Your Questions About the Federal Scholarship Tax Credit Proposed Regulations, Answered

On October 8, FACTS Compass hosted a webinar, “What Treasury’s Proposed FSTC Rules Mean for Your Organization,” with policy experts Peter Murphy of Invest in Education and Jacque Mosely of Nelnet on Treasury’s proposed regulations for the Federal Scholarship Tax Credit (FSTC), also called the Education Freedom Tax Credit (EFTC). Here are the highlights and the 10 most commonly asked questions.

These rules are proposed, not final. Comments are due around December 1, so details may change.

Only individuals can donate under the proposed rules. Corporations, partnerships, and S corporations cannot, and donors must be U.S. citizens or residents.

The credit is up to $1,700 per person each year, or $3,400 for joint filers when each spouse has the tax liability behind their share. It cannot be more than the federal income tax you owe, but any unused amount carries over for up to five years.

Not on the same dollars. A donor cannot take a state credit on dollars that earn the federal credit, and those dollars do not count as a charitable contribution, so they cannot be deducted either.

For example, a $2,000 gift can support a $1,700 federal credit, and the other $300 may qualify for a state credit where one exists. State rules vary, so donors should check with a tax advisor.

This was the most upvoted topic. A disqualified person is an officer, director, or trustee of the SGO (or someone with similar powers), a substantial contributor, or anyone who helps select scholarship recipients, including selection committee members. That includes school employees who help select recipients. Their family members are covered too, and dependents of a disqualified person cannot receive scholarships from that SGO.

A substantial contributor is a donor who gives more than $5,000 in a year, and whose gifts are more than 2% of what the SGO receives that year. Spouses count together, and the label carries over to the next year.

Donors who stay below those limits and have no role at the SGO can give, and their children can still be eligible for scholarships.

Students must come from households at or below 300% of area median gross income and be eligible to enroll in a public school, though they do not need to attend one. Treasury notes that about 95% of children are under that threshold, and SGOs can set a lower one.

Students must also live in a covered state, which is a state that has chosen to participate in the program. Exceptions apply for dependents of members of the Armed Forces and dependents of an individual residing on Indian Lands. What counts is where the student lives, not where the school is.

SGOs must verify household income and family size. They can review documents such as pay stubs, tax returns, or W-2s, or an award letter dated within the past 12 months showing that someone in the household receives SNAP, TANF, WIC, Section 8 housing assistance, or SSI. Foster children are treated as meeting the requirement without verification.

A household includes everyone living with the student, and only cash income counts, including child support and alimony. Free or reduced-price lunch eligibility does not count as verification because it applies school-wide, not to a household. Treasury has asked whether other programs should be added.

Yes. Parents can apply to more than one SGO, and schools can partner with more than one, though each adds a funding source to manage. Two SGOs cannot both fund the same expense for the same student, and the proposed rules require SGOs to have procedures to prevent and detect that kind of duplication.

Donors cannot earmark a specific student, but some SGOs let donors designate a school. The proposed rules do not appear to let one SGO pass funds through another.

An SGO must be a 501(c)(3) that is not a private foundation and be authorized to do business in each state where it operates, though it needs no physical presence there.

It must award scholarships to at least 10 eligible students in each state who do not all attend the same school, so an SGO that supports only one school would not qualify. It must also spend 90% of its income on scholarships by the end of the following tax year.

Because “income” could mean every dollar an organization takes in, the proposed rules include a safe harbor, which is a set of conditions that lets an SGO meet a requirement without further proof. It counts only qualified contributions held in a separate account, but only for organizations where at least 85% of activity supports scholarship granting, including administration, fundraising, governance, compliance, and outreach. A school foundation that mainly funds other projects may need to spin off a separate organization to use it. Treasury has asked for comment on how the 85% is measured.

Yes. The proposed rules count an after-tax payroll deduction as a cash contribution, so employers and payroll companies could offer it. Donors could give a little each paycheck instead of waiting for a refund.

Because the gift is made with after-tax dollars, employees may be able to adjust their W-4 withholding so take-home pay stays steady.

Under the proposed rules, no. The webinar panel described these as private dollars, which is why Congress used the tax code instead of federal spending. They also noted that future administrations could amend the regulations, so it is worth watching.

Use this time to prepare. The rules are still proposed, so avoid locking in final processes, but there is plenty to plan now.

Three things are worth thinking through:

• Your structure: Does most of your organization’s work go to scholarship granting? That helps determine whether the 85% safe harbor could apply to you, or whether the 90% spending rule would cover everything you take in.
• Reporting and audits: After each year of gifts, SGOs would send donors a receipt and report their totals to the IRS, starting in early 2028. States would also receive an audit. All of that is built from each gift, so it helps to plan now how you will track donors and contributions from day one.
• Registration: Under the proposed rules, SGOs must register electronically through an IRS portal, which is still being set up. Registration is also how an SGO gets instructions for creating donor numbers. You will likely need basics like your EIN, tax-exempt status, and proof you meet the program’s requirements, so it helps to gather them now.

You can also help shape the rules. Comments are due around December 1 and can be submitted through regulations.gov (docket IRS-2026-1354). The Federal Register notice explains each provision in plain language, and Treasury has asked for input on how to measure the 85% threshold, which other programs should count as proof of income, and how multistate SGOs are certified.

Treasury guidance on qualified expenses is expected by the end of the year.

Watch the on-demand recording of the webinar to hear Peter Murphy and Jackie Mosely walk through the proposed rules.

The Federal Scholarship Tax Credit starts January 1, 2027, and the details are still taking shape. FACTS Compass is here to help you navigate it and to provide the infrastructure behind your program, from donor contributions to family applications and eligibility to fund management. Visit FACTS Compass to learn more.