The U.S. Treasury Department released proposed regulations and temporary regulations on Thursday (Oct. 1) that clear away some of the cobwebs around the Federal Scholarship Tax Credit (FSTC), also known as the Education Freedom Tax Credit (EFTC), which Congress created last year. The temporary rules cover how states opt in and how scholarship granting organizations (SGOs) register and report. They apply beginning Sept. 1, 2026 so that the procedural framework is in place ahead of the credit’s Jan. 1, 2027 launch. The rest is proposed, and final rules are still to come.
If, like me, you nerd out on regulatory text, I encourage you to read through all 200-something pages (c’mon, it’s light reading for a Monday!).
Otherwise, here’s what stood out to me. (Read here first if you need a refresher on how the federal scholarship tax credit will work.)
95% of children meet income limit
According to U.S. Treasury estimates, around 95 percent of American children live in households under the scholarship tax credit’s income limit, which is 300 percent of area median gross income.
The Treasury estimates that 600 to 700 SGOs will operate by 2030 in participating states and support as many as two million scholarships a year by 2030. The size of the scholarship depends on how much the SGOs raise in donations. For students in states that opt in, this is a remarkable opportunity for their K-12 education journey.
No marriage penalty
Starting Jan. 1, 2027, individual taxpayers who donate to an SGO can claim a dollar-for-dollar federal credit of up to $1,700.
Treasury proposes to treat each spouse on a joint return as a separate taxpayer, so a couple can claim up to $3,400 if each spouse made their own qualified gifts of up to $1,700. The first return to claim the credit is the 2027 return, filed in 2028.
Donations can be made to SGOs in other states
While states have to opt into the program for students in that state to be eligible for the scholarships, taxpayers in a nonparticipating state can still claim the credit by giving to an SGO in a participating one.
As of this writing, 31 states have said they plan to participate or have formally opted in. Of Minnesota’s four neighbors, only Wisconsin is also sitting out.
Gov. Tim Walz’s decision keeps potentially millions of private scholarship dollars away from Minnesota students. I think it is a missed opportunity. Minnesota not opting in doesn’t stop Minnesota taxpayers from receiving the credit; it just means their gifts can’t fund scholarships for Minnesota residents. Because states opt in one year at a time, and Minnesota will have a new governor soon, future participation could still be in the cards.
Donor number to claim credit
Taxpayers who make a qualified donation to an SGO would claim the tax credit using a unique number from each SGO, not a Social Security number. Gifts must be cash — currency, check, money order, credit card, etc., but digital assets like crypto don’t count. The donor has to tell the SGO at the time of giving that the donation is meant to be credit-eligible, and that choice can’t be undone.
February deadline for SGO list
States opting in for 2027 must file an advance election by Jan. 1, 2027. The temporary rules give them until Feb. 15, 2027 to submit their SGO list to the IRS, but only for 2027.
States can’t cherry-pick SGOs
A participating state has to include every organization on its list that is seeking inclusion and meets the federal requirements. It can’t add requirements tougher than the federal ones, such as limiting which types of schools or expenses the scholarships can cover. States can, however, remove an SGO that stops qualifying, as long as the SGO gets due process.
Nonrefundable + five-year carryforward
The federal tax credit can’t push a taxpayer’s tax below zero or produce a refund by itself. If an individual decides to donate $1,700 to an SGO, and owes $1,000 in federal income tax, the credit offsets the $1,000 but the taxpayer would not get the other $700 back as cash. With the five-year carryforward, the remaining $700 carries forward to the next return. Unused credit can roll forward for up to five years after the year it arose.
Eligibility follows where the student lives
Under the proposed rule, scholarship eligibility is tied to the student’s home state, not the school’s state. A student who lives in an opt-in state can use a scholarship at a school in a state that hasn’t opted in. A student who lives in a non-participating state, though, can’t get a scholarship, even if their school’s state opted in. (The proposed rules carve out dependents of members of the Armed Forces and dependents of people living on Indian Lands.)
Applying that rule to Minnesota’s interstate enrollment agreements shows us how this could play out. Minnesota’s K-12 interstate tuition agreement with South Dakota lets students in border districts attend school across the line. South Dakota has opted into the federal scholarship tax credit, so under the proposed rule a South Dakota student attending a Minnesota public school could receive a scholarship from a South Dakota-listed SGO if otherwise eligible. A Minnesota student attending a South Dakota school wouldn’t qualify because Minnesota hasn’t opted in.
Minnesota has a similar K-12 agreement with Iowa, with a few different terms. Iowa has also officially opted in, so Iowa students attending a Minnesota public school would be eligible, and Minnesota students attending an Iowa public school would not.
A student who lives in North Dakota, South Dakota, or Iowa could also use a scholarship from a home-state SGO at a qualifying private school in Minnesota. Minnesota students at private schools in those states would not be eligible.
Oversight and audits
The IRS has several mechanisms already in place to prevent fraud involving charities such as SGOs. The temporary rules require states to certify their SGOs annually, and SGOs to report donor information to the IRS so that contributions can be checked against tax returns.
The proposed rules add a more detailed annual certification from each SGO to the IRS plus an annual independent financial and programmatic audit. The results would be sent to the state. SGOs with more than $500,000 in total receipts would need an outside auditor. Smaller organizations could use a committee of independent people unrelated to management.
To stop self-dealing, the proposed rules would prevent SGOs from awarding scholarships to their board members, officers, selection committee members, large donors (who gave over $5,000 in a year and more than two percent of that year’s contributions), and family members.
What’s still coming on expenses
The scholarship tax credit covers expenses tied to K-12 schooling, such as tuition, tutoring, special education services. Treasury says separate guidance on what counts as a qualified expense, and what counts as a “school,” is a high priority and will come “as soon as possible so that taxpayers may rely on.” A Treasury representative said that guidance is expected to be released by the end of the year.
Under the proposed rules, SGOs would pay tuition and fees straight to the school, pay other verified vendors directly, reimburse families against receipts, or use a “qualified digital wallet.” Families wouldn’t get unrestricted cash.
What happens next
Because these are proposed rules, they still have to go through rulemaking. Public comments are due Dec. 1, and a public hearing is set for Dec. 15. There is no date yet for final rules.
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