On Oct. 2, the Internal Revenue Service (IRS) issued regulations that determine how the Education Freedom Tax Credit (EFTC) will run and, in turn, how many states participate.

The EFTC — also known as the Federal Scholarship Tax Credit (FSTC), or IRS Section 25F — will allow individuals to receive federal tax credits for donations up to $1,700 to authorized scholarship-granting organizations (SGOs), but states must opt in annually to participate. The program is set to begin on Jan. 1, 2027.

The regulations came in two parts. The IRS proposed regulations related to student eligibility, calculating taxpayer credits, SGO operations, and state operations and requirements. It also issued temporary regulations that will implement some provisions of the proposed regulations early. The temporary regulations include procedural requirements for states and SGOs listed in the proposed regulations, which the IRS said must be effective for the program to begin in 2027.

The proposed rule has a 60-day comment period and a public hearing scheduled for Dec. 15, 2026. The temporary regulation also has a 60-day comment period and will take effect on Dec. 1.

Notable provisions of the proposed and temporary regulations included:

• Married couples filing jointly may receive up to $3,400 in federal tax credits under the program. Each spouse may claim the $1,700 tax credit for qualified contributions.
• Some students will be categorically eligible for scholarships. This includes need-based benefit recipients, those in foster care, and those schools selected as needing academic or special needs services if the school is located in low-income areas. Schools may select students for scholarships based on academic or special needs.
• Students may use scholarships based on future enrollment in schools. Expenses are eligible contingent on a student's school enrollment, but the regulations said students may use a scholarship in the summer if they are enrolled in the school year starting in the fall. Students may also be able to use scholarships for services before and after school.
• SGOs may have some financial flexibility. If 85% of an SGO's activities are scholarship-granting (either related to the EFTC, state tax credit scholarship programs, or any other scholarship organizations), then the SGO may apply the federal requirement that 90% of its income be used for scholarships solely to a segregated EFTC account. This helps SGOs that already provided scholarships under different programs participate in the federal program.
• "School" means any K-12 school that provides elementary or secondary education, as determined under state law. Depending on the state, homeschooled students or microschool students may be eligible for scholarships.
• States may not impose restrictions on SGOs more stringent than federal requirements. States must include on their list all SGOs that meet federal requirements and are requesting to participate.
• SGOs "located in the state" are defined as those authorized to do business in the state. They are not required to be physically located in the state. This enables multi-state SGOs.
• The credit is nonrefundable, but unused credits can be carried forward for five years. For donors with a tax liability of less than $1,700, credits not used in one year may roll over to the next.
• States may include SGOs with pending nonprofit designations on their SGOs list. They are only listed on the federal SGO list once the IRS approves their nonprofit status.
• States can officially elect to participate in the program, but can only complete their election by submitting a list of qualified SGOs. Many states have already made advance elections for 2027, but are not fully opted in until they submit a list of qualified SGOs.

Breakdown of the regulations

The IRS categorized the regulations by policies for calculating and receiving a tax credit; policies for scholarships and student eligibility; SGO recordkeeping and reporting requirements; and state procedural policies. Here's a breakdown of each section, excluding provisions featured as notable above.

§ 1.25F-2 Federal scholarship tax credit for qualified contributions.

• Federal tax credits may not also be used for Section 170 charitable contributions.
• The federal government will first deduct any state tax credits from an individual's total donations before calculating the federal tax credit under 25F. The IRS said this will maximize the federal tax credit donors will receive.
• No donations through businesses or partnerships may count as a tax credit to an individual.

§ 1.25F-3 Scholarship granting organizations.

• All SGOs must maintain a separate account for the program.
• All SGOs must satisfy annual reporting requirements.
• SGOs must verify that scholarships disbursed are used only for qualified elementary and secondary expenses.
• SGOs may not give scholarship funds directly to a family unless it's a qualified reimbursement.
• SGOs may determine a student's household income eligibility using the Section 8 definition of area median gross income, which considers family size in accordance with Section 8 of the United States Housing Act of 1937. However, the EFTC regulations exclude all non-cash imputed returns on net assets and consider only cash income.
• Students ineligible for scholarships include those whose families have made what the regulations define as significant donations ($5,000 and more than 2 percent of the year’s contributions) to the SGO, and the children of SGO officers, trustees, directors, or such individuals' family member.

§ 1.25F-4 Reporting and recordkeeping requirements for SGOs.

• SGOs must register on an IRS portal.
• SGOs certify to the IRS that they meet all the operational requirements.
• SGOs must complete reports to donors, including a timely written acknowledgement that a donor made a qualified contribution.
• They must report on the number and amount of scholarships, students, and schools that receive funds under the program.
• Each SGO must be audited annually. The audit requirements differ for SGOs above and below a $500,000 annual income threshold.

§ 1.25F-5 State election, State SGO list, and certification of SGOs.

• The IRS will create a state portal — called the State Section 25F — to submit SGO lists, make advance elections to participate, or notify the IRS of any changes in participation or SGOs.
• States have two options for opting in: they may complete an advance election that will later be perfected by the submission of a list of qualified SGOs, or elect to participate by submitting the SGO list.
• States may submit their SGO lists for 2027 as late as February 15, 2027.

Zooming out

Prior to the regulations' release, several Democratic governors indicated that they would wait until the IRS issued them before deciding whether to participate. No governor has opted in since last week.

As of Oct. 2, 30 states had officially elected to participate. This includes:

• All 23 states with a Republican trifecta.
• Five states with divided governments.
• Colorado and Virginia, which both have Democratic trifectas. (New York has signaled its intent to participate, but has not completed an advance election form).

Governors, state legislators, or any entity under state law with the authority to make tax decisions may opt a state into the program. Thirty-six states have gubernatorial elections in 2026. Because the IRS issued the regulations about 90 days before the program is set to begin, the IRS gave states until Feb. 15, 2027, to submit SGO lists, which completes their decision to participate. Newly elected governors who want to reverse their state's decision to participate could decide not to submit an SGO list and effectively opt out of the program. States have the option to opt in annually.

Of the 30 states that have completed an advance election form, 19 have gubernatorial elections in November.

Click here to read more about the Federal Scholarship Tax Credit rule.