Section 25F Proposed Rules: What SGOs Need to Know Before Finalizing Their Structures

Section 25F of the Internal Revenue Code, enacted as part of the One Big Beautiful Bill Act, creates the federal Scholarship Granting Organization program. The statute is effective January 1, 2027. The IRS has not yet issued final regulations interpreting the statute — but organizations that wait for final rules before beginning formation will miss the 2027 window entirely.

This post covers what the statute says, where regulatory uncertainty exists, and how SGOs should structure their operations in light of that uncertainty.

What the Statute Establishes

Section 25F creates a federal tax credit for individual taxpayers who make contributions to state-approved Scholarship Granting Organizations. The credit is non-refundable, taken against regular income tax liability, and is capped at $1,700 per taxpayer per year (with specific rules for married couples filing jointly).

The statute requires that qualifying SGOs meet four structural conditions:

1. State Approval. The SGO must be approved by a state that has enacted qualifying opt-in legislation. A federal tax credit is only available for contributions to SGOs operating in states that have formally opted into the program. This state-by-state approval requirement creates significant geographic complexity for organizations operating across state lines.

2. Section 501(c)(3) Status. The SGO must qualify under Section 501(c)(3) of the Internal Revenue Code, and its primary mission must be to provide scholarships to eligible students. This primary mission requirement has real consequences: existing 501(c)(3) organizations that have broad educational missions may need to amend their governing documents before qualifying.

3. Scholarship Distribution to Multiple Students and Schools. The statute requires that scholarships be awarded to ten or more students who do not all attend the same school. This multi-student, multi-school requirement is the statutory basis for the arm's-length award process that SGOs must implement. An SGO that effectively serves a single school's population faces structural compliance risk under this provision.

4. No Earmarking. Scholarship awards cannot be conditioned on the donor's identity or preferences. A donor cannot designate that their contribution benefit a specific student or a student at a specific school. This prohibition is explicit in the statute and is one of the most commonly misunderstood compliance requirements — particularly in faith community contexts where donors may expect their giving to benefit "their" community.

Where Regulatory Gaps Exist

The statute establishes these structural requirements but leaves several important implementation questions to the IRS to resolve through regulation.

Qualified Expense Definitions. Section 25F incorporates the Coverdell Education Savings Account expense definitions (Section 530(b)(4)) to define what scholarship funds can pay for. The Coverdell categories include tuition, fees, tutoring, academic enrichment, and educational materials at eligible institutions — both private K-12 schools and public school supplemental programs. However, the IRS has not yet provided guidance on how these categories apply in specific contexts. An after-school tutoring program that includes ministry components alongside academic content: what portion qualifies? A private school that provides services across multiple buildings on different campuses: is this one school or multiple for the ten-school distribution requirement? These questions await regulatory answers.

Income Verification Standards. The statute ties scholarship eligibility to household income at 300% of area median gross income. Area median income is a figure published by HUD for use in housing programs — but the Section 25F statute uses "area median gross income," a term that is not identical to HUD's published figures. Whether "area median gross income" tracks HUD's AMI figures, uses a different data source, or requires an independent calculation is a question that final regulations will need to answer. In the interim, SGOs that calibrate their income verification to HUD area median income are making a reasonable, documented choice — but they should maintain records of that methodology.

State Reporting Requirements. The statute requires that SGOs file annual reports with the state in which they are approved. The content and format of those reports is left to the states, which means that multi-state SGOs face different annual reporting requirements in each state. States with well-developed opt-in frameworks have begun to specify their reporting requirements; states in earlier stages of framework development have not yet done so.

Donor Receipt Content. Tax credit receipts under Section 25F are not the same as charitable contribution receipts under Section 170. The specific content requirements for a valid Section 25F tax credit receipt — the information that must appear on the receipt for a donor to successfully claim the credit — have not yet been specified in IRS guidance. SGOs should be designing their receipt systems now, based on the statutory language and analogous guidance from state tax credit programs, and should be prepared to update their systems when final guidance issues.

What SGOs Should Be Doing Now

Given the regulatory gap, the question for organizations in formation is how to structure their operations prudently in the absence of complete guidance.

Base formation decisions on the statute, not anticipated regulations. The statute is clear on the structural requirements: 501(c)(3) with primary SGO mission, state approval, multi-student multi-school distribution, and no earmarking. These requirements are not subject to regulatory revision — they are statutory. Form your organization to comply with these requirements now.

Document every methodology decision. Where the statute is ambiguous — expense categorization, income verification methodology, what constitutes a "school" for distribution purposes — document the rationale for the position you take. If the IRS issues final regulations that require adjustments, having documented your methodology demonstrates good faith and makes remediation straightforward.

Build adaptable systems, not brittle ones. Your donor receipt generation system, your income verification workflow, and your state reporting infrastructure should be designed to be updated as regulatory guidance issues. This means using platforms that can be reconfigured as requirements evolve, not custom-coded systems that are expensive to change.

Monitor the regulatory process. The IRS published a request for information in late 2025 seeking input on Section 25F implementation. Comments submitted in response to that request will inform the proposed regulations. Following the regulatory process — and having advisors who are following it closely — means you will not be surprised when proposed rules issue.

Do not wait for final regulations to begin formation. The formation and state approval process takes four to six months at minimum, and state approval timelines vary significantly. Organizations that begin in mid-2026 may not complete state approval before January 1, 2027. Organizations that wait for final regulations — which may issue in late 2026 — will almost certainly miss the first operational year of the program.

The regulatory environment for Section 25F will continue to evolve through 2027 and beyond. An ongoing infrastructure partner — not just formation counsel — is essential for organizations that need to track and implement regulatory changes as they occur.