Treasury, IRS Propose Rules Threatening School Tax-Exempt Status and Donation Deductions

WASHINGTON D.C. – The U.S. Treasury Department and the Internal Revenue Service (IRS) announced proposed regulations on September 3, 2026, that could revoke the tax-exempt status of thousands of private educational institutions and significantly diminish a valuable tax deduction for charitable donations. The sweeping proposal targets how schools manage admissions, scholarships, loans, and program operations, particularly scrutinizing policies deemed racially discriminatory.

This move represents a significant shift in the regulatory landscape for educational institutions across the country, potentially impacting up to 18,000 high schools, universities, and trade schools. While the immediate financial implications for schools losing their tax-exempt status might not always be substantial in terms of federal income taxes, the more critical consequence lies in the erosion of their fundraising capabilities. Donors rely heavily on the ability to deduct their gifts from their tax bills, making tax-exempt status a cornerstone of educational philanthropy. The proposed rules, which are expected to take effect after May 31, 2027, introduce a new layer of complexity and potential financial strain for institutions that depend on private contributions.

From our perspective at C&S Finance Group LLC, this proposal introduces considerable uncertainty for small and mid-sized businesses, as well as their owners and executives, who often contribute significantly to local educational institutions. We've seen firsthand how crucial these charitable deductions are, not just for the donors, but for the financial health of schools that serve our communities. The administration's focus on what it deems 'racially discriminatory' policies, without fully detailing what constitutes such discrimination, creates a regulatory minefield. Businesses and individuals need clear guidance to ensure their philanthropic efforts remain tax-efficient and compliant. Our view is that navigating these evolving tax laws requires proactive planning and expert advice to avoid unintended consequences, both for the donors and the recipient institutions. C&S Finance Group LLC specializes in tax preparation and compliance, helping our clients understand and adapt to complex regulatory changes like these, and we encourage anyone affected to reach out to us at csfinancegroup.com to discuss their specific situation.

The proposed regulations extend to any school, from secondary institutions to major universities, that maintains policies or programs, including those related to admissions and scholarships, which the IRS determines to be racially discriminatory. This initiative is part of a broader administration effort to scrutinize the nonprofit sector, questioning whether various groups truly merit their tax exemptions. The administration has not yet provided detailed definitions of what it would consider discriminatory under the new rules, creating a challenging environment for schools seeking to comply.

For scholarships explicitly tied to race, the administration suggests that schools “may need to work” with donors or their heirs to establish “an alternative set of criteria.” Acceptable alternatives highlighted by the Treasury include criteria based on geography, income level, or a student’s status as a first-generation college attendee. Religious schools, however, would retain the ability to select students “based on genuine religious affiliation or membership,” according to the administration’s proposal.

Beyond the direct impact on tax-exempt status, the Treasury Department’s proposal also addresses concerns related to the deduction for state and local taxes (SALT). Specifically, it aims to prevent taxpayers from circumventing the federal SALT cap by converting state tax payments into charitable contributions. Secretary Steven T. Mnuchin stated that the proposed rule upholds the limitation on SALT deductions, which primarily benefited high-income earners, to help fund broader tax cuts for American families. The rule applies a longstanding principle of tax law: if a taxpayer receives a valuable benefit in return for a donation, only the net value of the donation can be deducted as a charitable contribution.

This aspect of the rule is particularly relevant for taxpayers who utilize state tax credit programs, such as those supporting school choice initiatives. The Treasury projects that approximately 90 percent of taxpayers will not itemize under the current tax law due to a significant increase in the standard deduction and thus will not be affected by this part of the rule. Of the roughly 5 percent of taxpayers who itemize and have SALT deductions exceeding the cap, most will see no change in their federal tax benefits compared to prior law, but will be unable to exploit the charitable deduction to bypass the SALT cap. The Treasury estimates that only about 1 percent of taxpayers will experience an effect on tax benefits for donations to school choice tax credit programs. This builds on a 2018 Treasury Department rule requiring taxpayers to subtract the amount of state credits received for a donation from their federal charitable deduction.

The administration’s push is not entirely new; it follows a long-running battle with prominent universities, including repeated threats to revoke Harvard University’s tax exemption. Last year, President Trump had called for the IRS to strip Harvard of its tax-exempt status, a move that experts cautioned could be seen as politically directed and contrary to federal law prohibiting such audits. This renewed effort adds another front to the administration’s campaign against higher education, which has also included withholding federal research funding.

For small and mid-sized businesses, the ramifications extend beyond direct donations. Companies that offer tuition assistance, engage in corporate social responsibility initiatives with educational partners, or whose employees are significant donors could face increased scrutiny and potentially reduced tax benefits. The uncertainty surrounding what constitutes discriminatory practices could also lead to a chilling effect on diversity-focused programs, as institutions and their benefactors tread carefully to avoid jeopardizing their tax status.

As the proposed rules move forward, stakeholders will have an opportunity to provide feedback before they are finalized. Businesses and educational institutions should closely monitor the specifics of the final regulations and consider their implications for future fundraising strategies, scholarship programs, and overall financial planning. The coming months will be crucial for understanding the full scope of these changes and adapting to a potentially altered landscape for educational philanthropy and tax compliance.