Tax Credit for Donations to Scholarship-Granting Organizations

Key Takeaways

• On Oct. 1, the IRS and Treasury Department issued temporary and proposed regulations implementing the Federal Scholarship Tax Credit ($1,700 per individual; $3,400 for those filing jointly) for donations to scholarship-granting organizations (SGOs). Certain government press materials refer to the credit as the "Education Freedom Tax Credit."
• With the Jan. 1, 2027 launch date just 90 days away, now is the time for schools, donors and SGOs to prepare for what is estimated by Treasury to be the transfer of more than $26 billion annually in federal tax dollars to support K-12 private and public education.
• 95 percent of students nationally (private and public school students) are expected to qualify for scholarships of any amount needed for qualified educational expenses.

Temporary and Proposed Regulations

In 2027, taxpayers are eligible to receive a nonrefundable full federal income tax credit for cash contributions to SGOs, limited to $1,700 per individual per taxable year, with a five-year carryforward. The proposed regulations allow a married couple filing jointly to claim up to $3,400 if each spouse makes a qualified contribution. Companion Section 139K excludes qualifying SGO scholarships from the gross income of the student and the student's family.

Comments are due Dec. 1, 2026.

On Oct. 2, Treasury and the IRS published Temporary regulations (T.D. 10057; Temp. Treas. Reg. §§ 1.25F-1T, 1.25F-4T and 1.25F-5T) setting forth the rules for state elections and SGO lists, SGO registration with the IRS, and donor acknowledgment and reporting. They apply as of Sept. 1 and expire by Oct. 1, 2029.

Proposed regulations (REG-117199-25; Prop. Treas. Reg. §§ 1.25F-0 through 1.25F-5) issued the same date repeat those rules and add others addressing the computation of the credit, the state-credit reduction, married-filing-jointly taxpayers, the 90 percent test and a segregated-account safe harbor, the meaning of "located in a state," multistate SGOs, income verification, student residence, disqualified persons, an annual audit requirement with a small-organization alternative, unique-donor-number reporting, and the definition of "school." The proposed rules may change before finalization. States, SGOs and taxpayers may rely on the proposed regulations for contributions made on or after Jan. 1, 2027, until final regulations are published, if they follow the portions that apply to them in their entirety and consistently.

The tax credit is available to every taxpayer through participating states, beginning Jan. 1, 2027. Scholarships are available to students who live in states that elect to participate.

The credit is available only for contributions to SGOs on the list submitted by a state that elects to participate. An Advance Election by a state is not enough by itself; the state must also submit its SGO list with the required certification by the deadline. For 2027, a state must file its Advance Election by Jan.1, 2027, and submit its SGO list by Feb. 15, 2027. As of Sept.14, the IRS listed 30 states that have made the election. Maryland and the District of Columbia have not elected in yet. A taxpayer in a nonparticipating state may still use the credit by making a contribution to an SGO listed by any participating state. However, an SGO listed by a state may only give scholarships to students who reside in that state.

Scholarships may benefit public and private school students.

Any student who is eligible to enroll in a public elementary or secondary school, whether or not actually enrolled in one, and whose household income does not exceed 300 percent of area median gross income is eligible for a scholarship to help cover qualified educational expenses. For example, an SGO may fund academic tutoring or special needs services for public school students and full or partial tuition for private school students.

Treasury and the IRS intend to issue regulations under Section 530(b)(3) to clarify the definition of "qualified elementary and secondary education expenses."

A state credit reduces the federal credit only for designated contributions.

The proposed regulations subtract a state credit from the donor's qualified contributions before applying the $1,700 cap and treat a state credit as allowed first for cash that the donor did not designate. Many donors therefore may claim both a state credit and the full federal credit.

Key Positions in the Temporary and Proposed Regulations

• 90 percent test and safe harbor. The 90 percent test is generally measured against the organization's total gross receipts from all sources, unreduced by expenses. A single-state SGO with at least 85 percent of its activities in scholarship-granting activities may instead use a safe harbor that measures the "income of the organization" by the qualified contributions received by, and earnings credited to, its Section 25F segregated account during the year. A multistate SGO must meet the 85 percent threshold and must satisfy the test separately for each state-specific account. An SGO has until the end of the following taxable year to spend 90 percent of a year's income, and amounts count when paid out in cash.
• "Located in a state." For Section 25F(g), an organization is located in a state if it is authorized to do business in that state and complies with generally applicable state charitable organization rules, including rules for transparency, accountability and fraud prevention. States will list SGOs operating in their state and may not impose substantive SGO-specific requirements more restrictive than Section 25F, such as limits on the type of school a recipient may attend or the types of qualified expenses. An SGO may appear on more than one participating state's list if it is located in each state and maintains a separate Section 25F account for each state.
• Income verification. Household income may be verified directly through pay stubs, tax returns, IRS transcripts, Form W-2 or other relevant data sources, or categorically through recent documentation that a household member is approved for or participates in one of five specified federal programs (SNAP, TANF, WIC, Section 8 housing, or SSI). Foster children satisfy the income requirement without separate verification.
• Audit. Each SGO must obtain an annual financial and programmatic audit by a qualified independent third party and provide it to each covered state on whose list it appears. Smaller SGOs may instead use an audit by a committee unrelated to management, signed under penalties of perjury.
• Donor identification. The SGO provides each donor, by Jan. 31 of the following year, a timely written acknowledgment of annual contributions, including the total amount and a unique donor number that the SGO creates under IRS instructions. The SGO reports each donor's name, address and total qualified contributions to the IRS by Feb. 28 using that number, and the donor generally reports the number on their federal return. The donor does not provide a Social Security number to the SGO.
• Definition of "school." Consistent with Tax Code Section 530, "school" means any school providing K-12 education as determined under state law. The proposed regulations do not separately address home schools, microschools or tribal schools. Treasury intends to issue guidance under Section 530 on the meaning of "school" and of qualified expenses.
• Qualified expenses. The proposed regulations do not add to or narrow the Section 530 list, which includes academic tutoring and special needs services. They prescribe how an SGO pays: Expenses charged by a school must be paid directly to the school, other vendors may be paid directly or through a qualified digital wallet, and a family may be reimbursed only against receipts. Guidance on eligible expenses under Section 530 is expected separately, as noted above.
• State list deadline for 2027. For 2027 only, a state must submit its Advance Election on Form 15714 on or before Jan. 1, 2027, and must perfect the election by submitting its SGO list on or before Feb. 15, 2027. SGOs that have not yet been granted exempt status by the IRS may be included on a state list as long as their exempt status will be effective no later than Jan. 1, 2027.
• Married couples. Spouses who file a joint return are treated as separate taxpayers. The joint return may show a credit of up to $3,400 if each spouse makes a qualified contribution of $1,700. This interpretation of the statute seems correct; the Joint Committee on Taxation previously stated that the "same $1,700 limit applies to single and joint filers."
• State tax credits. The federal credit equals the donor's qualified contributions, reduced by any state credit allowed for those contributions, and then capped at $1,700. A state credit is treated as allowed first for cash contributions that the donor did not designate as qualified contributions.
• Donor designation and reliance. A cash contribution is a qualified contribution only to the extent the donor designates it as one when making it. A donor may give to an SGO on any state's list, regardless of where the donor lives, and may rely on the IRS SGO list at the time of the gift. A contribution made through a partnership or S corporation does not qualify for any credit.
• Student residence. "Solely within the State" refers to where the student resides under state law, not where the school is located. Exceptions apply to dependents of members of the Armed Forces and to dependents of individuals residing on Indian lands.
• Disqualified persons. An SGO may not award a scholarship to a substantial contributor (more than $5,000 and more than 2 percent of the year's contributions), an officer, a director, a trustee, an individual who participates in selecting recipients, or a family member of any of them.

Key Features of Section 25F

Credit Rather Than Deduction

Section 25F allows a 100 percent credit for qualified cash contributions to SGOs. The credit is available only to individuals who are U.S. citizens or residents within the meaning of Section 7701(b). The credit is reduced by any amount allowed as a credit on a state tax return for the same contributions, as discussed below. Cash includes checks, credit and debit card payments, electronic transfers, and after-tax payroll deductions but not digital assets. An individual may not claim the credit for a contribution made by a partnership or S corporation. A contribution for which the credit is allowed may not also be deducted as a charitable contribution; the part of a qualified contribution that exceeds the credit may be deductible under Section 170.

The proposed regulations treat spouses who file a joint return as separate taxpayers, so a couple filing jointly may claim up to $3,400, as discussed below.

SGO Requirements

Qualifying SGOs must be exempt as a Section 501(c)(3) public charity and maintain separate accounts exclusively for qualified contributions and appear on a list of SGOs submitted by their state. The Section 25F(d) operational requirements for SGOs include:

• Providing scholarships to 10 or more students who do not all attend the same school
• Spending not less than 90 percent of the income of the organization on scholarships for eligible students
• Providing scholarships only for qualified elementary or secondary education expenses
• Giving priority to students awarded a scholarship the previous school year, and then to eligible students who have a sibling previously awarded a scholarship by the organization
• Not earmarking contributions for a scholarship for any specific student
• Verifying the annual household income (measured for the calendar year prior to the date of the scholarship application) and family size of applicants and limiting awards to eligible students within the income ceiling
• Not awarding scholarships to disqualified persons

The 90 Percent Test and Segregated-Fund Safe Harbor

The proposed regulations provide that an SGO must spend at least 90 percent of its income on scholarships. If an SGO's activities are at least 85 percent scholarship-granting activities (generally, whether or not pursuant to Section 25F), then the SGO may apply the 90 percent test to its segregated Section 25F account.

Audit, Reporting and Fraud Prevention

The proposed regulations require each SGO to obtain an annual financial and programmatic audit by a qualified independent third party and to provide it to each covered state on whose list the SGO appears. An SGO whose total receipts for the year did not exceed $500,000 may have the audit conducted by a committee of independent persons unrelated to the organization's management, with the report signed under penalties of perjury.

Qualified Expenses

Qualified expenses are defined by cross-reference. Section 25F(c)(4) adopts the expenses described in Section 530(b)(3)(A), relating to Coverdell education savings accounts. That provision has three parts. Clause (i) covers tuition, fees, academic tutoring, special needs services, books, supplies and other equipment incurred in connection with enrollment in or attendance at a public, private or religious school. Clause (ii) covers room and board, uniforms, transportation and supplementary items and services, including extended-day programs, but only if required or provided by the school in connection with enrollment or attendance. Clause (iii) covers computer technology or equipment, Internet access and related services used by the student and the student's family during school years, excluding sports, game or hobby software unless predominantly educational.

The proposed regulations define "school" consistent with Section 530, to mean any school providing K-12 education as determined under state law. The IRS and Treasury have stated that they intend to issue clarifying regulations under Section 530 as soon as possible.

Prohibition on Awards to Disqualified Persons

The proposed regulations generally prohibit scholarships to a disqualified person or disqualified person's family member. Disqualified persons generally include substantial contributors (more than $5,000 contributed to the SGO during the taxable year if such amount is more than 2 percent of the SGO's contribution income); officers, directors or trustees of the SGO; scholarship committee members; and family members of the foregoing.

Coordination with State Tax Credits

The federal tax credit is reduced by "the amount allowed as a credit on any State tax return of the taxpayer for qualified contributions made by the taxpayer during the taxable year" (Section 25F(b)(2)). The proposed regulations apply the reduction in three steps: (1) total the donor's qualified contributions for the year, (2) subtract any state credits allowed for those qualified contributions, and (3) take the lesser of the result or $1,700. Two features of the computation favor donors. First, a contribution is a qualified contribution only to the extent the donor designates it as one, and a state credit for a contribution that is not a qualified contribution is not subtracted. If a state credit is allowed for a donor's cash contributions to an SGO that include both designated and undesignated amounts, the credit is treated as allowed first for the undesignated amount. Second, the state credit is subtracted before the $1,700 cap is applied, so a donor who designates more than $1,700 may absorb a state credit without losing any federal credit.

For example, a Virginia donor contributes $11,700 in cash to an SGO that is on Virginia's Section 25F list and is also an approved scholarship foundation under Virginia's credit program. The donor designates $1,700 as a qualified contribution and claims Virginia's 65 percent credit on the other $10,000. The $6,500 Virginia credit is treated as allowed for the $10,000 that the donor did not designate, and the federal credit is $1,700.

The proposed regulations include two examples. In the first, a donor designates a total of $2,000 to two SGOs and claims a $400 state credit for those contributions; the federal credit is $1,600. In the second, a donor gives $4,000 to one SGO, designates $1,700 and claims a $400 state credit on the full $4,000; the state credit is treated as allowed from the $2,300 that the donor did not designate, and the federal credit is $1,700.

Ohio's credit under R.C. 5747.73 is allowed only for cash donations to a certified SGO, up to $750 per individual. Under the proposed regulations, an Ohio donor seeking both state and federal credits does not need to direct the Ohio cash gift to a different organization. A donor who gives $2,450 in cash to an SGO that is both state-certified and on Ohio's federal Section 25F list and designates $1,700 as a qualified contribution has a $750 Ohio credit that is treated as allowed for the undesignated $750 and a federal credit of $1,700. A donor who gives and designates only $1,700 and claims the $750 Ohio credit on that gift has a federal credit of $950.

Donor Eligibility, Student Eligibility and 'Located in a State'

A qualified contribution is cash to an SGO that uses the contribution to fund scholarships for eligible students solely within the state in which the organization is listed. A state becomes a covered state only by voluntarily electing to participate and submitting a certified list of qualifying SGOs located in the state. The temporary regulations provide that an organization is "located in a state" if it is authorized to do business in that state and complies with generally applicable state charitable organization rules, including rules for transparency, accountability and fraud prevention. At the same time, a state may not impose substantive SGO-specific requirements that are more restrictive than Section 25F's requirements. The proposed regulations also provide a path for multistate operation: An SGO may be listed on more than one participating state's SGO list as long as it is located in each such state and maintains a separate Section 25F account for each state. A donor to a multistate SGO chooses the state account or accounts to which the contribution is allocated. The operational requirements apply separately to each state account, and at least 85 percent of the multistate SGO's activities as a whole must be scholarship-granting activities.

Section 25F(c)(3) requires that contributions fund scholarships for students "solely within the State," but the statute does not clarify whether that refers to the student's residence, the school's location or both. The proposed regulations provide that it is the student's residence, determined under state law, that must be within the state. Attending school or buying goods or services in the state is not sufficient. Two exceptions apply. A dependent of a member of the Armed Forces is treated as within both the state of the student's domicile and the state where the member resides. A dependent of an individual residing on Indian lands is treated as within both the state of the student's residence and the state where the student attends school.

For example, if Maryland elects to participate and the District of Columbia does not, an SGO on Maryland's list may award a scholarship to a Maryland resident who attends school in the district but not to a district resident who attends school in Maryland. A district resident may still claim the credit for a contribution to the Maryland-listed SGO (or any other SGO on any state list). An organization based in the district may appear on Maryland's list in such a situation if it maintains a segregated account for Maryland scholarships, is authorized to do business in Maryland and complies with Maryland's generally applicable charitable organization rules.

Donor Identification and IRS Matching

An SGO must provide each donor with a timely written acknowledgment of the donor's annual contributions, including the total amount of qualified contributions and a unique donor number. SGOs are required to provide that information no later than the end of January following the calendar year of the donor's qualified contribution. The SGO also must annually report to the IRS, by Feb. 28 of the year following the year of the qualified contribution, the unique donor number, donor's address and amount of contribution. Finally, SGOs must make various annual certifications to the IRS.

Technology, Intellectual Property, Privacy and Public Schools

SGOs should confirm in their contract with their technology vendor that either the SGO or the appropriate school or school affiliate entity owns the donor and student data, that the data is portable if the SGO changes vendors and that the SGO has audit rights over the vendor's records.

Schools that will partner with an SGO should obtain and review the SGO's vendor agreement for data ownership, security and privacy terms, and consider negotiating cobranded giving pages and acknowledgments that protect the school's relationship with students, their families and donors. Schools should also consider the SGO's policy on school designations of donor funds and on redeployment of designated funds as scholarships. Schools should begin donor education on how the credit may work with state programs and how any donation to an SGO for a federal tax credit should be in addition to existing annual giving.

Public school systems and their foundations should assess whether the school district's foundation or a regional SGO may be used to satisfy the Section 25F(d) operational requirements. A number of public school systems are preparing to use SGO scholarships to fund high-impact tutoring and other programs for public school students.

Current State Participation

As of Oct. 1, the IRS listed 30 states as having made an Advance Election to participate under Section 25F for 2027: Alabama, Alaska, Arkansas, Colorado, Florida, Georgia, Idaho, Indiana, Iowa, Kansas, Kentucky, Louisiana, Mississippi, Missouri, Montana, Nebraska, Nevada, New Hampshire, North Carolina, North Dakota, Ohio, Oklahoma, South Carolina, South Dakota, Tennessee, Texas, Utah, Virginia, West Virginia and Wyoming. Arizona, California, the District of Columbia, Illinois, Maryland, New Jersey, New York and Pennsylvania were not on the list.

Section 139K Income Exclusion

Amounts provided to an individual, or to any dependent of the individual, pursuant to a scholarship from a qualifying SGO for qualified elementary or secondary education expenses of an eligible student are excluded from gross income under companion Section 139K. Parents therefore are not taxed on scholarships that pay their children's expenses. The exclusion applies to amounts received after Dec. 31.

Married Couples Filing Jointly and the $1,700 Cap

Section 25F(b)(1) limits the credit to $1,700 for "any taxpayer for any taxable year" but does not specifically state whether spouses on a joint return are one taxpayer or two. The proposed regulations treat married taxpayers who file a joint return as separate taxpayers. A couple therefore may claim up to $3,400 on a joint return if each spouse makes a qualified contribution of $1,700. In the regulation's example, each spouse contributes, designates the contribution and receives an acknowledgment from the SGO. A couple therefore should make and document two separate gifts. This is a proposed rule and could change in the final regulations. We believe the proposed regulations reflect the best interpretation of the statute on this point. The Joint Committee on Taxation's explanation of the statute states that the $1,700 limit applies on a per-taxpayer basis, "including in the case of a joint return." Taxpayers may rely on the regulations and take a $3,400 credit on a joint tax return.

Public School Students May Use the Program

Public school students in qualifying households may receive scholarships and may use the funds for school fees, academic tutoring, special needs services, books, supplies and equipment incurred in connection with enrollment or attendance at their school. Room and board, uniforms, transportation and supplementary items and services, including extended-day programs, may be covered when required or provided by the school. Computer technology, Internet access and educational software used by the student and family during school years also may be covered.

Under a safe harbor, an SGO that funds individual academic tutoring, or special needs services for a special needs student, at a school in a low-income area need not verify household income if the school selects the student based on academic or special need. The school must be located in a Department of Housing and Urban Development-qualified census tract or certify that at least 80 percent of its students live in one. The SGO must obtain an annual third-party audit that covers the school's eligibility, the selection of students, the providers' qualifications, an independent diagnosis of each student's need, and the quality and results of the services. For a scholarship based on need for tutoring or special needs services, an SGO may set priority by need for the services instead of by prior-recipient or sibling status.

Issues the Proposed Regulations Leave Unresolved or Fail to Specifically Address

Items not specifically addressed include:

• The detailed scope of Section 530 qualified expenses and the definition of "school," which Treasury will address in separate guidance before the end of 2026
• Whether a donor may designate a contribution for a particular school, parish, district or program (we believe the answer is clearly yes)
• How an organization should measure whether 85 percent of its activities are scholarship-granting activities
• Whether "gross receipts" is a permissible gloss on the statutory term "income"
• Whether pass-through fundraising organizations may qualify as SGOs
• The treatment of home schools, microschools and nonschool extended-day providers
• Whether state and tribal needs-based programs will be added to the categorical income verification method
• What procedures, beyond a qualified digital wallet, are sufficient to prevent duplicate awards
• The procedure for a state that makes its first election for a year after 2027, which the temporary regulations leave to future guidance

Comment Period

The proposed regulations invite comments received within 60 days after Federal Register publication. A public hearing will be held on Dec. 15 at 10 a.m. EST at the IRS building in Washington, with a telephone option. Comments may be submitted through the federal Rulemaking portal at regulations.gov under docket REG-117199-25. Treasury has requested comments on all aspects of the proposed regulations and specifically on (1) the definition of a qualified digital wallet and whether to add other safe harbors for verifying expenses; (2) how an organization should measure its scholarship-granting activities and whether 85 percent is a reasonable threshold; (3) how the Section 501(c)(3) requirements interact with Section 25F; (4) other needs-based programs, such as state or tribal programs, to include in the categorical income verification method; (5) the certifications states must make, including for multistate SGOs, and whether any is disproportionately burdensome; and (6) whether less burdensome alternatives would adequately mitigate the risk of fraud or improper payment of scholarships.

Prospective SGOs that find a proposed requirement impracticable, such as the cost of a third-party audit for a small or newly formed organization, should provide comments, ideally with an alternative rule. Schools, dioceses and foundations that cannot meet the 85 percent threshold should consider commenting on the gross receipts definition of "income." Tutors, extended-day and after-school providers, and other education service providers should consider commenting on the treatment of their services as qualified expenses, both in this rulemaking and when Treasury issues the Section 530 guidance.

Effective Date and Reliance

The credit under Section 25F is effective for taxable years ending after Dec.31, and the Section 139K exclusion applies to amounts received after that date. As a practical matter, the program operates on a calendar-year basis beginning in 2027, with state election and SGO listing required before a donor may claim the credit for a contribution to an SGO in a state.

The temporary regulations apply as of Sept. 1 and expire by Oct. 1, 2029. If finalized, the proposed regulations would apply for taxable years ending on or after the date final regulations are published in the Federal Register. The preamble provides that taxpayers, SGOs and states may rely on the proposed regulations for qualified contributions made on or after Jan. 1, 2027, in taxable years ending before that date, provided they follow the portions of the proposed regulations that apply to them in their entirety and in a consistent manner.