A Few Key Provisions in the New Federal Tax Credit Scholarship
The United States Department of Treasury recently released the long-awaited rules for the upcoming federal Education Freedom Tax Credit. This program has the potential to revolutionize school choice funding across the United States by allowing taxpayers to redirect some of their federal tax liability to a scholarship granting organization (SGO) rather than the Internal Revenue Service (IRS).
Below, we’ll take a few minutes to highlight the most significant portions of the rules and what they mean for South Carolina.
- States are not permitted to restrict SGOs beyond federal law
The Rule: Generally speaking, states cannot create special rules and regulations for SGOs beyond those that normally apply to other 501(c)(3) nonprofits in their state. Additional restrictions, such as a requirement that the SGOs only serve a certain group of students or that scholarships may only be spent on a list of eligible expenses different from the federal standard, are not allowed.’
What it Means: This helps prevent Governors who may have begrudgingly opted-in to the program from adopting additional rules and regulations that make implementation difficult or impossible. By setting a uniform standard for participation, every state operates under a single standard and has the same opportunity to take advantage of the tax credit program. This is a positive rule for the program, but likely has little impact on South Carolina’s implementation.
- States must annually elect to participate in the program
The Rule: A state’s election to participate in the federal tax credit program is only valid for a single calendar year, and must be renewed every year.
What it Means: This provision helps ensure that state government stays responsive to its citizenry. Should the program prove to be “more trouble than it’s worth” – a wild proposition even in a worst case scenario – states have the ability to withdraw from the program. However, given the billions of dollars in potential funding that can flow to school choice, I suspect that these scenarios will be few and far between, especially in South Carolina.
- It is up to states to decide what qualifies as a “school”
The Rule: According to EdChoice, “Treasury says that to spend scholarship funds on eligible education expenses, students must be enrolled in a public, private, or religious school, based on how each state defines a ‘school.’”
What it Means: Most students across the country will be eligible by default, however, there are still many tens of thousands of students who are homeschooled or attend microschools that may be excluded from tax credit scholarship eligibility.
In South Carolina, “school” is defined as “…a division of the school system consisting of pupils composed of one or more grade groups, organized as one unit with one or more teachers to give instructions of a defined type, and housed in a school plant of one or more buildings. More than one school may be housed in one school plant, as in the case when elementary and secondary programs are housed in the same plant.” Needless to say, there will be a team of lawyers who will need to determine whether home- and microschooling qualifies under this definition. Do homeschool co-ops (Option 3 homeschoolers, usually) who meet regularly in-person in a dedicated building qualify, but a true parent-led homeschooler does not? What sort of buildings qualify as a “school plant?”
- The tax credit is $1,700 per taxpayer, regardless of marital status
The Rule: The Education Freedom Tax Credit avoids the marriage penalty by guaranteeing a $1,700 credit per taxpayer, even if they are married-filing jointly. Each person must have $1,700 of liability for the couple to claim the full $3,400 credit – their liability is not just rolled together.
What it Means: Although this may complicate the tax returns for married couples who file jointly, protecting against the marriage penalty significantly increases the potential funding stream. The marriage penalty is common across the country, although the South Carolina legislature declined to take up both a House and Senate bill introduced to fix this issue last session.
- SGOs are free to set their own priorities
The Rule: States are limited in their ability to restrict SGOs beyond federal requirements, but the SGOs are free to restrict themselves. They may choose to award scholarships to a certain type of student (e.g. English learners or special needs students) or for a certain category of expenses.
What it Means: A marketplace of SGOs will quickly spread throughout the country, all with different missions and focus. A taxpayer can donate to any SGO that they like – it is not limited to those in their state. Taxpayers will need to take the time to do their research and decide what sort of scholarships they would like to support.
Moving Forward
We have to keep in mind that these rules are going to evolve over the next year. The Department of Treasury also released proposed regulations at the same time last week so they can be refined over the first year of the program. Ultimately, this federal tax credit program has the potential to send billions of dollars into supporting school choice across the United States, creating countless new educational opportunities for millions of children. States should take care to faithfully implement the program as it was intended, and should not be looking for opportunities to slow implementation with arbitrary and capricious policies and procedures. Millions of children need something more to support their educational journey, and it is time that we gave them the help and resources that they need.
