Par. 2. Sections 1.25F-0 through 1.25F-5 are added to read as follows:
(a) Overview. This section provides rules for SGOs under section 25F(c)(5) and (d) of the Internal Revenue Code (Code). Paragraph (b) of this section lists the requirements to qualify as an SGO. Paragraph (c) of this section provides operational requirements for SGOs. Paragraph (d) of this section defines disqualified persons with respect to an SGO.
(b) Scholarship granting organization. The term scholarship granting organization (SGO) means an organization that:
(1) Is described in section 501(c)(3), exempt from tax under section 501(a), and not a private foundation, as defined in section 509(a);
(2) Prevents the co-mingling of qualified contributions with other amounts by maintaining a section 25F segregated account, which must contain only qualified contributions and the earnings therefrom, depositing all qualified contributions into its section 25F segregated account, and maintaining a complete set of books and records for its section 25F segregated account;
(3) Satisfies the operational requirements of section 25F(d)(1) and paragraph (c) of this section;
(4) Does not award scholarships to any disqualified person as defined in paragraph (d) of this section;
(5) Is included on the State SGO list of one or more covered States in which the organization is located; and
(6) Satisfies the reporting and recordkeeping requirements in § 1.25F-4.
(c) Operational requirements for SGOs —(1) In general. An SGO meets the requirements of this paragraph (c)(1) if the organization:
(i) Provides scholarships to 10 or more students who do not all attend the same school;
(ii) Spends not less than 90 percent of the income of the organization on scholarships for eligible students consistent with paragraph (c)(4) of this section;
(iii) Verifies, in accordance with paragraph (c)(5) of this section, that scholarships are used solely for qualified elementary or secondary education expenses;
(iv) Verifies that scholarships are awarded only to eligible students who are members of a household described in paragraph (c)(6) of this section and who are eligible to enroll at a public elementary or secondary school;
(v) Verifies that the recipient eligible students are solely within the State in accordance with paragraph (c)(7) of this section;
(vi) Awards scholarships with a priority, in accordance with paragraph (c)(8) of this section, for eligible students awarded a scholarship for the previous school year and, thereafter, for any eligible students who have a sibling who was awarded a scholarship from such SGO; and
(vii) Does not earmark or set aside contributions for scholarships on behalf of any particular student.
(2) Safe harbor for a single-State SGO whose activities are at least 85 percent scholarship granting activities —(i) In general. If at least 85 percent of a single-State SGO's activities consist of scholarship granting activities (whether pursuant to section 25F, in accordance with State tax credit scholarship rules, or any other scholarship granting activities), then the SGO may apply the operational requirements of paragraph (c)(1) of this section to the organization's section 25F segregated account, rather than to the organization as a whole. For purposes of this paragraph, administrative, fundraising, governance, investment, compliance, outreach, and other activities are treated as scholarship granting activities to the extent each such activity is conducted in support of scholarship granting activities. This activity test is separate from the 90 percent of income spending requirement, for which only expenditures on scholarships for eligible students are taken into account.
(ii) Application of paragraph (b)(4) of this section to a single-State SGO that qualifies for the safe harbor. In addition to satisfying the requirement in paragraph (b)(4) of this section at the level of the organization as a whole, such organization also must test and satisfy that requirement at the level of its section 25F segregated account.
(3) Multistate SGOs. At least 85 percent of a multistate SGO's activities must consist of scholarship granting activities (whether pursuant to section 25F, in accordance with State tax credit scholarship rules, or any other scholarship granting activities). In addition, a multistate SGO must maintain a separate section 25F segregated account for each covered State on whose State SGO list the SGO appears. The SGO must allow donors to designate how their qualified contribution should be allocated among one or more of those covered States, and all qualified contributions must be deposited into the SGO's section 25F segregated account for one or more of those covered States in accordance with donor designations. The SGO must maintain a complete set of books and records for its section 25F segregated account for each covered State on whose State SGO list the SGO appears. The SGO must meet the requirements of paragraph (c)(1) of this section separately for its section 25F segregated account for each such covered State. Finally, in addition to satisfying the requirement in paragraph (b)(4) of this section at the level of the organization as a whole, such organization also must test and satisfy that requirement at the level of its section 25F segregated account for each covered State on whose State SGO list the SGO appears, provided however that being a disqualified person at the section 25F segregated account level applies only with regard to that section 25F segregated account.
(4) 90 percent of income spending requirement —(i) In general. An SGO must spend not less than 90 percent of the income of the organization, as provided in paragraph (c)(4)(ii) of this section, on scholarships for eligible students solely within the State within the time, and pursuant to the requirements, provided in paragraph (c)(4)(iii) of this section.
(ii) Income of the organization —(A) In general. Except as provided in paragraph (c)(4)(ii)(B) of this section, income of the organization means the total gross receipts of the organization from all sources computed using the cash receipts and disbursements method of accounting under section 446(c)(1) and § 1.446-1(c)(1)(i) during its annual accounting period, unreduced by any expenses, regardless of the overall method used by the organization in its books and records.
(B) Meaning of income for purposes of the safe harbor and multistate SGOs. For a single-State SGO using the safe harbor in paragraph (c)(2) of this section, income of the organization, for purposes of the spending requirement under this paragraph (c)(4)(ii), means the total amount of qualified contributions received by, and earnings credited to, the section 25F segregated account during the taxable year. For a multistate SGO, income of the organization, for purposes of the spending requirement under this paragraph (c)(4)(ii), means the total amount of qualified contributions received by, and earnings credited to, the section 25F segregated account during the taxable year, determined separately for the section 25F segregated account in each covered State.
(iii) Timing of 90 percent of income spending requirement— (A) In general. An organization must meet the 90 percent of income spending requirement as of the last day of the taxable year following the taxable year in which such income is received, including an organization's short period as set forth in section 443. Thus, satisfaction of the 90 percent of income spending requirement for the SGO's first year of operation does not need to be met until the end of its second year of operation.
(B) Amounts treated as spent when paid. For purposes of the 90 percent of income spending requirement, amounts are treated as spent when the amounts are paid under the cash method of accounting described in section 446(c)(1) and § 1.446-1(c)(1)(i).
(C) Ordering rule. Amounts are treated as paid from contributions and other income received in the earliest year first, and then from subsequent years in chronological order.
(D) Treatment of return of excess payment. An SGO that receives a return of any payments made to a school or vendor that are in excess of the student's costs, or that were disbursed in error, as set forth in paragraphs (c)(5)(iii) and (iv) of this section, respectively, must treat the return as income received in the year of the return and will have until the end of the taxable year following the year of the return to satisfy the 90 percent of income spending requirement with respect to such funds.
(E) No double counting. In no event may any amount spent by the SGO be treated as spent in more than one taxable year.
(5) Verification that scholarships are used solely for qualified elementary or secondary education expenses —(i) In general. An SGO must implement reasonable procedures for the prevention and detection of fraud and abuse, including systems to prevent and detect the duplication of scholarship awards to the same student for the same qualified elementary or secondary education expense that collectively exceed the cost of the expense. In addition, an SGO is required to verify that scholarship funds are used exclusively for qualified elementary or secondary education expenses in accordance with the allowable methods of payment described in paragraphs (c)(5)(ii) through (v).
(ii) No funds may be paid directly to the family of the eligible student unless it is a qualified reimbursement. An SGO will not be treated as satisfying this paragraph (c)(5)(ii) if money is paid to the family of the eligible student, unless the payment is a qualified reimbursement, meaning a reimbursement of expenses for which the family of the eligible student provides a receipt that verifies both that the payment was made and that the expense is a qualified elementary or secondary education expense and, before making the reimbursement, the SGO satisfies its procedures to prevent a single expense from being reimbursed for more than the total cost by more than one source.
(iii) Direct payments to the school. Scholarship funds used for payments for tuition, fees, room and board, and other similar expenses described in section 530(b)(3)(A) that are charged by the school must be paid directly to the school. The school must return any payments from the SGO that are in excess of the student's costs or that are disbursed by the SGO in error.
(iv) Paying other vendors directly. An SGO will be considered to meet the requirements of this section if it pays a vendor directly for expenses described in section 530(b)(3)(A) and the vendor:
(A) Has been verified as an appropriate provider of such services or items;
(B) Is not related, directly or indirectly, to the scholarship recipient; and
(C) Is required to reimburse the SGO for any payments from the SGO that are in excess of the student's costs or that were disbursed by the SGO in error.
(v) Qualified digital wallet. An SGO will be considered to meet the requirements of this section if it uses a qualified digital wallet to pay qualified elementary or secondary education expenses.
(6) Methods of verifying that a student's household income is not greater than 300 percent of the area median gross income —(i) In general. A scholarship recipient must be an eligible student who satisfies the household income requirement described in section 25F(c)(2)(A), § 1.25F-1(a)(4), and paragraph (c)(6)(ii) of this section. An SGO must use one or more of the methods described in paragraph (c)(6)(iii) of this section to verify that a scholarship recipient is an eligible student who satisfies this household income requirement.
(ii) Household income requirement —(A) Area median gross income. For purposes of computing the household income limit under section 25F(c)(2)(A) of 300 percent of area median gross income, area median gross income means the income limit determined based on area median gross income and family size in accordance with section 8 of the United States Housing Act of 1937 (Section 8).
(B) Family size. Family size is equal to the number of persons who are part of a household. A student's household includes the individual whose status as an eligible student is being determined, as well as each other person residing with that individual. For purposes of determining the number of members of the student's household in situations in which the student resides in more than one household during the calendar year (for example, in cases of shared custody), the relevant household is the one in which the student resides for the longest period of time during the year or, if the time spent by the student in each household is equal, then the household of the taxpayer with the highest household income.
(C) Household income. For purposes of determining the household income of a particular eligible student to be measured against the limit established in section 25F(c)(2)(A) and § 1.25F-1(a)(4)(i)(A), the term household income means annual income, as defined in 24 CFR 5.609; however, for this purpose, household income must be determined by disregarding the imputed return on net assets (for example, unrealized appreciation in a home or stock). This definition includes receipts by a member of the household in the form of child support and alimony not included in taxable income but excludes non-cash receipts.
(iii) Permissible verification methods —(A) Direct income verification method. Under the direct income verification method, income may be verified through review of written documentation including pay stubs, prior-year Federal or State tax returns, IRS transcripts, Forms W-2, evidence of other income not reflected on such documents (such as evidence of child support and alimony not reported as income) or a certification that there is none, or may be verified through other relevant data sources.
(B) Categorical eligibility verification method. Under the categorical eligibility verification method, income may be verified through written documentation, such as an award letter, dated within the last 12 months, confirming that an individual in the student's household currently is approved for assistance from or participation in Supplemental Nutrition Assistance Program (SNAP), Temporary Assistance for Needy Families (TANF), the Special Supplemental Nutrition Program for Women, Infants, and Children (WIC), Section 8 housing, or Supplemental Security Income (SSI)).
(C) Safe harbor for an SGO providing individual scholarships for individual academic tutoring or special needs services at schools in low-income areas —( 1 ) In general. If an SGO provides scholarships to individual students at schools in a low-income area for individual academic tutoring, or for special needs services in the case of a special needs student, and the individual students receiving those services are selected by the school on the basis of the particular student's academic or other need, the recipient students will be treated as satisfying the requirements in section 25F(c)(2)(A) and § 1.25F-1(a)(4), whether or not the student's household income is verified, if either:
( i ) The school is located in a qualified census tract as identified at https://www.huduser.gov/portal/sadda/sadda_qct.html (or a tract identified in future guidance); or
( ii ) The school certifies that at least 80 percent of its students reside in such a qualified census tract, regardless of the location of the school.
( 2 ) Requirements for safe harbor. An SGO using the safe harbor described in paragraph (c)(6)(iii)(C) of this section must annually obtain, and provide to the covered State, a third-party audit to certify that:
( i ) The school meets the eligibility requirement in paragraph (c)(6)(iii)(C)( 1 )( i ) or ( ii) of this section;
( ii ) The scholarship recipients were selected by the school based on academic or special need;
( iii ) Tutors or other providers were qualified to render the services;
( iv ) The student's need for the services, including the nature and extent of the services needed, is independently diagnosed by a professional not associated with the provider or vendor of the services; and
( v ) The services met appropriate quality standards, were provided with a duration and frequency commonly required to produce benefit, and their impact on each individual scholarship recipient was assessed.
(D) Safe harbor for foster children. An eligible student who is a foster child will be treated as satisfying the requirements in section 25F(c)(2)(A) and § 1.25F-1(a)(4)(i)(A), whether or not the student's household income is verified.
(7) Students solely within the State —(i) In general. 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. Except as provided in paragraph (c)(7)(ii) of this section, an eligible student is considered solely within a State only if the eligible student resides in that State in accordance with State law. Attending school in a State or purchasing goods or services in a State is not sufficient to treat the student as being solely within a State.
(ii) Exceptions. A student who is a dependent (as defined in section 152) of a member of the Armed Forces of the United States will be treated as solely within both the State of the domicile of the student and the State in which that member of the Armed Forces is residing. In addition, a student who is a dependent (as defined in section 152) of an individual residing on Indian Lands (as defined in 25 U.S.C. 3501(2)) will be treated as solely within both the State of the student's residence and the State in which the student attends school.
(iii) Examples. The application of this paragraph (c)(7) is illustrated by the following examples.
(A) Example 1. Organization EF is an SGO that operates only in State X and is on the IRS SGO list under State X for 2027. Student A resides in State X and attends school in State Y. Student B both resides and attends school in State Y. Neither student is in a military or Tribal family as described in paragraph (c)(7)(ii) of this section. Student A, but not Student B, is an eligible student solely within the State in which EF is listed as an SGO for purposes of section 25F. Thus, EF can award a scholarship from its section 25F segregated account to Student A, but not to Student B.
(B) Example 2. Organization GH is an SGO that operates in State X and State Y and is on the IRS SGO list under both State X and State Y for 2027. GH is not on the State SGO list of any other covered State. Student A resides in State X and attends school in State Y. Student B both resides and attends school in State Y. Student C resides in State Z and attends school in State Y. None of these students is in a military or Tribal family as described in paragraph (c)(7)(ii) of this section. Student A and Student B, but not Student C, are eligible students solely within the States in which GH qualifies as an SGO. Thus, GH can award a scholarship from its State X section 25F segregated account to Student A, and can award a scholarship from its State Y section 25F segregated account to Student B. However, GH cannot award a scholarship to Student C.
(8) Priority in awarding scholarships. In complying with section 25F(d)(1)(D), which requires that scholarships be awarded with priority consideration being given to eligible students awarded a scholarship for the previous school year and, thereafter, to any eligible students solely within the State who have a sibling who was awarded a scholarship from that SGO, an SGO has flexibility to consider the particular needs of potential scholarship recipients and the type of expenses for which the scholarship is being awarded. For example, a prior scholarship recipient should be given priority with regard to an award for tuition, fees, and room and board to ensure that the eligible student is able to continue attending the same school. Similarly, the siblings of such an award recipient should be given priority so that siblings are able to attend the same school. However, if a scholarship is awarded based on need for individual academic tutoring or special needs services, the fact that a student was a previous scholarship recipient, or that a student has a sibling who was a previous scholarship recipient, may not be relevant and priority instead can be based on need for the services.
(d) Disqualified person —(1) In general. The term disqualified person means, with respect to an SGO, a person who is:
(i) A substantial contributor to the SGO or to the section 25F segregated account, as defined in paragraph (d)(2) of this section;
(ii) An officer, director, or trustee of the SGO, as well as an individual having powers and responsibilities similar to those of such persons;
(iii) Any individual participating in, including as a member of a committee, the selection of scholarship recipients or the determination of scholarship awards; and
(iv) A member of the family, as defined in paragraph (d)(3) of this section, of any individual described in paragraph (d)(1)(i), (ii), or (iii) of this section.
(2) Substantial contributor —(i) In general. The term substantial contributor means any person who contributed an aggregate amount of more than $5,000 to the SGO during the taxable year, if such amount is more than 2 percent of the total contributions received by the SGO during the taxable year. For this purpose, an individual will be treated as making all contributions made by his or her spouse. In addition, the term substantial contributor means any person who contributed an aggregate amount of more than $5,000 to a section 25F segregated account during the taxable year, if such amount is more than 2 percent of the total contributions received by the section 25F segregated account during the taxable year. A person's status as a substantial contributor is determined as of the close of each taxable year of the SGO.
(ii) Excepted scholarships. A scholarship awarded by an SGO to a substantial contributor or a substantial contributor's family member will not be treated as an award to a disqualified person if, at the time the scholarship was awarded:
(A) The recipient would not have been a disqualified person had the substantial contributor determination been made as of the date of the award, based on contributions received by the SGO through that date; and
(B) The SGO did not know and did not reasonably expect that the recipient would be a disqualified person based on the substantial contributor determination made as of the close of the taxable year.
(3) Member of the family —(i) In general. The family of any individual includes only:
(A) The individual's spouse;
(B) The ancestors and descendants of the individual or the individual's spouse;
(C) The siblings of the individual or the individual's spouse;
(D) The descendants of siblings described in paragraph (d)(3)(i)(C) of this section; and
(E) The spouse of any individual described in paragraph (d)(3)(i)(B), (C), or (D) of this section.
(ii) Descendant. For purposes of this paragraph (d)(3)(ii), an individual's legally adopted child and an individual's step-child are each treated as a descendant of that individual.
(4) Duration of disqualified person status —(i) Substantial contributor to the SGO. An individual described in paragraph (d)(1)(i) of this section will be treated as a substantial contributor for any taxable year of the SGO in which the individual is so described and for the immediately succeeding taxable year of the SGO.
(ii) Officers, directors, trustees, individuals having similar powers and responsibilities, and individuals involved in selecting scholarship recipients. An individual described in paragraph (d)(1)(ii) or (iii) of this section will be treated as a disqualified person for so long as the individual is so described. An individual who ceases to be described in paragraph (d)(1)(ii) or (iii) of this section will continue to be treated as a disqualified person through the end of the taxable year of the SGO in which such cessation occurs and through the end of the immediately succeeding taxable year of the SGO.
(iii) Members of the family. An individual described in paragraph (d)(1)(iv) of this section is a disqualified person by virtue of that paragraph only while any family member is treated as a disqualified person under paragraph (d)(1)(i), (ii), or (iii) of this section.
(5) Examples. The following examples illustrate the application of this paragraph (d):
(i) Example 1: Determination of substantial contributor status— (A) Facts. On May 2, 2027, Taxpayer A, an individual, gave $6,000 to O, an SGO operating on a calendar year basis. As of May 2, 2027, O had received $250,000 from all sources as total contributions and bequests, including A's contribution, during the calendar year 2027. Between May 3, 2027, and December 31, 2027, O received $200,000 in contributions and bequests from others. Therefore, as of December 31, 2027, O had received $450,000 from all sources as total contributions and bequests during the year, and A's $6,000 contribution represented 1.33 percent of the total contributions and bequests received by O during 2027. Neither A nor any other family member of A is a disqualified person for any reason other than possible status as a substantial contributor.
(B) Analysis. A is not a substantial contributor to O for the tax year ending December 31, 2027, since A's contributions to O were not more than 2 percent of the total contributions and bequests received by O during its taxable year that ended on December 31, 2027.
(ii) Example 2: Duration of disqualified person status— (A) Facts. On July 1, 2027, Taxpayer B, an individual, gave $6,000 to P, an SGO operating on a calendar year basis. As of July 1, 2027, P had received $250,000 from all sources as total contributions and bequests, including B's contribution, during the calendar year 2027. Between July 2, 2027, and December 31, 2027, P received $30,000 in contributions and bequests. Therefore, as of December 31, 2027, P had received $280,000 from all sources as total contributions and bequests during the year, and B's $6,000 contribution represented 2.14 percent of P's total contributions and bequests during 2027. Neither B nor any other family member of B is a disqualified person for any reason other than possible status as a substantial contributor.
(B) Analysis. B will be treated as a substantial contributor for the tax year ending December 31, 2027, and for the following tax year ending December 31, 2028. Generally, any scholarships awarded to B's family members during the tax years ending December 31, 2027, or December 31, 2028, will be treated as scholarships awarded to a disqualified person. However, any scholarship awards made to B's family members prior to July 1, 2027, may qualify as an excepted scholarship if the requirements of paragraph (d)(2)(ii) of this section are met.
(iii) Example 3: Excepted scholarship— (A) Facts. On February 10, 2027, Taxpayer C, an individual, gave $7,000 to Q, an SGO operating on a calendar year basis. As of August 15, 2027, Q had received $400,000 from all sources as total contributions and bequests, including C's contribution, during the calendar year 2027. Q awarded a scholarship to C's daughter on August 15, 2027. Neither C nor any other family member of C is a disqualified person for any reason other than possible status as a substantial contributor. C did not make a pledge or otherwise inform Q of any intent to make additional contributions during 2027, and Q had no reason to anticipate any additional contribution from C during 2027. Nevertheless, on November 16, 2027, C gave an additional $7,000 to Q. As of December 31, 2027, Q had received $650,000 from all sources as total contributions and bequests during the year, and C's total contributions of $14,000 represented 2.15 percent of Q's total contributions and bequests during 2027.
(B) Analysis. Because C's contributions exceeded $5,000 and 2 percent of Q's total contributions and bequests for the tax year ending December 31, 2027, C is a substantial contributor for that tax year and for the succeeding tax year. However, had the substantial contributor determination been made as of the date of the award (August 15, 2027) based on contributions received by the organization through that date ($400,000), C would not have been considered a substantial contributor because C's contributions were not more than 2 percent of the total contributions received by Q by the date of the award. Further, as of August 15, 2027, Q did not know or have reason to expect that C would make an additional contribution to Q during 2027, resulting in C becoming a substantial contributor by the end of 2027. Based on these circumstances, the scholarship awarded to C's daughter on August 15, 2027, will not be treated as a scholarship awarded to a disqualified person by reason of paragraph (d)(2)(ii) of this section. However, C is otherwise considered a disqualified person for the tax years ending December 31, 2027, and December 31, 2028, and any scholarships awarded to C's family members in 2028 will be treated as scholarships awarded to a disqualified person.
(e) Applicability date. This section applies to taxable years ending on or after [date of publication of the final regulations in the Federal Register ].