How the New Federal Tax Credit Works
Explaining the new federal tax credit for K–12 scholarships
The new federal K–12 tax credit in the One Big Beautiful Bill Act (OB3) is meant to create a national “scholarship pipeline” that flows through states and nonprofit Scholarship Granting Organizations (SGOs), instead of only through school districts and traditional grants. For LearningSpring, this creates a time-limited opportunity: states that opt in must stand up entirely new systems for approving SGOs, tracking donations and credits, and monitoring compliance by January 1, 2027, and most do not yet have that infrastructure.
How the federal tax credit works
Under OB3, individual and corporate taxpayers can contribute to state-approved SGOs and receive a federal income tax credit, up to a capped amount each year. The law sets a national framework: Treasury and IRS run the credit, but states must opt in, define certain state-level rules, and maintain a list of qualifying SGOs.
The credit is nonrefundable and capped (e.g., up to around $1,700 per individual and $3,400 for joint filers, with higher caps for some businesses), so it is attractive to middle- and upper-income donors with tax liability.
If a state already offers its own tax credit for the same type of donation, the federal credit is reduced by the amount of state credit claimed, to limit double-dipping.
SGOs must spend the vast majority of their funds (typically at least 90 percent) directly on scholarships for “qualified” K–12 education expenses, with only a small slice allowed for administration.
In practice, that means donors send money to SGOs, SGOs send scholarships to families or schools, and the IRS provides a federal tax benefit on the back end.
What SGOs and states have to build
OB3 assumes that states and SGOs can quickly build a working ecosystem: application and approval processes for SGOs, data flows to Treasury, and robust reporting and audit trails. Many states already running ESA or tax credit programs have partial infrastructure, but even they will need new layers to comply with the federal rules on caps, eligible expenses, and interaction with state credits.
States that opt in will need to:
Create or update rules defining which nonprofits can qualify as SGOs, how they are supervised, and how they report scholarship activity.
Maintain real-time or near–real-time data feeds on approved SGOs and donation volumes so that Treasury can manage national caps and credit allocations.
Monitor that SGOs stay within the 10 percent (or similar) cap on non-scholarship spending and follow required student-eligibility and anti-discrimination rules.
SGOs, in turn, must build or buy systems that can:
Accept and receipt donations in a way that lines up with federal and state credit rules.
Track scholarships at the student level, including eligibility, approved expenses, and payments to schools and vendors.
Produce clean, auditable reports back to both the state and the IRS-linked systems.
The big upcoming problem for states
States that choose to opt in to the new federal tax credit scholarship program will face a major operational challenge: building working systems fast enough to be ready by January 1, 2027. The law assumes states and SGOs can quickly create the machinery to approve organizations, move money, and document everything, but most do not have that capacity sitting idle today.
States will need to stand up processes to receive, review, approve, and, when necessary, remove SGOs in ways that match federal eligibility and spending rules. They also have to track contributions in close to real time (information such as who gave, to which SGO, and for which tax year) so they stay within any federal allocation limits and avoid over-promising credits. On top of that, they must exchange data with federal systems securely and consistently so taxpayers receive the correct credits and oversight agencies can monitor for errors or abuse.
At the same time, SGOs will be under pressure to accept and receive donations in ways that satisfy both state and federal requirements, award scholarships for “qualified education expenses,” and keep transaction-level records that can withstand audits. They will also have to report regularly to states, showing that they are staying under administrative spending caps and targeting students and uses as required.
All of this has to happen on a short timeline, across multiple agencies and many SGOs, with real families and real tax dollars at stake. The looming question is whether states can reach operational readiness in time to launch a program that is effective, auditable, and fraud-proof on day one.
