Education Freedom Tax Credit

The Education Freedom Tax Credit is a nonrefundable federal income tax credit for cash donations to nonprofits that award K-12 scholarships, known as scholarship granting organizations (SGOs), in states that elect to participate. It was created by section 25F of the Internal Revenue Code, added by the One Big Beautiful Bill Act in July 2025, and applies to tax years ending after December 31, 2026, so the first qualifying gifts are made in 2027. The credit equals the donor's qualified contributions for the year, up to $1,700, reduced by any state tax credit allowed for the same gifts. Because it is a credit rather than a deduction, a donor does not need to itemize to claim it.

The two names refer to the same credit. "Education Freedom Tax Credit" is the name Treasury uses in its announcements and the one most people search for; the regulations, Form 8525 and IRS.gov call it the Federal Scholarship Tax Credit, and the IRS's own news release describes it as "commonly known as the Education Freedom Tax Credit." The statute uses neither name: section 25F is headed "Qualified elementary and secondary education scholarships."

What the statute settles. Section 25F allows the credit to a U.S. citizen or resident for "qualified contributions," which it defines as charitable contributions of cash to an SGO that uses them to fund scholarships for eligible students solely within the state where the organization is listed. The credit "shall not exceed $1,700," a figure the statute does not adjust for inflation, and it is reduced by any credit allowed on the donor's state tax return for the same contributions. A contribution that produces the credit "shall not be taken into account as a charitable contribution" under section 170, so one dollar cannot earn both a credit and a deduction. Any credit larger than the donor's federal income tax carries forward, but not beyond the fifth tax year after the year it arose, and the oldest amounts are used first.

Which states and which organizations. A state takes part only if it chooses to, by an election made by its governor or whoever state law designates, and it then gives the IRS a list of qualifying SGOs. The IRS publishes the participating states on its Federal Scholarship Tax Credit page on IRS.gov; as of September 14, 2026, 30 states had made advance elections for 2027. An SGO must be a 501(c)(3) organization that is not a private foundation, keep qualified contributions in separate accounts, give scholarships to at least 10 students who do not all attend the same school, spend at least 90% of its income on scholarships for eligible students, and pay only qualified expenses. It must give priority to students it funded the previous year and then to their siblings, may not earmark gifts for any particular student, must verify each applicant's household income and family size, and may not award a scholarship to a disqualified person, defined by rules similar to those that apply to private foundations.

The student side. An eligible student is one who can enroll in a public elementary or secondary school and whose household income for the prior calendar year is not more than 300% of the area median gross income, the measure used for the low-income housing credit. The proposed regulations would adjust that limit for family size using the multipliers HUD applies to Section 8 housing assistance. The scholarships can pay any expense listed in section 530(b)(3)(A), the same list that governs a Coverdell education savings account: tuition, fees, academic tutoring, special needs services, books, supplies and equipment for a student at "a public, private, or religious school"; room, board, uniforms, transportation and supplementary items or services, including extended day programs, that the school requires or provides; and computer technology, equipment or internet access. Section 139K excludes these scholarships from the family's gross income for amounts received after December 31, 2026.

Set by temporary regulations. Temporary regulations that take effect on December 1, 2026, and expire no later than October 1, 2029, define a qualified contribution as cash given by an individual, counted only to the extent the donor tells the SGO at the time of the gift that it is intended for the credit, and that designation "once made, is irrevocable." Cash includes a check, money order, electronic transfer or after-tax payroll deduction in U.S. dollars, and it does not include any digital asset. The value of anything the SGO provides in return, such as a dinner, is subtracted. The SGO must send a written acknowledgement by January 31 of the following year. The proposed regulations contain the same definition.

Still proposed. Most of the rules on computing the credit come from regulations proposed on October 2, 2026, which can change before they are final. Taxpayers may rely on them for contributions made on or after January 1, 2027, if they follow them consistently and in full. Under the proposed rules, spouses on a joint return are treated as separate taxpayers for the $1,700 limit, so a couple can claim up to $3,400 if each spouse gives at least $1,700. A state credit comes off the qualified contributions before the $1,700 cap is applied, and where a state credit covers a gift that is only partly designated, it is treated as coming first from the undesignated part. The portion of a gift above the credit may be deductible as a charitable contribution if it meets the ordinary section 170 rules. A partner's or S corporation shareholder's share of the entity's gift does not count. A donor may give to an SGO on any participating state's list regardless of where the donor lives, may rely on the organization's presence on the IRS's SGO list at the time of the gift, and claims the credit on Form 8525 with the donor number from each SGO's acknowledgement. The proposed rules also read "solely within the State" as a test of where the student lives, not where the school is, with exceptions for the children of service members and of families living on Indian lands.

Where state programs already exist. Some states already give their own tax credits for gifts to scholarship organizations. A gift that earns a state tax credit can still qualify for the federal credit, but the state credit reduces it. Because the proposed regulations define a state credit as a tax credit, a state income tax deduction for the gift generally would not reduce the federal credit.

The credit is figured once a year on the donor's federal return, after the donor has made designated cash gifts to listed SGOs during the year.

1. Add up the designated gifts. Total the cash given to SGOs during the year that was designated for the credit at the time of giving, less the value of anything received in return.

2. Subtract any state credit. Under the proposed regulations, a state tax credit allowed for those same gifts comes off this total first.

3. Apply the cap. The credit is the smaller of that result and $1,700 (under the proposed regulations, $1,700 for each spouse on a joint return).

4. Apply the tax limit. The credit can offset only the federal income tax, including any alternative minimum tax, that is left after the child tax credit, the child and dependent care credit, the education credits, the Saver's Credit and several other nonrefundable credits.

5. Carry forward what is left. An unused amount carries forward for up to five years and is used before the next year's new credit, oldest first.

For example: Odette, who files single, gives $2,000 by electronic transfer in March 2027 to an SGO on a participating state's list and designates the whole gift for the credit. Her state offers no credit for it, and her federal income tax after her other credits is $6,200. Her credit is the smaller of $2,000 and $1,700, so $1,700, and her tax falls to $6,200 − $1,700 = $4,500. The remaining $300 of the gift is an ordinary charitable contribution that may be deductible under the usual rules. For the $1,700 that earned the credit, her federal tax falls by exactly the amount she gave. A $1,700 charitable deduction, by comparison, saves at most $1,700 times the donor's marginal tax rate, even where the full amount is deductible: $1,700 × 22% = $374 at a 22% rate.

Consider a married couple. Tomasz and Ines each give $1,700 to an SGO in 2027, each designating the gift for the credit, and they file jointly; their federal income tax after other credits is $2,500. Under the proposed regulations their credit is $1,700 + $1,700 = $3,400, but only $2,500 can be used in 2027, which brings their tax to zero. The other $3,400 − $2,500 = $900 carries forward to 2028 and can be used through 2032, the fifth year after 2027.

Take an example with a state credit. A donor gives $2,500, designates all of it for the credit, and receives a $500 state credit for it. Under the proposed rule, $2,500 − $500 = $2,000, which the cap reduces to a $1,700 federal credit. Applying the cap first would instead give $1,700 − $500 = $1,200. The preamble to the proposed regulations uses this same scenario to illustrate that cap-first reading, which Treasury and the IRS declined to adopt.

Pros

• A credit reduces tax dollar for dollar, so the first $1,700 of designated gifts can be fully offset by the credit for a donor with enough federal income tax.
• The donor does not need to itemize deductions to claim it.
• Unused credit carries forward for up to five years rather than being lost.
• Under the proposed regulations, a donor can give to an SGO in any participating state, and a married couple filing jointly can claim up to $3,400.
• Scholarship recipients do not owe income tax on the award, and the expense list reaches public-school students as well as private and religious school students.

Cons

• It is nonrefundable, so a donor with little or no federal income tax gets no current benefit and may lose the credit if the five-year carryforward runs out.
• Only cash qualifies. Appreciated stock, other property and digital assets do not.
• It works only through SGOs on the list of a state that has chosen to participate, and the scholarships reach only students in those states.
• The designation has to be made when the gift is made and cannot be revoked afterward, and a donor cannot direct the money to a particular student.
• A state credit for the same gift reduces the federal credit, and gifts above the credit receive only ordinary charitable-deduction treatment.
• The joint-return limit, the state-credit order, the across-state giving rule and the Form 8525 reporting rule are proposed and can change before the regulations are final.