Education Freedom Tax Credits

by Tom Yamachika, President, Tax Foundation Hawaii

One of the new features in the tax landscape wrought by the One Big Beautiful Bill Act is a program called Education Freedom Tax Credits.

The program supports scholarships for American students, but in a very indirect way.  It supports scholarship-granting organizations (SGOs), 501(c)(3) nonprofits that give out scholarship money to deserving primary and secondary school students.  Under the program, credits don’t go to the SGOs.  They go to individuals who donate money to the SGOs.  The federal nonrefundable credits match the individual donations, dollar for dollar, up to $1,700 per individual.  There are income limits for individual donors, so that donors get their donations matched if their income level is under a certain amount and get a tax deduction otherwise.

The SGOs, in theory at least, would be able to attract more donations from folks because those folks wouldn’t have a net economic loss.  And the SGOs could then give more money to more kids.

States have a role to play in this process too.  A state that opts in to the program is tasked with producing a list of qualified SGOs that award scholarships in that state.  This is, presumably, done to cut down the possibility of fly-by-night SGOs that take money and run.

Some states, including ours, were not eager to sign on to the program.  Would an opt-in election, for example, require the state to commit to specific Trump Administration policy priorities such as rescinding any DEI (diversity, equity, and inclusion) initiatives and terminating any LGBTQ support?  So far, the statute and existing Treasury guidance indicate that the only requirement to opt in is a commitment to come up with the SGO list.

Is this tax credit scheme just a way to implement a school voucher system, which would be politically problematic here because such a program tends to prioritize private schools over public ones, as HSTA and other school unions across the country have argued?  Not necessarily, as the nonprofit Edchoice.org argues, because SGO-granted scholarship money does not have to be spent on tuition.  It can go toward school supplies, transportation costs, fees for enrichment programs (band uniforms, for example), and other related costs listed in Internal Revenue Code section 530.

Shortly after the One Big Beautiful Bill Act became effective, some commentators wondered if opting in to the credit program would violate the Hawaii Constitution’s provision in Article X, Section 1 that taxpayer funds cannot be “appropriated for the support or benefit of” private education.  To us, this does not seem to be a problem because no state funds are appropriated and no state credits or other incentives are being awarded.

As a practical matter, furthermore, neither donors nor scholarship seekers are limited by Hawaii’s list.  They may donate to or apply for a scholarship from any SGO on any state’s list.  If Hawaii does not participate, the disadvantage will primarily be to smaller SGOs that are only known in Hawaii and thus might not make it to any other state’s list.

The only potential pitfall would be if the Trump Administration asserts that opting in to the program entails agreement to support Trump Administration policy positions.  So far, no such conditions have appeared in IRS preliminary guidance on the program, but, as some may say, the night is still young.