-218. Further, the House Report states
that an extension would be appropriate where the State Attorney General would
undertake appropriate actions to ensure that the set-aside funds will be timely and
charitably distributed. Id., at 218. In this case, the Q Program is a complex, long-
term program and its charitable objectives cannot be achieved over a period of
time that is anything less than the expected duration of the underlying refinanced
student loans of the roughly one hundred twenty-eight (128) participating Q.
Further, as the Q Program is a collaborative endeavor between you and T, a State
agency, and the R, a Type I supporting organization formed to advance the
mission and purposes of T, the Attorney General would have a direct role in
ensuring your grant commitment is distributed in accordance with the program
requirements and the program’s charitable purposes.

Basis for our determination

Internal Revenue Code section 4942(g)(2)(A) states that an amount set aside for a
specific project, which includes one or more purposes described in section
170(c)(2)(B), may be treated as a qualifying distribution if it meets the
requirements of section 4942(g)(2)(B).

Internal Revenue Code section 4942(g)(2)(B) states that an amount set aside for a
specific project will meet the requirements of this subparagraph if, at the time of
the set-aside, the foundation establishes that the amount will be paid within five
years and either clause (i) or (ii) are satisfied.

Internal Revenue Code section 4942(g)(2)(B)(i) provides requirements for
approval of a set-aside for a specific project that will be paid out in 5 years. A
foundation must establish that the project is one that can better be accomplished
using the set-aside than by making an immediate payment. A set-aside also may
have its period to pay extended if it satisfies the requirements of section
4942(g)(2)(B)(i) of the Code and good cause is shown.

Section 53.4942(a)-3(b)(1) of the Foundations and Similar Excise Taxes
Regulations provides that a private foundation may establish a project as better
accomplished by a set-aside than by immediate payment if the set-aside satisfies
the suitability test described in section 53.4942(a)-3(b)(2).

Section 53.4942(a)-3(b)(2) of the Foundations and Similar Excise Taxes
Regulations provides that specific projects better accomplished using a set-aside
include, but are not limited to, projects where relatively long-term expenditures
must be made requiring more than one year’s income to assure their continuity.

Section 53.4942(a)-3(b)(7)(i)(e) of the Foundation and Similar Excise Taxes

Regulations provides that you must provide a statement showing good cause as to
why the set aside payment period should be extended, specifying the requested
extension of time.

In Revenue Ruling 74-450, 1974-2 C.B. 388, an operating foundation converted a
portion of newly acquired land into a public park under a four-year construction
contract. The construction contract payments were to be made mainly during the
final two years. This constituted a “specific project.” The foundation's set-aside of
all its excess earnings for four years was treated as a qualifying distribution under
Internal Revenue Code section 4942(g)(2).

What you must do

Your approved set-aside(s) will be documented on your records as pledges or
obligations to be paid by the date specified. The amounts set aside will be taken
into account to determine your minimum investment return under Internal Revenue
Code section 4942(e)(1)(A), and the income attributable to your set aside(s) will
also be taken into account in computing your adjusted net income under section
4942(f) of the Code.

Additional information

This determination is directed only to the organization that requested it. Internal
Revenue Code section 6110(k)(3) provides that it may not be used or cited as a
precedent.

Please keep a copy of this letter in your records.

If you have any questions, please contact the person listed in the heading of this
letter.

Sincerely,

Jeffrey I. Cooper
Director, Exempt Organizations
Rulings and Agreements

Enclosure