Scholarship Funding Organization: Certification, Eligibility, and IRS Rules

A scholarship funding organization must hold public-charity status under Internal Revenue Code Section 501(c)(3), meet the operational requirements set out in 26 U.S.C. §25F, obtain separate certification from any state whose tax credit program it participates in, and follow ongoing rules on spending ratios, fund segregation, income verification, and IRS reporting. The scholarship funding organization requirements below combine the federal baseline created by the One, Big, Beautiful Bill Act with the additional obligations that most state programs impose.¹

The federal statute uses the term “scholarship granting organization” (SGO); many state programs use “scholarship funding organization” (SFO). The function is the same: collecting private contributions, converting them into K-12 scholarships for qualifying students, and giving donors a tax benefit.

Tax-Exempt Status

The threshold requirement is 501(c)(3) status. To qualify at the federal level under §25F, the organization must be tax-exempt under Section 501(c)(3) and cannot be a private foundation.² Getting there means applying to the IRS and receiving a determination letter confirming the organization is organized and operated exclusively for charitable or educational purposes.³ Public charity classification, rather than private foundation classification, is essential; a private foundation cannot function as a qualifying SGO under the federal credit.

Federal Operational Requirements Under §25F

Section 25F sets five operational rules that a scholarship organization must satisfy for its donors to claim the federal credit:

Scholarships must go to at least 10 students who do not all attend the same school.
At least 90% of the organization’s income must be spent on scholarships for eligible students, leaving no more than 10% for administrative costs.
Donors cannot earmark contributions for a specific student. The organization decides which eligible students receive awards.
People with certain personal or financial ties to the organization — those treated as disqualified persons under rules similar to 26 U.S.C. §4946 — cannot receive scholarships.
The organization must verify each applicant’s household income and family size before awarding a scholarship.

These requirements come directly from the statute. States that participate in the federal program must certify, under penalties of perjury, that each SGO on the list they submit to Treasury complies with them, and cannot simply rely on SGO self-reporting.² An organization located in a state that has not elected to participate cannot receive federal-credit-eligible contributions regardless of how well it meets the operational rules.⁴

State Certification

State programs layer additional requirements on top of the federal baseline. Common certification steps include submitting the IRS determination letter, obtaining a surety bond or irrevocable letter of credit (minimums typically range from $25,000 to $100,000), and clearing background checks for officers and directors. Some states require notarized compliance statements and proof of liability insurance.

Applications usually go through the state’s department of education. Review periods can stretch 30 to 60 days. An organization cannot accept tax-credit contributions or distribute scholarships until the state authorization is finalized. Because state certification and federal listing are independent tracks, an organization operating in a state with an established tax credit scholarship program will need to keep meeting state-level requirements even after landing on the federal SGO list.

IRS Rules on Scholarship Selection

Beyond §25F, any 501(c)(3) that awards scholarships must follow an objective, nondiscriminatory selection process. The pool of potential recipients must be large enough to constitute a charitable class; a scholarship benefiting a group so narrow that it effectively serves private interests will not qualify. Acceptable selection criteria include academic performance, financial need, test scores, and personal recommendations.⁵

The people making selection decisions cannot be in a position to derive a private benefit from the choices. If board members or officers steer scholarships toward their own relatives, the organization risks losing its tax-exempt status. The §25F disqualified-persons prohibition and the longstanding IRS private-benefit rules overlap on this point and reinforce each other.⁵

Spending Ratios, Fund Segregation, and Audits

The 90% federal spending threshold is the ongoing obligation with the least room for error. Some state programs are stricter, requiring 100% of contributions to be spent on scholarships within a rolling three-year period. The remaining percentage available for administrative costs has to cover staff salaries, technology, compliance work, and audit fees, and it runs thin quickly for smaller organizations.

Fund segregation is mandatory. The federal statute explicitly requires SGOs to prevent commingling of scholarship contributions with other organizational assets, including money used for administrative expenses.¹ In practice, that means maintaining separate bank accounts dedicated exclusively to qualified contributions. Mixing scholarship funds with operating capital is one of the fastest ways to lose eligibility.

Most state programs require an annual independent financial audit conducted by a certified public accountant. The audit evaluates whether the organization followed Generally Accepted Accounting Principles and hit its scholarship distribution targets. When an audit reveals that required spending ratios were missed or that funds were mishandled, the state can revoke eligibility and impose financial penalties. Audit reports are often made publicly available.

Verifying Student Eligibility

Scholarship organizations have to verify that every recipient qualifies before any money changes hands. Federal and state eligibility rules differ, so organizations participating in both need to track compliance on parallel tracks.

Federal Standard

Under §25F, a student’s household income must be at or below 300% of the area median gross income, calculated using U.S. Department of Housing and Urban Development figures. The income used is from the calendar year before the scholarship application date. The student must be eligible to enroll in a public elementary or secondary school, which effectively limits scholarships to K-12 students of school age.¹

SGOs must give priority first to students who received a scholarship from the organization the previous school year, then to eligible students who have a sibling already receiving a scholarship from the same organization.² After those two groups are served, the organization has discretion over how it allocates remaining awards.

State Standards

State income thresholds typically use the federal poverty level rather than area median income. Common caps range from 185% to 260% of the federal poverty level. The 2026 federal poverty level for a family of four in the 48 contiguous states is $33,000, so a 260% threshold would cap eligibility at roughly $85,800 in household income.⁶ Tax returns or pay stubs are typically used to confirm these figures.

Many state programs mandate priority access for students in foster care, out-of-home care, or experiencing homelessness. The organization also usually has to confirm state residency and age eligibility, with birth certificates and residency affidavits reviewed annually.

IRS Reporting

Scholarship organizations that distribute more than $5,000 in grants to domestic individuals in a tax year must report those awards on Schedule I of Form 990.⁷ Generic descriptions like “educational” or “charitable” are not acceptable. Each type of scholarship must be listed separately with the number of recipients, total cash amount, and any noncash assistance provided.

Organizations that pay scholarships directly to students, rather than to the school, must obtain annual reports of the student’s courses and grades from the educational institution. When the organization pays the school directly and the school agrees to supervise how the funds are used, that follow-up reporting requirement is relaxed.⁵

The Secretary of the Treasury also has authority to issue additional recordkeeping and reporting requirements specific to the §25F program. Proposed regulations are expected as the January 2027 credit launch approaches, so organizations should track IRS guidance releases through 2026.

Losing Eligibility

If a state revokes certification or removes an organization from its SGO list, the organization can no longer accept tax-credit eligible contributions, and donors who contribute after the revocation date will not qualify for the credit. Students currently receiving scholarships face potential disruption if funds already committed are not disbursed before revocation takes effect.

At the federal level, the Secretary of the Treasury has broad authority to issue guidance on enforcement and compliance. Because state governments verify SGO eligibility and submit annual lists to Treasury, an organization that fails to meet §25F requirements can be delisted by the state even if the IRS has not taken independent action. The compliance points that most commonly trigger problems, and that auditors look at first, are the spending ratios, fund segregation rules, and income verification requirements.

1
Congressional Research Service. Federal Tax Credit Scholarship Program Included in P.L. 119-21
2
Office of the Law Revision Counsel. 26 USC 25F – Qualified Elementary and Secondary Education Scholarships
3
Office of the Law Revision Counsel. 26 USC 501 – Exemption From Tax on Corporations, Certain Trusts, Etc.
4
Internal Revenue Service. Treasury, IRS Allow States to Make an Advance Election to Participate in the New Federal Tax Credit for Individual Contributions to Scholarship Granting Organizations Under the One Big Beautiful Bill
5
Internal Revenue Service. IRC 4945 – Scholarship Grants to Individuals
6
Assistant Secretary for Planning and Evaluation. 2026 Poverty Guidelines
7
Internal Revenue Service. Instructions for Schedule I (Form 990)