The Treasury Department and IRS on Thursday proposed a rule that would strip federal tax benefits from private schools that factor race into admissions, scholarships or other student programs—putting donor deductions and some scholarships at risk and potentially reshaping how tens of thousands of institutions handle diversity policies. That decision matters now because, if finalized, the change would affect tax years starting May 31, 2027, and could alter giving patterns and financial aid for hundreds of thousands of students.
What the proposal says
The agencies say organizations that do not operate exclusively for charitable and educational purposes may lose their 501(c)(3) status. Treasury officials estimate the change could touch roughly 18,000 private schools across the United States, from elementary and trade schools to colleges and professional programs.
The draft rule would reach beyond admissions to cover “educational policies, scholarships and loans, athletics, and every other school-administered or school-supported program,” according to the Treasury Department’s statement. Religious-based selection policies would not be affected.
- Scope: An estimated 18,000 private schools could fall under the rule’s review.
- Timing: The regulations would apply to taxable years beginning on or after May 31, 2027, if finalized.
- Students potentially affected: Treasury and IRS estimate about 750,000 students attend schools that award scholarships on the basis of race, ethnicity or national origin.
- Donor impact: Gifts to schools that lose tax-exempt status would likely no longer be deductible for federal income tax purposes.
Why donors and students could feel it
Removing tax-exempt status typically eliminates the tax deduction for charitable donations, which can influence giving. Tax advisers warn that if an institution is stripped of its exemption, contributions to that school would generally stop qualifying for the federal charitable deduction, changing the calculus for individual and major donors.
Experts note the timing overlaps with a recently expanded charitable deduction created by Congress, which allows some taxpayers to claim a limited deduction without itemizing. Still, the number of taxpayers who itemize is much smaller today than it was a decade ago, after the 2017 tax overhaul raised the standard deduction and reduced the share of filers who claim itemized charitable deductions.
Scholarships and legacy funds — a legal tangle
The proposal flags an awkward legal problem: older scholarship funds that include race-based eligibility conditions. Tax and school officials say those arrangements could require renegotiation with donors or heirs to preserve the awards without violating the new rule.
Troy Lewis, a tax professor and CPA, described such legacy restrictions as among the most complicated practical issues schools will face. He said institutions may need to work with donors, their estates or trustees to alter eligibility terms in order to remain compliant while still honoring the intent of the original gift.
Reactions from both sides
Treasury Secretary Scott Bessent said the proposed regulations are intended to stop racial discrimination in education and make clear that institutions using discriminatory practices will not keep federal tax benefits.
Administrators at the IRS echoed that stance, warning schools that continue to use race-conscious approaches could lose their tax-exempt designation. At the same time, civil-rights advocates and education groups argue the rule would punish schools for programs aimed at addressing barriers that students of color face.
“Addressing racial inequity is not discrimination,” said Denise Forte of EdTrust, who warned that the proposal could undermine efforts to remove long-standing obstacles to opportunity.
Practical consequences and open questions
How many donors would actually stop giving, or how many scholarships would be discontinued, is uncertain. Some tax experts predict Treasury is betting most institutions will change their policies to preserve exemption, minimizing long-term disruption.
Others say enforcement and implementation will be difficult to predict. The draft leaves open complex compliance and legal questions—how the government will identify violations, how it will treat preexisting restricted funds, and what standards schools must satisfy to demonstrate compliance.
Because these are proposed regulations, they could be revised after public comment and legal review. Still, the timeline in the proposal gives schools, donors and students a clear deadline: taxable years beginning on or after May 31, 2027, would be governed by the new standard if the rule is finalized.
Bottom line
The administration’s proposal represents a significant shift in how the federal tax code could be used to influence campus policy. Beyond legal and philosophical debates, the concrete stakes are financial: donor tax benefits, the future of race-based scholarships, and how private schools choose to structure admissions and aid.
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Jordan Keller specializes in analyzing the US financial markets. With concrete recommendations, he helps you secure and boost your investments by providing strategies that adapt to market fluctuations.