Treasury Department Guidance Clarifies the Education Freedom Tax Credit

Section 25F of the Internal Revenue Code, enacted as part of the law commonly known as the One Big Beautiful Bill Act (OBBB), creates a new federal incentive for individual taxpayers to contribute to qualifying Scholarship Granting Organizations (SGOs) that fund K-12 educational scholarships. The credit, referred to in recent guidance as the Federal Scholarship Tax Credit but commonly called 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. Scholarships received from SGOs are generally excluded from recipients' gross income under new Section 139K.

Section 25F is significant – by 2030, the U.S. Department of the Treasury and IRS estimate that the program could support 600 to 700 SGOs, with more than 11 million taxpayers making nearly $26 billion in qualified contributions annually and funding as many as 2.2 million scholarships each year.

Prior guidance included IRS Notice 2025-70, which requested public comments, and Revenue Procedure 2026-6, which set forth the procedures for states to elect into the program. The recent guidance builds on that guidance and responds to many of the comments received. (See Holland & Knight's previous alert, "Education Freedom Tax Credit Takes Effect 2027: Proposed Regulations Expected Soon," August 21, 2026.)

Overview of Proposed Regulations

Beginning with contributions made on or after January 1, 2027, eligible individuals who are U.S. citizens or residents may claim a nonrefundable federal income tax credit for qualified contributions to an SGO.

Key provisions under the Proposed Regulations include:

• $1,700 Per Taxpayer/$3,400 for Married Couples Filing Jointly. The Proposed Regulations clarify that spouses filing jointly are treated as separate taxpayers, so a couple may claim a credit up to $3,400 under Section 25F if each spouse contributes at least $1,700.
• State Credit Reduction Applies Before the Cap. The Proposed Regulations provide that the $1,700 per taxpayer limit applies after reducing the qualified contributions by any applicable state tax credits.
• Excess Contributions May Be Eligible for Deduction. Qualified contributions cannot generate both the credit and a Section 170 charitable deduction for the same dollars. The Proposed Regulations confirm, however, that amounts in excess of the allowed credit may be deductible if the Section 170 requirements are met.
• Unused credits may be carried forward for up to five years. The Proposed Regulations clarify that carryforward credits are used in chronological order and before current year credits.
• Individuals Only. The Proposed Regulations clarify that contributions made through partnerships or S corporations do not qualify for a credit, even if passed through as charitable contributions deductible under Section 170.
• No Donor State Residency Requirement. Donors may give to an SGO in any covered state, regardless of the taxpayer's state of residence.
• "Qualified Contribution" Defined. A "qualified contribution" is a cash contribution in U.S. dollars, reduced by the value of any goods or services received, irrevocably designated as a Section 25F qualified contribution at the time of the contribution. Digital assets are explicitly excluded.
• Donor Substantiation. SGOs must give each donor a unique, IRS-formatted donor number in a written acknowledgment by January 31 of the following year, and donors must report that number on new Form 8525 attached to their Forms 1040.

Participation Is Voluntary for States

Under Section 25F, a state must affirmatively elect to become a "covered state" and must submit a list of qualifying SGOs. The election must be made by the governor or another individual, agency or entity designated under state law. The IRS maintains a list of participating states on its website. As of September 14, 2026, it identifies 30 states that elected to participate.

SGO Qualification

An SGO must be a Section 501(c)(3) public charity (not a private foundation), satisfy operational requirements, be "located in" the covered state, maintain a segregated Section 25F account, avoid awards to disqualified persons and comply with certain reporting requirements.

• Public Charity with Pending Application: The Proposed Regulations provide that organizations with exemption applications pending with the IRS may be listed on state SGO lists if the state identifies all SGOs with pending applications, meets other certification criteria and represents that the organization's exempt status, if granted, will be retroactive to January 1 of the list year or earlier.
• Operational Requirements: The Proposed Regulations include certain operational requirements for SGOs, including a safe harbor for SGOs that operate in a single state and special rules for SGOs that operate in more than one state. Although the Proposed Regulations state that an SGO may only provide scholarships for "qualified elementary or secondary education expenses," as defined in Section 530(b)(3)(A) of the Internal Revenue Code, the Treasury Department and IRS noted that this term will be clarified in forthcoming guidance.
• "Located in" the State: The Proposed Regulations clarify that 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.
• Segregated Accounts: All designated qualified contributions must be deposited into a Section 25F segregated account containing only those contributions and earnings. SGOs operating in more than one state must maintain a separate segregated account for each state.
• Disqualified Persons: The Proposed Regulations define a disqualified person with respect to an SGO to include certain substantial contributors, officers, directors and trustees, as well as an individual having powers and responsibilities similar to those of such persons, anyone participating in selecting recipients (including uncompensated committee members) and family members of any individual identified above.
• Registration: SGOs must register in the IRS SGO portal, preferably before appearing on any state SGO list. The Proposed Regulations state that an organization will not be able to comply with the acknowledgement and reporting requirements of the Proposed Regulations until the organization has registered in the IRS SGO portal.

Student Eligibility and Verification

• Income and Categorical Eligibility: An eligible student must be eligible to enroll in a public elementary or secondary school and be a member of a household with prior-year income not exceeding 300 percent of area median gross income. Area median gross income will be calculated in a manner consistent with determinations under Section 8 of the United States Housing Act of 1937, adjusted for family size. The Proposed Regulations provide that the eligibility may be verified through direct income verification, categorical eligibility and certain safe harbors.
• Residency: The Proposed Regulations provide that an SGO must ensure that qualified contributions are used to fund scholarships that are awarded to eligible students solely within the state on whose state SGO list the SGO appears. "Solely within the State" refers to where the student resides under state law, not where the student attends school, with limited exceptions for dependents of U.S. Armed Forces members and individuals residing on Indian lands.
• Priority: SGOs must give priority to prior-year recipients and their siblings; although, the Proposed Regulations provide some flexibility for scholarships based on need for individual academic tutoring or special needs services. Funds may not be earmarked for a particular student.

Reporting and Audit Requirements of SGOs

The Proposed Regulations set forth numerous reporting, certification and audit requirements, including:

• SGOs must provide written donor acknowledgments to donors by January 31 and contribution reports to the IRS by February 28 of the following year.
• Annual certifications and operational data must be provided to the IRS (generally as a Form 990 attachment) and concurrently furnished to each covered state on whose SGO list the SGO appears.
• An annual financial and programmatic audit conducted with results provided to each covered state; SGOs with receipts of $500,000 or less may use a committee of independent persons unrelated to the organization's management rather than an independent auditor.

Next Steps

• For calendar year 2027, a state must submit its advance election by January 1, 2027. The state may perfect its advance election by submitting its state SGO list by February 15, 2027.
• Given the upcoming January 1, 2027, deadline, states and organizations interested in participating should begin preparing for implementation.
• Prospective SGOs should evaluate whether they satisfy the operational requirements, which generally apply to the organization as a whole. Multipurpose organizations may consider forming a separate SGO.
• SGOs must take steps to be listed by a covered state, consider registering in the IRS SGO portal early and proceeding to set up compliance systems such as establishing segregated accounts, donor number and acknowledgment systems and eligibility verification and payment controls and reviewing selection committees and substantial contributor tracking for disqualified person issues.

Opportunities to Shape Final Regulations

The Treasury Department and IRS have asked for comments on all aspects of the Proposed Regulations and on several topics in particular. Comments are due December 1, 2026, and a public hearing is scheduled for December 15, 2026. Public charities, schools, states, Tribal entities and other stakeholders should consider commenting to help shape the final regulations on areas that include:

• The 85 Percent Test. How organizations should measure scholarship-granting activities (e.g., receipts, expenditures, staff time or another administrable metric) and whether 85 percent is a reasonable threshold to ensure that the organization's overall mission and operations are aligned with the statutory scholarship purpose behind the section 25F credit.
• Categorical Student Eligibility. Whether to expand categorical eligibility categories, such as through the inclusion of state or Tribal programs.
• State Certifications. The certifications states must make under Proposed Treas. Reg. Section 1.25F-5(d)(3), whether Multi-State SGOs should require other certifications and whether any certification is disproportionately burdensome compared to the benefits to tax administration.
• Tribal and Bureau of Indian Education (BIE) Schools. The Proposed Regulations reference BIE schools in a footnote to the student residency exceptions but define school by reference to Section 530(b)(3)(B) of the Internal Revenue Code, which recognizes determinations under state law.

Comments on the Proposed Regulations are due December 1, 2026, and may be submitted at regulations.gov. As of the date of this alert, more than 10,000 comments had been submitted. A public hearing is scheduled for December 15, 2026, at 10 a.m. ET. Outlines of topics are due by December 1, 2026, and attendance requests are due by 5 p.m. ET on December 10, 2026.

Holland & Knight can assist stakeholders in preparing comments or testimony and establishing SGOs to help ensure readiness for 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.