The new school scholarship credit runs through Charities.

The first federal tax credit for gifts that fund K-12 scholarships begins on January 1, 2027, and every dollar of it has to pass through a charity. On October 1, the Treasury Department and the IRS released proposed regulations for the credit, created by section 25F of the tax code, along with temporary rules that states and scholarship organizations need now to get ready. Both appeared in the Federal Register on October 2.

The administration calls it the Education Freedom Tax Credit. For donors the offer is simple. For the nonprofits that receive the gifts, the conditions are detailed, and the first deadlines arrive within three months.

What donors get

The credit reduces federal income tax dollar for dollar, up to $1,700 per person each year. The proposed rules treat each spouse on a joint return as a separate taxpayer, so a married couple can claim up to $3,400 if each spouse gives at least $1,700. The credit is nonrefundable, and any unused amount carries forward for up to five years.

Three limits matter. Only cash counts, including checks, cards, and payroll deductions, but not digital assets. The donor must designate the gift as a qualified contribution when making it. And a gift that earns the credit cannot also be deducted as a charitable contribution, while any state tax credit claimed for the same contributions reduces the federal one.

Who can receive the gifts

Only a scholarship granting organization, or SGO, qualifies. Under the law and the proposed rules, an SGO must be a 501(c)(3) public charity, not a private foundation. It must keep qualified contributions in a separate account, register through a new IRS portal, and appear on a list of approved organizations submitted to the IRS by a state that has chosen to take part.

That last condition depends on each state. As of September 14, the IRS listed 30 states that had made an advance election for 2027, from Alabama to Wyoming. For 2027, a state must file that election by January 1 and can complete it by submitting its list of SGOs by February 15. A charity counts as located in a state if it is authorized to do business there and complies with the state's charity laws, so one located only in a state that has not opted in cannot qualify. The proposed rules also bar participating states from imposing requirements stricter than federal law, including limits on the kind of school a scholarship may pay for.

What an SGO must do

1. Serve at least ten students. Scholarships must go to ten or more students who do not all attend the same school.
2. Spend 90 percent of income on scholarships. The proposed rules test this at the end of the tax year after the year the money arrives, and count money as spent only when it is paid out.
3. Verify household income. Students must come from households earning no more than 300 percent of area median gross income. An SGO may choose a lower limit.
4. Pay only for qualified expenses. These include private school tuition, tutoring, special-needs services, books, supplies, and computers.
5. Put returning students first. Priority goes to students who received a scholarship the previous year, and then to their siblings.
6. Keep insiders and earmarks out. A donor cannot direct a gift to a particular student. Scholarships cannot go to disqualified persons, which the proposal defines as substantial contributors, officers and directors, anyone who helps choose recipients, and their family members.
7. Report to donors and the IRS. Each donor gets a written acknowledgment with a unique donor number by January 31 of the following year, so the SGO does not have to collect donors' Social Security numbers. The SGO also files an annual report and is subject to audits.

How big it could get

Treasury and the IRS estimate that by 2030 the program could support 600 to 700 SGOs, with more than 11 million taxpayers giving nearly $26 billion a year and funding as many as 2.2 million scholarships. They also estimate that a safe harbor in the proposal, for organizations whose activities are at least 85 percent scholarship granting, could let about 450 more organizations take part.

What to do now

A charity that already runs a state scholarship program should ask the state office that will certify SGOs how it plans to build its list, and when. A group thinking of starting one should plan for a separate bank account and an income-verification process from the first day, on top of the basics in our guide to 501(c)(3) status. Other charities should know that a gift claimed for the credit cannot also be deducted, and that the credit applies only to gifts made to an SGO.

Comments on the proposal are due December 1, 2026. The IRS has scheduled a public hearing for December 15, which it will cancel if no one asks to speak.