Organizations hoping to receive contributions that qualify for the new federal scholarship tax credit should build their compliance systems now rather than wait on state action, according to a tax attorney advising scholarship groups.
Treasury and the IRS released temporary and proposed regulations October 1 implementing the credit under IRC § 25F, which was added by the One Big Beautiful Bill Act, P.L. 119-21.
For contributions made on or after January 1, 2027, U.S. citizens and residents can claim a nonrefundable credit of up to $1,700 for cash gifts to scholarship-granting organizations (SGOs) listed by participating states.
Richard L. Lieberman, senior counsel in the Chicago office of Dykema, told Checkpoint that his clients are working to have compliance systems in place by then.
“Treasury delivered the operating manual on time,” Lieberman said. “Now everyone has about 90 days to build the machine.”
Clients drafting to the proposed rules
Lieberman said his clients are forming entities and adopting policies without waiting for state guidance. When he requests expedited handling of Form 1023, Application for Recognition of Exemption Under Section 501(c)(3) of the Internal Revenue Code, he said, the IRS has been responding in two to three weeks rather than the usual two to six months.
The temporary regulations have “taken some of the pressure off,” he said, by letting a state list an organization whose exemption application is still pending. A state using that option must include every pending applicant seeking a spot and certify that the organization’s exempt status, if granted, will be effective by January 1. First lists are due February 15, 2027.
Taxpayers and organizations can rely on the proposed regulations for 2027 contributions if they follow them in their entirety. Lieberman said he is treating them as the governing standard.
“Whatever the regs say, that’s what we’re drafting to, and we’re not making any accommodations,” he said.
Siblings join disqualified-person definition
Under § 25F(d)(2), an SGO can’t award a scholarship to a disqualified person, determined under rules similar to the private foundation provisions of IRC § 4946. The proposed definition covers officers, directors, and trustees; anyone who participates in selecting recipients; substantial contributors; and the family members of each, including siblings of the individual or the individual’s spouse. A substantial contributor is anyone who gives more than $5,000 to a segregated account in a tax year, if that exceeds 2% of the account’s contributions.
“One of the things the proposed regs have done is to expand the list of disqualified persons beyond what’s simply in the Code to now include siblings,” Lieberman said.
He said the sibling rule has already impacted one of his clients, and that he revised client conflicts policies once the proposed rules came out. He does not expect the definition to be narrowed in final rules, viewing it as an anti-abuse measure.
Spending rule pushes clients toward separate entities
Section 25F(d)(1)(B) requires an SGO to spend at least 90% of its income on scholarships, and the proposed regulations define income as total gross receipts from all sources, unreduced by expenses.
Keeping costs within the remaining 10% has been the biggest focus of his client work, Lieberman said.
“That 10% is really a very hard 10,” he said. “And when I work with my clients on this, and we talk about credit card fees, processing fees, and we talk about state organization fees and the auditors’ fees, etc. It eats up a lot of that 10%.”
A safe harbor lets organizations whose activities are at least 85% scholarship granting apply the test only to their § 25F segregated account. Lieberman said it did not help school district clients hoping to use existing foundations with broader missions.
“If we were already that close, then we’re effectively a scholarship organization,” he said. Those clients are forming separate entities instead, an outcome the preamble acknowledges the safe harbor may require.
States control participation
Beyond the portal and unique donor numbers, Lieberman said, the IRS plays a limited role. “It’s really on the states to make this program work,” he said. “And unfortunately, the states right now don’t know what to do.”
He said no state he knew of had issued guidance on listing SGOs, and Illinois, where he practices, has not opted in. His clients are finalizing policies, audits, and records so they can apply as soon as their states open.
Multistate SGOs must keep a separate segregated account for each covered state. He advises them to start in a few states and expand later, because the costs of qualifying everywhere at once may outweigh what each state generates.
Deadlines also move earlier after 2027, with elections due by September 30 of the preceding year.
“We are building the machine, and we are ready,” Lieberman said.
For more on how states elect to participate under § 25F and manage lists of scholarship granting organizations, see Checkpoint’s Federal Tax Coordinator 2d ¶ A-4823.
Take your tax and accounting research to the next level with Checkpoint Edge and CoCounsel. Get instant access to AI-assisted research, expert-approved answers, and cutting-edge tools like Advisory Maps and State Charts. Try it today and transform the way you work! Subscribe now and discover a smarter way to find answers.
