Education Freedom Tax Credit to Take Effect in 2027: Proposed Regulations Expected Soon

Section 25F of the Internal Revenue Code, enacted as part of the law commonly known as the One Big Beautiful Bill Act, creates a new federal incentive for individual taxpayers to contribute to qualifying Scholarship Granting Organizations (SGOs) that fund K-12 educational scholarships. The Education Freedom Tax Credit is expected to create substantial opportunities, as well as compliance obligations, for states, nonprofit scholarship organizations, donors, private schools, charter schools, religious schools and education service providers.

This type of giving may be more attractive to taxpayers given the recent changes to the tax law on charitable contributions and should be considered as part of a taxpayer's philanthropic planning. (See Holland & Knight's previous alert, "Impact of the One Big Beauitful Bill Act on Tax-Exempt Organizations," April 12, 2025.)

Overview of the Section 25F Credit

Beginning with contributions made on or after January 1, 2027, eligible taxpayers may claim a nonrefundable federal income tax credit equal to the amount of their qualified contributions to an eligible SGO, subject to an annual cap of $1,700 per individual taxpayer.

To qualify, contributions generally must be made in cash to an SGO identified by a participating state. SGOs use those funds to provide scholarships for qualified elementary and secondary education expenses.

Eligible students are generally those who:

• are eligible to enroll in a public elementary or secondary school
• are members of households with income not exceeding 300 percent of area median gross income

The credit is reduced by any state tax credit claimed for the same contribution, and taxpayers may not claim both the federal credit and a charitable deduction for the same contribution. Unused credits may be carried forward for up to five years.

Qualified educational expenses generally incorporate the expenses described in Section 530(b)(3)(A) (Coverdell education savings accounts), which include a broad range of elementary and secondary school costs. The U.S. Department of the Treasury has indicated that forthcoming guidance is expected to clarify the treatment of educational services such as tutoring and support services for students with special needs.

To date, the Treasury Department has issued IRS Notice 2025-70, seeking public comment on anticipated future regulations and Revenue Procedure 2026-6.

Participation Is Voluntary for States

A state must affirmatively elect to become a "covered state" and submit a list of qualifying SGOs to the Treasury Department. If a state elects to be a covered state, the list of qualifying SGOs must include all organizations that have requested to be designated and that meet the federal requirements. States cannot impose additional requirements for qualifying SGOs.

The statute authorizes either the governor or another state-designated official, agency or entity to make the election on behalf of the state. States must do this by submitting IRS Form 15714, Advance Election to Participate Under Section 25F for 2027. Per the IRS website, 30 states have already officially made the election.

SGO Qualification

SGOs must be tax-exempt entities. The statute also requires SGOs to be "located in" the state and to spend at least 90 percent of their income on scholarships for eligible students. The SGO must provide scholarships for 10 or more students who do not all attend the same school. An SGO must prevent the co-mingling of qualified contributions with other amounts by maintaining one or more separate accounts for qualified contributions. The Treasury Department also signaled that SGOs may participate in multiple states, provided they satisfy state-specific requirements and maintain separate segregated accounts for each state in which they operate. IRS Notice 2025-70 sought public comment on the definition of "located in." SGOs must give taxpayers the ability to choose what state they want their contributions deployed to.

Student Eligibility Verification and Priority of Scholarships

The Treasury Department previewed several methods through which SGOs may verify household income and student eligibility. These methods are expected to include direct verification techniques and certain forms of categorical eligibility.

An SGO must provide scholarships to eligible students, with priority for students awarded a scholarship the previous year and any eligible students who have a sibling who was awarded a scholarship from an SGO during any year. Funds cannot be set aside or earmarked for a particular student.

Audit and Anti-Abuse Measures

The Treasury Department emphasized program integrity and previewed annual independent financial and programmatic audit requirements for SGOs. It also announced plans for an IRS-administered online portal intended to facilitate registration, reporting and compliance activities.

In addition, the Treasury Department indicated that donors may receive IRS-issued unique identification numbers for reporting purposes rather than providing Social Security numbers directly to SGOs.

Issues to Watch

Several important implementation questions remain unresolved and are expected to be addressed in proposed regulations expected shortly. These include:

• procedures for state certification and annual SGO listing requirements
• documentation necessary to substantiate contributions and credit claims
• additional guidance regarding qualified educational expenses under Section 530
• how SGOs demonstrate the 90 percent test and students' eligibility
• recordkeeping and information reporting requirements for states, SGOs and donors
• operational rules governing multistate SGOs
• enforcement standards and compliance reviews

Practical Implications

States considering participation and nonprofit organizations interested in becoming SGOs should begin evaluating program readiness now. Organizations may need to develop segregated accounting systems, scholarship eligibility verification procedures, governance policies, audit protocols and reporting processes well before the credit becomes available in 2027.

For more information or questions regarding a specific matter, please reach out to the authors.

Information contained in this alert is for the general education and knowledge of our readers. It is not designed to be, and should not be used as, the sole source of information when analyzing and resolving a legal problem, and it should not be substituted for legal advice, which relies on a specific factual analysis. Moreover, the laws of each jurisdiction are different and are constantly changing. This information is not intended to create, and receipt of it does not constitute, an attorney-client relationship. If you have specific questions regarding a particular fact situation, we urge you to consult the authors of this publication, your Holland & Knight representative or other competent legal counsel.