Private School Tax Exemptions at Risk Under New IRS Rule

The IRS issued a proposed rule on September 3 that would strip 501(c)(3) status from private schools whose admissions or scholarship decisions consider race, color, or national or ethnic origin, regardless of whether the policy is framed around diversity or remedial goals. The agency estimates the change would affect roughly 18,000 private elementary, secondary, and post-secondary schools. The proposal, published as REG-119986-25, comes after years of court challenges to race-conscious admissions policies at colleges and universities.

The proposed regulation clarifies that a school is not "operated exclusively for exempt purposes," the core requirement for maintaining 501(c)(3) status, if its admissions, scholarship, loan, athletic, or other school-administered programs factor in race, color, or national or ethnic origin. That standard would apply broadly:

These Standards all fall under the same rule, no matter how the school characterizes its rationale for the policy. Religious affiliation as a selection criterion is unaffected, even where it overlaps with ethnic identity.

Donors would also be affected: funding a scholarship earmarked by race or ethnicity through a school would no longer be permitted, though the IRS notes donors could still achieve similar outcomes through other structures. Alongside the new rule, the IRS also intends to revise existing guidance to remove language that previously treated policies favoring racial minority groups as an exception to nondiscrimination requirements. If finalized, the rule would apply to tax years beginning after May 31, 2027, giving affected schools a runway to review and adjust policies before it takes effect.

Tax-exempt private schools have been required to operate under a racially nondiscriminatory policy since the early 1970s, a standard that grew out of federal court rulings and IRS guidance issued at the time. The current proposal doesn't change that underlying requirement so much as it narrows how the exception for diversity-related purposes has been interpreted since then. The IRS points to a shifting legal backdrop, most notably the Supreme Court's 2023 decision in Students for Fair Admissions v. Harvard, as the basis for this update. The agency says its longstanding guidance, some of it dating back decades, is no longer consistent with a single nondiscrimination standard and needs to be brought in line with current case law.

As with any proposed regulation, the IRS opened a public comment period and the option to request a hearing before moving toward a final rule, giving schools and other interested parties a chance to weigh in on the proposal as written. For most schools, the more useful planning horizon is the 2027 effective date rather than the comment period itself. Schools should use the time between now and then productively: reviewing admissions criteria, scholarship and loan program documentation, and athletic eligibility rules for any language tied to race or ethnicity, and checking donor agreements that restrict scholarships along those same lines. Talking with counsel or a tax advisor sooner rather than later gives schools time to plan rather than react once the rule is finalized.

A rule this broad can touch more parts of a school's operations than it first appears to. CSH's Not-for-Profit tax team tracks these kinds of developments and works with exempt schools to figure out what they actually mean for existing admissions, scholarship, and compliance documentation.

Have questions about how this proposed rule might apply to your school? Reach out to a CSH advisor to start the conversation.