$2,200 back on a $2,500 gift: Treasury lets donors keep their state credit and the full §25F credit

The headline number in Treasury's §25F rules is $3,400 for married couples. The number that matters most to donors in states that already run scholarship tax credits is $2,200. Under the proposed regulations released October 1, 2026, a donor who gives $2,500 and claims a $500 state credit keeps the full $1,700 federal credit. That is $2,200 back on a $2,500 gift. The donor gets both credits, where a different reading of the statute would have left them with $1,700 back in total.

Why there was a question at all. §25F does two things to the credit. Section 25F(b)(1) caps it at $1,700. Section 25F(b)(2) reduces it "by the amount allowed as a credit on any State tax return of the taxpayer for qualified contributions." The statute lists the cap first and the state-credit reduction second, so one way to read it is: cap the gift at $1,700, then subtract the state credit. On a $2,500 gift with a $500 state credit, that gives a federal credit of $1,700 minus $500, or $1,200. Add the $500 state credit and the donor gets $1,700 back.

Treasury read it the other way. The preamble says Treasury and the IRS "do not interpret this ordering of the provisions as reflecting an intent to apply the $1,700 limitation to the amount of a taxpayer's qualified contributions before application of the State credit reduction," and the proposed rule sets out three steps: total the qualified contributions, subtract any state credits allowed for them, then take the lesser of that amount or $1,700. On the same gift: $2,500 minus $500 is $2,000, so the federal credit is the full $1,700. With the $500 state credit, the donor gets $2,200 back, $500 more than under the rejected reading. Treasury explains that the state-credit reduction exists to stop a donor from "receiving combined Federal and State tax benefits exceeding the value of the taxpayer's qualified contributions," not to shrink the federal credit in states that already offer their own, which "would discourage those States from continuing to provide a State tax incentive."

The gift has to be big enough to cover both. The reduction still applies; it just comes first. In Treasury's Example 3, a donor gives $2,000 in qualified contributions and claims a $400 state credit. Subtracting the $400 leaves $1,600, which is under the cap, so the federal credit is $1,600: $2,000 back on a $2,000 gift. The combined benefit can reach the size of the gift, never more. Treasury's economic analysis walks through a larger case: a donor in a state with a 100% credit of up to $2,000 gives $5,000 and designates $1,700 of it for §25F. That donor gets $2,000 off state tax and $1,700 off federal tax, a total of $3,700.

Designate part of a gift, and the state credit lands on the rest. When one contribution earns a state credit and only part of it is designated for §25F, the proposed rule treats the state credit as coming first from the part that is not designated. In Example 4, a donor gives $4,000, designates $1,700 as a qualified contribution, and claims a $400 state credit on the whole gift. The $400 is absorbed by the $2,300 that was not designated, so the full $1,700 federal credit survives. Two more details work in the donor's favor: a state tax deduction, as opposed to a credit, does not reduce the federal credit at all, and the part of a gift that does not earn the federal credit may still be deductible as a charitable contribution if it meets the usual section 170 rules.

This replaces the advice we gave in May, when the safest reading was to treat state and federal credits as applying to separate donations. Treasury estimates that about 46.5 million taxpayers will be eligible for both a state and a federal credit for SGO contributions, and that at a 10% take-up rate the rule applying a state credit to non-designated dollars first is worth up to $1,700 a year to 3.1 million taxpayers and up to $3,400 a year to another 1.55 million married taxpayers. These are proposed rules, and comments are open until December 1, but Treasury says taxpayers may rely on them for contributions made on or after January 1, 2027. The rule text and examples are in our archive of the proposed regulations (proposed § 1.25F-2(c)).

For SGOs in states with their own scholarship credit programs, this is the clearest pitch the rules offer: a donor no longer has to choose between the state credit and the federal one. Our explainers on how §25F works alongside state credits and which states run their own programs cover the background, and recruiting donors for your SGO covers the ask. Check where your state stands on the states page, and if you are forming an organization, the free SGO Builder walks through each step.