IRS Private School Tax Exemption Rule: 2026 Guide for Schools & Donors

On September 3, 2026, the U.S. Department of the Treasury and the Internal Revenue Service published a proposed regulation — REG-119986-25 — that would formally write a race-neutral nondiscrimination test into the tax code for private schools claiming 501(c)(3) tax-exempt status. If finalized, the rule would apply to roughly 18,000 private schools nationwide starting with tax years beginning after May 31, 2027, and it would eliminate longstanding IRS guidance that has allowed schools to favor specific racial groups in admissions, scholarships, and financial aid.

This isn't a small technical tweak. It's the most significant rewrite of federal tax-exemption rules for private education since the Supreme Court's 1983 decision in Bob Jones University v. United States — and it directly imports the logic of the Court's 2023 affirmative-action ruling in Students for Fair Admissions v. Harvard into the tax code for the first time. Below, we break down exactly what the proposed rule says, where it came from, who it affects, and what each stakeholder group should do next.

• Agencies: U.S. Department of the Treasury and the Internal Revenue Service

• Action: Notice of Proposed Rulemaking (NPRM), not a final rule

• Regulation number: REG-119986-25, adding new §1.501(c)(3)-2 to the Income Tax Regulations (26 CFR Part 1)

• Published: September 3, 2026 (Federal Register document 2026-18127)

• Comment deadline: November 3, 2026

• Effective date if finalized: Applies to private-school tax years beginning after May 31, 2027

• Scale of impact: An estimated 18,000 tax-exempt private elementary, secondary, and postsecondary schools, and roughly 750,000 students who may currently qualify for race-based scholarships

• Signed by: IRS Chief Executive Officer Frank J. Bisignano

To understand why Treasury and the IRS are doing this now, it helps to know the rule didn't come out of nowhere. It's the product of a legal chain that stretches back more than 70 years:

1954 — Brown v. Board of Education. The Supreme Court struck down state-sponsored school segregation, establishing that racial discrimination in education violates the Constitution.

1970s — Green v. Connally and Revenue Ruling 71-447. After courts and the IRS began denying tax exemptions to segregated private schools in the South, the IRS formalized a rule that a school cannot be tax-exempt under §501(c)(3) unless it maintains a "racially nondiscriminatory policy as to students." Notably, the IRS's 1975 companion guidance (Revenue Procedure 75-50) also allowed a carve-out: policies favoring racial minority groups in admissions, financial aid, and facilities were not treated as discriminatory if their purpose was to promote the school's own nondiscrimination goals. That carve-out is exactly what the new proposal deletes.

1983 — Bob Jones University v. United States. The Supreme Court upheld the IRS's authority to revoke tax exemption from schools with racially discriminatory policies, ruling that such discrimination violates a "fundamental public policy" incompatible with charitable tax status.

1978–2016 — The affirmative-action years. Cases like Bakke, Grutter, Gratz, and Fisher allowed colleges to use race as one factor among many in admissions, provided programs were narrowly tailored to a compelling interest in diversity.

2023 — Students for Fair Admissions v. Harvard. The Supreme Court effectively ended race-conscious college admissions, ruling that Harvard's and UNC's policies failed strict scrutiny under the Equal Protection Clause and Title VI. This is the case Treasury and the IRS repeatedly cite as the legal foundation for the new proposal.

The new regulation is Treasury and the IRS's attempt to extend the logic of SFFA — race-neutral treatment — out of admissions offices and into the tax code itself, covering not just college admissions but K-12 schools, scholarships, athletics, and every other school-administered program.

The operative text is short but sweeping. The new regulation, §1.501(c)(3)-2, would provide that a private school is not "operated exclusively for exempt purposes" — and therefore not eligible for 501(c)(3) tax-exempt status — if it adopts, maintains, or enforces any policy or practice that discriminates on the basis of race, color, or national or ethnic origin in:

• Admissions policies

• Educational policies

• Scholarship and loan programs

• Athletic programs

• Any other school-administered or school-supported program

Critically, the proposed rule states that this prohibition applies "for any purpose" — meaning intent doesn't matter. A scholarship fund designed to remedy historical discrimination or promote diversity would be treated the same as one designed to exclude a group. Treasury and the IRS are explicit that this closes the door on the "benign" or remedial race-based preferences that prior guidance had permitted.

Who counts as a "private school" under the rule

The definition covers any private primary or secondary school, college, university, professional school, or trade school organized under §501(c)(3) and classified as an educational organization under §170(b)(1)(A)(ii). It excludes government-operated schools, since public schools are governed separately.

What the rule does not touch

The proposal includes two notable carve-outs:

1. Religious identity is preserved. Schools may still select students based on genuine religious affiliation or membership — even if members of that religious community happen to share ancestry or ethnicity — as long as the selection is based on religion, not race.

2. Race-neutral, need-based criteria remain fully allowed. Schools can continue to target aid and admissions using factors like family income, geographic location, first-generation status, individual hardship, military family status, or academic achievement — even if those criteria happen to correlate with race.

September 3, 2026: Proposed regulations (REG-119986-25) published in the Federal Register

November 3, 2026: Deadline for written/electronic public comments and hearing requests via regulations.gov

Before May 31, 2027: Treasury and IRS expect to issue final regulations, incorporating comment feedback

Tax years beginning after May 31, 2027: Final rule takes legal effect; noncompliant schools risk losing 501(c)(3) status

Because the applicability date is tied to each school's own tax year, the practical compliance deadline will vary slightly by institution — schools on a July 1 fiscal year, for example, would need to be compliant by July 1, 2027.

Treasury's own regulatory impact analysis, released alongside the proposal, offers a rare look at the scale of the change:

• ~18,000 private schools — from elementary schools through universities — currently hold 501(c)(3) status and would need to certify compliance.

• ~750,000 students may currently be eligible for scholarships that use race, ethnicity, or national origin as an eligibility factor.

• Up to 16% of scholarship dollars are funded through donor-restricted endowments, meaning most race-based aid programs could likely be restructured administratively without violating a specific donor's binding legal instructions — though endowed funds with an explicit racial restriction in the gift agreement will require schools to renegotiate terms with donors or their heirs.

• Treasury explicitly states it does not expect the rule to significantly affect athletic programs, since team eligibility is "generally based on athletic ability, not race or ethnicity."

• Colleges and universities are expected to see the smallest disruption in admissions specifically, since most already overhauled admissions criteria after the 2023 SFFA ruling. The larger compliance lift falls on scholarship and financial-aid programs, which SFFA did not directly address but this rule does.

It's worth noting independent reporting has suggested the scope here goes further than many expected: coverage of Treasury's internal deliberations earlier in 2025 indicated the draft rules could bar private nonprofit schools from tax exemption if they favor any racial group in financial aid, loans, facility use, or other programs — reaching well beyond the admissions-only scope of the Supreme Court's SFFA ruling and potentially drawing scrutiny to practices at more than 1,500 colleges and universities, including every Ivy League school. That broader financial-aid and facilities scope is now visible directly in the September 2026 text.

This Isn't Treasury's First Attempt at This Kind of Rule

Older readers may notice the historical echo. In the late 1970s, the IRS tried something similar and far more prescriptive — a proposed "badge of doubt" procedure that would have flagged schools founded around the time of local desegregation orders and forced them to prove "significant minority enrollment" or pass a battery of good-faith tests. That 1978 proposal triggered one of the era's biggest church-and-state fights, with roughly 250 witnesses testifying at a four-day IRS hearing and religious school organizations across denominations lining up in opposition, warning of First Amendment violations. The IRS ultimately withdrew that approach amid the backlash and congressional intervention. The 2026 proposal is structured very differently — it doesn't use racial-enrollment quotas or a "badge of doubt" presumption, and it explicitly preserves religious selection criteria — but it revives the same fundamental question that dominated the 1970s fight: how far can the IRS go in policing a private school's internal policies as a condition of tax exemption?

This latest push has also been building for over a year inside the agencies. Treasury and the IRS flagged guidance on the fundamental public policy against racial discrimination in schools as a priority guidance project as early as September 2025, and the draft regulation cleared White House regulatory review in June 2026 before formal publication this week.

For private school administrators and boards

• Audit every policy that touches race, ethnicity, or national origin — not just admissions. Review scholarship criteria, financial-aid formulas, facility-use policies, athletic eligibility rules, and any diversity-targeted programming.

• Inventory donor-restricted scholarship funds. Identify any endowed scholarship whose governing gift agreement explicitly ties eligibility to race, ethnicity, or national origin, and flag these for legal review — these are the highest-risk, highest-cost items to fix.

• Model a transition to race-neutral criteria now (income, geography, first-generation status, hardship) rather than waiting for the final rule, since schools that pre-adapt reduce both legal exposure and administrative disruption.

• Preserve religious-affiliation criteria carefully. If your school selects students by religious membership, document that the criterion is genuinely religious and not a proxy for ethnicity or ancestry — the preamble draws this line explicitly.

• Consider submitting a formal comment before November 3, 2026, particularly if your institution has specific compliance concerns; Treasury has invited comment on all aspects of the rule, including economic-impact estimates.

For donors and scholarship funders

• Review the language in your gift agreements and letters of intent. If a scholarship you fund or plan to fund uses racial or ethnic eligibility criteria, expect schools to reach out about restructuring it before 2027.

• Consider race-neutral alternatives now — income-based, geographic, or merit-based criteria can often achieve similar real-world outcomes for underserved communities without the compliance risk.

• Talk to your tax advisor about how a restructured scholarship fund could affect your charitable-deduction planning under §170.

For families, students, and financial-aid applicants

• Race-based scholarships at tax-exempt private schools may be phased out or restructured starting in the 2027–2028 school year. If you or your child currently receives, or hopes to receive, aid tied to racial or ethnic criteria, ask your school's financial-aid office how it plans to comply.

• Watch for new race-neutral aid categories (income-based, first-generation, geographic, military-family) that schools are likely to introduce as substitutes.

• This proposed rule does not change anything for the 2026–2027 school year — it only affects tax years beginning after May 31, 2027.

For tax and compliance professionals

• Treat this as a priority 501(c)(3) governance item for any private-school or scholarship-fund client for the 2026–2027 planning cycle.

• Monitor the comment docket at regulations.gov under REG-119986-25 for industry comment letters, which often signal how the final rule may be narrowed or clarified.

• Prepare clients for the likely modification of Revenue Procedure 75-50 (as modified by Rev. Proc. 2019-22), specifically the deletion of the provisions allowing minority-favoring policies "to promote" nondiscrimination — this is the operative guidance schools have relied on for nearly 50 years.

Is this rule final yet? No. As of publication, this is only a Notice of Proposed Rulemaking. It must go through a public comment period (ending November 3, 2026) before Treasury and the IRS can issue a final rule, and the substance could change based on comments received.

Does this rule end affirmative action at private schools? It goes further than the 2023 SFFA Supreme Court ruling, which addressed college admissions only. This proposed rule extends a race-neutral standard to K-12 admissions, scholarships, financial aid, athletics, and virtually every school-administered program — for both K-12 schools and higher education.

Can religious schools still select students based on faith? Yes. The proposal explicitly preserves the ability of religious schools to admit students based on genuine religious affiliation or membership, even where that religious community also shares common ancestry or ethnicity — provided the selection criterion is religion, not race.

What happens if a school doesn't comply? A noncompliant school would not be described as an organization exempt from federal income tax under §501(c)(3) for tax years beginning after May 31, 2027. That would mean the loss of federal tax exemption and the loss of tax-deductibility for donor contributions — a major financial and operational consequence.

Does this affect public schools? No. The definition of "private school" in the proposed regulation explicitly excludes governmental units, agencies, or instrumentalities of government — public schools are governed by separate civil-rights statutes, not this tax regulation.

How can the public comment on this rule? Comments can be submitted electronically through the Federal eRulemaking Portal at regulations.gov, referencing IRS and REG-119986-25, or by mail to the IRS's Office of Associate Chief Counsel. The deadline is November 3, 2026.

The Bigger Picture

Supporters of the proposal frame it as simply enforcing, at long last, a colorblind nondiscrimination standard that the Supreme Court has been building toward since Brown v. Board of Education — closing what they see as a loophole that let "benign" racial preferences survive SFFA. Critics — including some of the same religious-school associations and civil-rights groups that fought the IRS's 1970s enrollment-quota proposal — are likely to argue that eliminating race-conscious scholarship and outreach programs will make it harder for under-resourced students of color to access private education, regardless of the intent behind those programs. Because the rule is still in the proposal stage, both sides now have an eight-week window to make their case directly to Treasury and the IRS before the policy is locked in.

Whichever side of that debate you're on, the practical reality is the same: any private school, donor, or family connected to race-based aid or admissions criteria has roughly nine months, from publication to the expected finalization window, to understand this rule and prepare — and less than two months to formally weigh in before the comment period closes.