On September 4, 2026, the IRS published a proposed regulation, REG-119986-25, that would tighten the racial nondiscrimination requirement private schools have operated under for over 50 years. Private schools have long known that a racially discriminatory admissions policy costs them their 501(c)(3) exemption. What is new here is that the proposed rule would eliminate the long-standing exception that let schools use race-conscious scholarships and financial aid to promote diversity or remedy past discrimination.
The Existing Rule
Since Rev. Rul. 71-447 in 1971 and the Supreme Court’s decision in Bob Jones University v. United States in 1983, the IRS has treated racial discrimination in private education as contrary to a fundamental public policy of the United States, disqualifying a school from tax exemption regardless of what the Internal Revenue Code itself says about “charitable” or “educational” purposes. Rev. Proc. 75-50 built the compliance framework schools use to document a nondiscriminatory policy. That guidance also included a carve-out: a policy or scholarship program that favored a racial minority group did not count as discrimination if its purpose and effect was to promote the school’s own nondiscriminatory policy.
What the Proposed Rule Changes
The proposed regulation adds a new section, 1.501(c)(3)-2, and states plainly that a private school is not operated exclusively for exempt purposes if it discriminates on the basis of race, color, or national or ethnic origin in any educational policy, admissions policy, scholarship or loan program, athletic program, or other school-administered program, “for any purpose.” That last phrase is the point. The IRS is proposing to eliminate the sentence in Rev. Proc. 75-50 that shielded remedial or diversity-oriented race-based scholarships, along with the related sentences in section 4.05 covering financial assistance programs. A scholarship fund restricted to students of a particular race would no longer be defensible on the ground that it was designed to promote diversity or offset historical discrimination.
The IRS is explicit about the legal chain behind this: Brown v. Board of Education, the Civil Rights Act of 1964, Bakke, Grutter, Gratz, Fisher, and finally Students for Fair Admissions v. Harvard in 2023, which ended race-conscious college admissions. This proposed rule extends that same reasoning to K-12 private schools and to scholarship and financial aid programs specifically, an area SFFA did not directly address.
What It Does Not Touch
The preamble goes out of its way to preserve two things. A religious school can still select students based on religious affiliation, even where that affiliation correlates with shared ancestry or ethnicity, as long as the actual selection criterion is religion, not ethnicity. And a school can still adopt policies aimed at eliminating prejudice and discrimination generally, so long as it does so by means that do not themselves discriminate on the basis of race, color, or national or ethnic origin.
Who This Affects
The IRS estimates roughly 18,000 private elementary, secondary, and postsecondary schools currently hold exempt status, and roughly 750,000 students attend schools that may currently offer race-based scholarships. The IRS’s own analysis notes that only a small share of scholarship dollars, no more than 16%, come from endowments with donor-restricted racial eligibility criteria, so the practical disruption may be concentrated in a relatively narrow set of legacy scholarship funds rather than across the sector broadly.
Timeline
Comments are due November 3, 2026, and anyone who submits timely comments can request a public hearing. The Treasury Department and IRS expect to finalize the rule before May 31, 2027, and the rule as proposed would apply to a private school’s taxable years beginning after that date. Schools have a real window here, not an immediate deadline.
What Private Schools Should Do Now
Any private school or scholarship-granting foundation with race-restricted financial aid should start now, not after the rule is finalized. Pull the actual gift instruments and letters of intent behind any scholarship or loan fund that uses race, ethnicity, or national origin as an eligibility criterion. Where a fund was created by donor restriction, that restriction generally cannot be changed unilaterally, and reworking it may require going back to the donor, the donor’s estate, or in some cases a court under the state’s doctrine for modifying charitable gifts. Where the criteria were set by the school itself rather than by a binding donor restriction, shifting to income, geography, or first-generation status as eligibility criteria is a more straightforward fix, and one the IRS’s own economic analysis assumes most schools will make.
Ellis Carter is a nonprofit lawyer with Caritas Law Group, P.C. licensed to practice in Washington and Arizona. Ellis advises nonprofit and socially responsible businesses on federal tax and fundraising regulations nationwide. Ellis also advises donors concerning major gifts. To schedule a consultation with Ellis, call 602-456-0071 or email us through our contact form. This post is for general informational purposes and does not constitute legal advice.