Today, the Treasury Department and the IRS released proposed regulations for the new federal scholarship tax credit (Section 25F, the FSTC, the Education Freedom Tax Credit; take your pick). The statute written into the One Big Beautiful Bill left a lot open to interpretation, and the field has been waiting months to see which way Treasury would lean.
The answer: Where the law was ambiguous, the proposed rules generally chose readings that allow more donations and make it easier for Scholarship Granting Organizations (SGOs) to operate. Treasury projects more than 11 million taxpayers giving roughly $26 billion a year by 2030, enough for about 2 million full-time scholarships.
Some of the rules are clear now. Others will take more guidance or will be worked out during implementation. Here’s what we know so far, from what’s settled to what’s still open:
Settled. The $1,700 cap applies to each individual, so a married couple filing jointly can claim up to $3,400 if each spouse gives $1,700. Any state scholarship credit is subtracted from the gift before the federal cap applies, which benefits donors in states with their own scholarship credits. Unused credit carries forward for up to five years.
Treasury also defines broadly where an SGO is “located.” An SGO only needs to be authorized to do business in the state and follow its charity laws. It does not need a headquarters or staff there, and states cannot add stricter requirements. As a result, national organizations can operate in several states, as long as they have a separate account for each one.
Settled, with requirements specified. The statute says little about how scholarships are paid, and the proposed rules set out three options. SGOs can reimburse families who submit a receipt, pay schools directly for tuition and related charges, or pay verified vendors that are not related to the student. The rules also define a “qualified digital wallet,” a third-party platform that approves vendors, tracks expenses, and pays vendors or collects receipts.
SGOs also get some flexibility on operating requirements. One of the most-discussed requirements has been that 90% of SGO income go to scholarships for eligible students. However, the new rules allow a single-state SGO that does at least 85% scholarship work to set up a separate account for federal tax credit scholarships—a “25F account”—and apply those requirements to that account instead of the whole organization. The segregated account, recordkeeping, reporting, and oversight requirements still apply, but the proposed regulations let an organization apply that test to its 25F account alone.
Not yet settled. State law determines what counts as a “school.” That is straightforward for public, charter, and private schools. It is less clear for homeschools, micro-schools, and other models, because not every state treats them as schools. Qualified expenses must be tied to a student’s enrollment at a school, so the same question affects what families can buy with a scholarship. Treasury says further guidance on schools and qualified expenses under the federal statute governing Coverdell accounts, which Section 25F borrows from, is a high priority and is forthcoming.
Additionally, a safe harbor lets SGOs skip household income verification for tutoring and special needs scholarships at schools in low-income areas. In exchange, the SGO must give the state an annual third-party audit. The audit must certify, among other things, that services “met appropriate quality standards.” Commenters will likely ask Treasury to define those standards.
A key feature of the new federal program—one that’s been drawing interest from Democratic governors around the country—is that public school students are eligible to benefit. The rules do not explicitly place new duties on school districts. However, SGOs will need enrollment confirmations from schools and, under the safe harbor, student selections and supporting documentation. Districts do not yet have a process for providing this information.
The IRS also needs to build the systems the program depends on. These include a portal for SGO registration, a portal for state elections and certifications, and a system of unique donor numbers. None of these exist yet.
These proposed rules open a 60-day comment period that runs from their October 2 publication in the Federal Register, with a public hearing on December 15 at 10 a.m. ET (requests to attend are due December 10).
We’ll keep watching as the rules take shape, and if you’re trying to figure out what this means for your organization, we’d love to talk it through.
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