New Guidance Regarding Scholarship Granting Organizations

On October 2, 2026, the Treasury Department (“Treasury”) and Internal Revenue Service (“IRS”) issued Proposed Treasury Regulations and Temporary Treasury Regulations (“Regulations Package”) implementing the Internal Revenue Code (“IRC”) §25F tax credit for qualified contributions to scholarship granting organizations (“SGOs”).[1] SGOs are IRC §501(c)(3) tax-exempt organizations that fund scholarships to eligible students for qualified elementary or secondary education expenses. The §25F tax credit program (“Federal Scholarship Tax Credit Program”) is effective beginning in 2027.[2]

A State must elect to participate in the Federal Scholarship Tax Credit Program on an annual basis for any organization located in the State to be treated as an SGO for the applicable year.[3] Massachusetts has not yet elected to participate in the program for 2027, and it is unknown whether Massachusetts will make the election.

A State has until January 1, 2027, to elect to participate for 2027, and until February 15, 2027, to perfect its election by submitting its list of eligible SGOs for the year (“State SGO list”) to the IRS.[4] Thirty States have elected to participate in the program to date.[5]

Krokidas & Bluestein LLP previously published an alert regarding the Federal Scholarship Tax Credit Program, including certain preliminary guidance issued by the IRS in respect of the program.

The Regulations Package provides detailed guidance regarding the requirements that participating States, SGOs, and donors must satisfy in respect of the Federal Scholarship Tax Credit Program. An organization considering SGO status should be prepared to undertake significant ongoing compliance obligations. Comments on the Proposed Regulations are due by December 1, 2026.

Certain Key Provisions of the Regulations Package

SGO Must Be Located in the State

An SGO must be included on the State SGO list(s) of one or more States “in which the organization is located”.[6] Under the Temporary Regulations, an organization is located in a State if the organization is authorized to do business in the State and is in compliance with the generally applicable State laws and requirements for charitable organizations in the State, including provisions for transparency, accountability, and fraud prevention.[7] Therefore, an SGO can be “located” in more than one State for this purpose so long as it satisfies the foregoing requirements in each State.

A single-State SGO is an SGO included on the State SGO list of only one State.[8] A multistate SGO is an SGO included on the State SGO list of more than one State.[9]

State Determination of SGO Status

A State that elects to participate in the Federal Scholarship Tax Credit Program is required to certify to the IRS that each SGO on its State SGO list is located in the State and make a number of additional certifications regarding each SGO on the list.[10] A State must make its own determination that an SGO satisfies applicable requirements and cannot rely on self-certification by the organization.[11]

An SGO is required to be an IRC §501(c)(3) tax-exempt organization that is not a private foundation.[12] The Proposed Regulations permit an organization to be named on a State SGO list while its IRS Form 1023 Application for Recognition of Exemption Under IRC §501(c)(3) is pending if the State makes certain certifications to the IRS including that:[13]

1. The organization has applied for, but has not yet received, tax-exempt status under §501(c)(3); and
2. The organization’s tax-exempt status, if granted, will be effective retroactively to a date that is on or before January 1 of the year for which the State SGO list applies.

SGO Required to Register With IRS to be Included on IRS SGO List

An organization that plans to solicit qualified contributions as an SGO must electronically register with the IRS through an IRS SGO portal. This registration will allow the organization to obtain instructions for creating a unique donor number in a uniform format to be used by all SGOs, authorize disclosure of its name and identifying information on the IRS SGO list, and report qualified contribution information.[14] Until an organization has registered in the IRS SGO portal, the organization will not be able to comply with the required acknowledgment and reporting requirements, which is a necessary part of substantiating that a donor’s qualified contribution is eligible for the §25F credit.[15]

Scholarships Solely for “Qualified Elementary or Secondary Education Expenses” and the definition of “School”

An SGO must provide scholarships for “qualified elementary or secondary education expenses” and verify that scholarships are used solely for this purpose.[16] The preamble states that Treasury and the IRS have received many comments requesting guidance that will clarify the meaning of qualified expenses and school and that such guidance is intended to be issued as soon as possible so that taxpayers may rely on it. [17]

Under the Proposed Regulations, “qualified elementary or secondary education expenses” means any expense of an eligible student that is described in IRC §530(b)(3)(A) and any guidance thereunder.[18]

As a general matter, IRC §530(b)(3)(A) defines "qualified elementary and secondary education expenses" to mean:

1. Expenses for tuition, fees, academic tutoring, special needs services in the case of a special needs beneficiary, books, supplies, and other equipment which are incurred in connection with the enrollment or attendance of the designated beneficiary as an elementary or secondary school student at a public, private, or religious school;
2. Expenses for room and board, uniforms, transportation, and supplementary items and services (including extended day programs) which are required or provided by a public, private, or religious school in connection with such enrollment or attendance; and
3. Expenses for the purchase of any computer technology or equipment or internet access and related services, if such technology, equipment, or services are to be used by the beneficiary and the beneficiary's family during any of the years the beneficiary is in school.

The Proposed Regulations provide that “school” – which is used in §530(b)(3)(A) in relation to qualified expenses as well as in certain other §25F requirements – has the definition set forth in IRC §530(b)(3)(B) and any guidance issued thereunder.[19] IRC §530(b)(3)(B) defines "school" to mean any school which provides elementary education or secondary education (kindergarten through grade 12), as determined under State law.

As set forth above, according to the preamble to the Proposed Regulations, additional guidance on the meaning of “qualified elementary or secondary education expenses” and “school” is expected to be issued.

Scholarships for Eligible Students “Solely Within the State”

An SGO must fund scholarships for eligible students “solely within the State” on whose State SGO list the SGO is included.[20] An eligible student is considered solely within a State only if the eligible student resides in that State in accordance with State law.[21] Attending school in a State or purchasing goods or services in a State is not sufficient to treat the student as being solely within the State.[22]

For example, assume an SGO is named on the State SGO list of only State X for 2027. Student A that resides in State X and attends school in State Y is an eligible student solely within State X for purposes of §25F. However, if Student B both resides and attends school in State Y, Student B is not an eligible student solely within State X for purposes of §25F.[23] The SGO could award a scholarship to Student A (assuming all the other applicable requirements are met), but not Student B.

Eligible Students – Household Income Limit

A student is eligible for an SGO scholarship only if the student is a member of a household with an income that, for the calendar year prior to the date of the application for a scholarship, is not greater than 300% of the area median gross income determined based on area median gross income and family size in accordance with section 8 of the United States Housing Act of 1937.[24] The Proposed Regulations require an SGO to verify that a student satisfies the income eligibility requirement.[25]

Qualified Contribution – Designation by Donor

To be a qualified contribution, the donor must designate to the SGO, at the time of making the contribution, that the contribution is intended to be a qualified contribution for purposes of §25F, and the designation once made is irrevocable.[26] An individual may make a qualified contribution to any SGO on any State SGO list regardless of the individual’s State of residence.[27] An individual may rely on the SGO’s presence on the IRS SGO list at the time of the contribution to establish that the organization is an SGO.[28]

Qualified Contributions - Acknowledgement and Reporting by SGO to Donor and IRS

An SGO must provide a written acknowledgment to each donor that includes, among other information, the total amount of contributions made by the donor to the organization during the calendar year that the donor designated as qualified contributions and the unique donor number the SGO is required to create through the IRS SGO portal.[29] The written acknowledgment must be provided by the SGO to the donor no later than January 31st of the calendar year following the calendar year in which a donor made a qualified contribution to the organization.[30]

An SGO is also required to report information regarding qualified contributions to the IRS on an annual basis with respect to each unique donor number assigned to the SGO.[31] The information must be reported to the IRS no later than February 28th of the year following the year in which the qualified contributions were made.[32]

Qualified Contributions - Reporting and Substantiation by the Donor on Tax Return

A taxpayer who claims the §25F credit on the taxpayer’s federal income tax return must substantiate the credit on IRS Form 8525, Federal Scholarship Tax Credit, by reporting such information as may be required in the form and instructions, including, for each SGO to which the taxpayer has made a qualified contribution during the taxable year, the unique donor number that the SGO was required to provide to the donor in its written acknowledgment.[33] A taxpayer that does not provide the required donor number for an SGO on its IRS Form 8525 will be presumed not to have made a qualified contribution to that SGO. [34]

No Scholarships to Disqualified Persons

An SGO is not permitted to award a scholarship to any disqualified person, which means:[35]

1. Substantial contributors to the SGO or to the §25F segregated account as discussed below;
2. An officer, director, or trustee of the SGO, or an individual having powers and responsibilities similar to those persons;
3. Any individual participating in, including as a member of a committee, the selection of scholarship recipients or the determination of scholarship awards; and
4. A member of the family of any of the foregoing persons.

Proposed Regulations §1.25F-3(d) provides detailed rules further defining each category of disqualified person, including the timing for determining substantial contributor status.

SGO Must Maintain §25F Segregated Account(s)

SGOs are required to prevent the co-mingling of qualified contributions with other accounts by maintaining a §25F segregated account, which must contain only qualified contributions and the earnings therefrom.[36] The SGO must deposit all qualified contributions into its §25F segregated account and maintain a complete set of books and records for the account. [37] A multistate SGO must maintain a separate §25F segregated account for each covered State on whose State SGO list the SGO appears.[38]

90% Income Spending Requirement

An SGO must spend not less than 90% of the income of the organization on scholarships for eligible students solely within the State (“90% Income Spending Requirement”).[39] Proposed Regulations §1.25F-3(c)(4) provides further detail with respect to this requirement, including:

1. Income of the organization means the total gross receipts of the organization from all sources computed using the cash receipts and disbursements method of accounting during its annual accounting period, unreduced by any expenses, regardless of the overall method used by the organization in its books and records;
2. An organization must meet the 90% Income Spending Requirement as of the last day of the taxable year following the taxable year in which such income is received. As a result, satisfaction of the 90% Income Spending Requirement for the SGO’s first year of operation does not need to be met until the end of its second year of operation; and
3. Amounts are treated as spent when paid under the cash method of accounting. Amounts are treated as paid from contributions and other income received in the earliest year first, and then from the subsequent years in chronological order.

85% Safe Harbor for Single-State SGO

If at least 85% of a single-State SGO’s activities consist of scholarship granting activities (whether pursuant to §25F, in accordance with State tax credit scholarship rules, or any other scholarship granting activities), the SGO may apply the required operational requirements to the organization’s §25F segregated account, rather than to the organization as a whole.[40] For this purpose, administrative, fundraising, governance, investment, compliance, outreach, and other activities are treated as scholarship granting activities to the extent each such activity is conducted in support of scholarship granting activities.

For a single-State SGO using the 85% safe harbor, income of the organization for purposes of the 90% Income Spending Requirement means the total amount of qualified contributions received by, and earnings credited to, the §25F segregated account during the taxable year.[41]

A single-State SGO using the safe harbor still must meet the requirement that the organization not award scholarships to any disqualified person tested at the level of the organization as a whole, as well as at the §25F segregated account level.[42]

Multistate SGOs

At least 85% of a multistate SGO’s activities must consist of scholarship granting activities (whether pursuant to §25F, in accordance with State tax credit scholarship rules, or any other scholarship granting activities).[43] Under Proposed Regulation §1.25F-3(c)(3):

1. As set forth above, a multistate SGO must maintain a separate §25F segregated account for each covered State on whose State SGO list the SGO appears;
2. The SGO must allow donors to designate how their qualified contribution should be allocated among one or more of those covered States, and all qualified contributions must be deposited into the SGO’s §25F account for one or more of those covered States in accordance with the donor designations;
3. The SGO must maintain a complete set of books and records for its §25F segregated account for each covered State on whose State SGO list the SGO appears.
4. The SGO must meet the operational requirements for SGOs separately for its §25F segregated account for each covered State, and
5. The requirement that the organization not award scholarships to any disqualified person must be met considering the organization as a whole, and also must be tested and satisfied at the level of the §25F segregated account for each covered State.[44]

For a multistate SGO, the 90% Income Spending Requirement is determined separately for the §25F segregated account for each covered State.[45]

New Annual Financial and Programmatic Audit Requirement

The Proposed Regulations impose a new annual audit requirement on SGOs. Each organization that was an SGO during any part of the preceding taxable year must undergo an annual financial and programmatic audit by a qualified independent third party and provide the audit results to each covered State on whose State SGO list the SGO appeared.[46] If the organization’s total receipts (whether or not required to be deposited in its §25F segregated account) for the most recent taxable year were more than $500,000, the organization must hire an external, independent professional or accredited body that regularly assesses an organization’s compliance, financial records, or processes (including internal controls) against specific standards to perform the required audit.[47]

The scope of the required SGO audit is comprehensive and must cover at a minimum:[48]

1. The organization's procedures for soliciting scholarship applications or otherwise identifying possible scholarship recipients from eligible students in the State, for verifying each such student's eligibility, and for processing scholarship applications;
2. The organization's procedures for selecting scholarship recipients, including procedures to establish priority for students previously awarded a scholarship and then any eligible students who have a sibling who was awarded a scholarship from such organization, and procedures to prevent the award of a scholarship to a disqualified person;
3. The organization's procedures for determining the amount of the scholarship awarded to each recipient;
4. The method(s) the organization uses to track how scholarship money for qualified elementary and secondary education expenses is paid (whether by direct payment, through a qualified digital wallet,[49] or by reimbursement);
5. Verification that scholarship expenses were qualified elementary and secondary education expenses;
6. Verification that the organization is located within the State; and
7. Verification that the organization met all of the applicable operations requirements for being an SGO.

Additional Requirements for States and SGOs Regarding Registering with the IRS and Complying with Required Information Reporting and Certification Requirements

The Regulations Package contains a number of additional detailed provisions addressing the process by which a State electing to participate in the Federal Scholarship Tax Credit Program registers with the IRS, makes an annual election to participate in the program, reports required information and makes required certifications to the IRS and updates[50] its SGO list for a year.

Similarly, the Regulations Package contains detailed rules for an organization to register with the IRS to be an SGO, and report required information and make certifications to the IRS and the State(s) on whose State SGO list(s) the SGO appears.

If you have any questions about the Regulations Package, please reach out to K&B Nonprofit or Education attorneys, Elka Sachs (esachs@kb-law.com), Jonathan Cohen (jcohen@kb-law.com), or Marguerite Lombardo (mlombardo@kb-law.com).

Krokidas & Bluestein’s Nonprofit Law Practice provides a full array of advice and guidance to nonprofit organizations of all types, on a wide range of legal matters, including tax exemption, nonprofit governance, public charities law, mergers, acquisitions and corporate affiliations, regulatory and compliance matters, employment, real estate, financing and litigation.

Krokidas & Bluestein LLP’s Education Law Practice provides a full array of advice and guidance to charter schools and other education entities on a wide range of legal matters, including student discipline, special education, employment, governance, tax, regulatory and compliance matters, real estate, financing and litigation.

[1] An individual taxpayer is eligible for up to a $1,700 nonrefundable tax credit ($3,400 on a combined basis for married taxpayers filing a joint return). Proposed Regulations §1.25F-2 includes a number of provisions addressing technical aspects of calculating the §25F credit.

[2] The Temporary Regulations are effective on December 1, 2026, and retroactively applicable to September 1, 2026. The Proposed Regulations are proposed to apply to taxable years ending on or after the date on which the final regulations are published. However, taxpayers, organizations, and States may rely on the Proposed Regulations for qualified contributions made on or after January 1, 2027, in taxable years ending before the date the final regulations are published, provided that taxpayers, organizations, and States follow the portions of the proposed regulations applicable to each in their entirety and in a consistent manner. The Temporary Regulations were also concurrently published as Proposed Regulations and therefore are subject to comment.

[3] A State could elect to participate in the Federal Scholarship Tax Credit Program for one year, but not another. §1.25F-5T(c) The preamble to the Proposed Regulations states that many stakeholders believe that States should not be able to opt out on a year-to-year basis, as families and students will rely on these scholarships for multiple years. However, according to the preamble, Treasury and the IRS believe an annual election is consistent with the IRC §25F statutory requirements.

[4] §1.25F-5T(c)(3(i)(B)(1) and §1.25F-5T(c)(3)(ii)(B). These are special deadlines for the first year of the program. Different deadlines apply for subsequent years.

[5] The IRS has published a list of States that have elected to participate on its website: Federal Scholarship Tax Credit (FSTC) - Participating states | Internal Revenue Service

[6] IRC §25F(c)(5)(D) and §25F(g)(1)(A); Proposed Regulations §1.25F-3(b)(5).

[7] §1.25F-1T(a)(10).

[8] §1.25F-1T(a)(20).

[9] §1.25F-1T(a)(11).

[10] §1.25F-5T. Temporary Regulation §1.25F-5T(d)(2) and (d)(3) set forth the information and certifications, respectively, that a State must provide to the IRS with respect to an SGO named on its State SGO list.

[11] The preamble to the Proposed Regulations states that many stakeholders favored self-attestation by SGOs that they meet the applicable requirements so as to avoid the need for any State-level review process, stating that requiring States to verify compliance is overly burdensome and could discourage participation. However, Treasury and the IRS interpret §25F(g) as requiring each covered State to verify that each organization on the State’s SGO list satisfies the applicable requirements.

[12] IRC §25F(c)(5)(A); Proposed Regulations §1.25F-3(b)(1).

[13] §1.25F-5T(d)(5).

[14] §1.25F-4T(b)(1).

[15] §1.25F-4T(b)(2).

[16] §25F(d)(1)(C); Proposed Regulations §1.25F-3(c)(1)(iii). Proposed Regulations §1.25F-3(c)(5) prescribes procedures an SGO must use to verify use of scholarship funds.

[17] This guidance will be issued under IRC §530(b)(3) (addressing Coverdell education savings accounts), which IRC §25F(c)(4) refers to as describing “qualified elementary or secondary education expenses” for purposes of the Federal Scholarship Tax Credit Program.

[18] Proposed Regulations §1.25F-1(a)(14).

[19] Proposed Regulations §1.25F-1(a)(17).

[20] §25F(c)(3); Proposed Regulations §1.25F-3(c)(1)(v).

[21] Proposed Regulations §1.25F-3(c)(7)(i).

[22] Proposed Regulations §1.25F-3(c)(7)(i).

[23] Proposed Regulations §1.25F-3(c)(7)(iii)(A), Example 1. The Proposed Regulations also include an example of the requirement that a student be “solely within the State” for a multistate SGO in Proposed Regulations §1.25F-3(c)(7)(iii)(B), Example 2.

[24] IRC §25F(c)(2)(A); Proposed Regulation §1.25F-3(c)(6). Area median income data is accessible on the U.S. Department of Housing and Urban Development’s portal.

[25] Proposed Regulation §1.25F-3(c)(6).

[26] Proposed Regulations §1.25F-1(a)(12)(i). A qualified contribution must be made in “cash” defined as physical currency, check, money order, electronic transfer, after-tax payroll deduction, or other similar method, in each case all in U.S. dollars, but does not include any digital asset. Proposed Regulations §1.25F-1(a)(12)(iii). An individual must directly make the qualified contribution to the SGO and cannot claim a §25F credit for a contribution made through a partnership or S-corporation for U.S. federal income tax purposes. Proposed Regulations §1.25F-2(a)(3).

[27] Proposed Regulations §1.25F-2(a)(1).

[28] Proposed Regulations §1.25F-2(a)(1). A taxpayer may not rely on the IRS SGO list in certain narrow circumstances, including if the taxpayer knows the organization did not satisfy applicable requirements to be an SGO. Proposed Regulations §1.25F-2(b)(2).

[29] §1.25F-4T(c)(1)(i).

[30] §1.25F-4T(c)(1)(ii).

[31] §1.25F-4T(c)(2)(i).

[32] §1.25F-4T(c)(2)(ii).

[33] Proposed Regulations §1.25F-2(g)(1).

[34] Proposed Regulations §1.25F-2(g)(2). The taxpayer will have the ability to rebut the presumption by providing certain documentation satisfactory to the IRS.

[35] IRC §25F(d)(2); Proposed Regulations §1.25F-3(d)(1).

[36] IRC §25F(c)(5)(B); Proposed Regulation §1.25F-3(b)(2).

[37] Proposed Regulations §1.25F-3(b)(2).

[38] Proposed Regulations §1.25F-3(c)(3).

[39] IRC §25F(d)(1)(B); Proposed Regulations §1.25F-3(c)(4)(i).

[40] Proposed Regulations §1.25F-3(c)(2)(i).

[41] Proposed Regulations §1.25F-3(c)(4)(ii)(B).

[42] Proposed Regulations §1.25F-3(c)(2)(ii).

[43] Proposed Regulations §1.25F-3(c)(3).

[44] Proposed Regulations §1.25F-3(c)(3) provides that being a disqualified person at the §25F segregated account level applies only with regard to that §25F segregated account.

[45] Proposed Regulations §1.25F-3(c)(4)(B).

[46] Proposed Regulations §1.25F-4(e)(1).

[47] Proposed Regulations §1.25F-4(e)(2)(i). An alternative compliance mechanism applies for an organization whose total receipts did not exceed $500,000. Proposed Regulations §1.25F-4(e)(2)(ii).

[48] Proposed Regulations §1.25F-4(e)(3).

[49] The Proposed Regulations create the concept of a “qualified digital wallet” which is an electronic payment platform in which a third-party provider provides a streamlined interface for managing the administration of §25F scholarships by having eligible students and their families submit purchase requests, tracking approved expenses, and maintaining controls to ensure that all payments are made for qualified elementary or secondary education expenses by pre-approving vendors and paying vendors directly or requiring timely submission of receipts. Proposed Regulations §1.25F-1(a)(13).

[50] A State cannot add to its State SGO list for a calendar year after the deadline for perfecting its SGO election (i.e., February 15, 2027, in the case of 2027 and January 1 for future years). §1.25F-5T(d)(7) (ii). If an SGO requests a State to be removed from its SGO list the State must comply with the request. §1.25F-5T(d)(7)(iii)(A). A State may remove an SGO from its State SGO list if the State determines through procedures providing due process to the organization, that the SGO is not located in the State, or that the SGO does not satisfy the SGO requirements. §1.25F-5T(d)(7)(iii)(B). The State must promptly notify the IRS of the removal and its effective date through the IRS State §25F portal.