Tax Exempt Status At Risk - What the IRS’s New Proposed Racial-Nondiscrimination Rule Means for Private Schools

09.22.2026

A newly proposed federal tax rule would terminate the tax-exempt status for private schools that discriminate by race, color, or national or ethnic origin with respect to any of their programs. In light of the proposed regulations, private schools should reexamine how race enters their admissions, financial aid, athletics, and other student programs.

On September 4, 2026, Treasury and the IRS published the proposed regulations (REG-119986-25) which would add a new section, 26 C.F.R. Sec. 1.501(c)(3)-2, to the Treasury regulations. These regulations would have a very wide impact, as the IRS estimates that roughly 18,000 private elementary, secondary, and postsecondary schools, (and some 750,000 students who might qualify for race or ethnicity-based scholarships), may fall within the reach of the regulations.

The proposed regulation defines a “private school” as any organization that qualifies under section IRC section 501(c)(3) and is classified as an educational organization under IRC section 170(b)(1)(A)(ii), meaning tax-exempt private primary and secondary schools, colleges, universities, and professional or trade schools would all likely meet the definition. That said, governmental units and their instrumentalities are excluded, so public colleges and universities fall outside the scope of the “private school” definition.

One thing that makes the proposed regulations notable is how they handle enforcement of the proposed nondiscrimination rules. Rather than creating a civil-rights based framework, the proposed regulations address race-conscious programming through the tax code. One serious consequence of that structure is that the penalty for a violation could cause the loss of a school’s tax exempt status.

I. Background and Relevant Changes

While the requirement that tax-exempt private schools maintain racially-nondiscriminatory policies is not new, the proposed regulation goes substantially further in that it would treat any discriminatory policies as prohibited, even if those policies were remedial or designed to create diversity and to promote nondiscrimination.

In the early 1970s, a federal court enjoined the IRS from recognizing racially discriminatory private schools as tax-exempt, and IRS Revenue Ruling 71-447 concluded that a school without a racially nondiscriminatory policy toward students could not be “charitable” and could not qualify for exemption. (Green v. Connally, 330 F. Supp. 1150 (D.D.C. 1971)) The Supreme Court later endorsed that view, reasoning that an institution counts as charitable only if it serves a public purpose and does not offend established public policy. (Bob Jones Univ. v. United States, 461 U.S. 574 (1983)) The IRS implemented that principle through Revenue Procedure 75-50, which directs private schools to adopt and publish a nondiscrimination policy, keep records on the racial makeup of students and faculty, and certify compliance each year.

For decades that framework treated two kinds of race-conscious conduct differently. Turning students away because of race was barred but, in certain circumstances, policies favoring members of racial minority groups were expressly protected. Section 3.02 of Revenue Procedure 75-50 provided that a policy favoring racial minority groups was not race discrimination when its purpose and effect were to advance the school’s nondiscriminatory policy toward students, and section 4.05 treated scholarships and loans similarly. Thus, a school could run minority-focused scholarships or scholarships with diversity-oriented criteria without risking its tax exemption.

The proposed regulations remove that distinction. In the preamble of the proposed regulations, it states that every form of racial discrimination in education offends fundamental national public policy “regardless of the intent behind or the legality of such discrimination,” including where defended as remedial or as serving diversity. As such, the language that once protected minority-favoring admissions and aid in section 3.02 and section 4.05 of Revenue Procedure 75-50 would be stricken.

Proposed Sec. 1.501(c)(3)-2(b) provides that a private school is not operated exclusively for exempt purposes if it “adopts, maintains, or enforces any policy or practice that 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 or school-supported program, and it adds that such discrimination “for any purpose” is covered. The result is that race-conscious design, whichever direction it runs and whatever its motive, can cost a school its tax exemption. The catch-all for “other school-administered or school-supported” programs can also reach pipeline, mentoring, and similar initiatives that select participants by race or ethnicity.

II. Risks for Private Schools

The IRS appears to expect the rule will primarily impact scholarships and financial aid, especially at the postsecondary level, where most institutions already revised admissions policies after the Court struck down the race-conscious admissions programs at Harvard and UNC, requiring that any racial classification survive strict scrutiny, avoid stereotype and racial harm, and reach an eventual end. (Students for Fair Admissions, Inc. v. President & Fellows of Harvard Coll., 600 U.S. 181 (2023)) Treasury and the IRS estimate that scholarship dollars tied to any restricted endowment, whatever the restriction, amount to no more than sixteen (16) percent of total scholarship dollars, and for aid not donor-restricted by race, the IRS indicates that a school can simply rewrite its eligibility rules.

However, the solution is not as straight forward with respect to donor-restricted and endowed funds. When a gift instrument ties eligibility to race, a school may have to work with the donor, or the donor’s heirs, to settle on replacement criteria, which could be problematic and could come at a cost. Existing rules generally prohibit a school from unilaterally modifying such terms. Such modifications typically require the donor’s agreement or, when the donor is gone or unwilling, a court’s approval through a cy pres proceeding. As potential criteria substitutes, the proposed regulations point to income, geography, and first-generation status, which are described as more closely tied to disadvantage than to race.

Those substitutes carry a warning the proposed regulation does not state. The Department of Justice’s July 29, 2025, guidance on unlawful discrimination cautions that facially neutral criteria can operate as forbidden proxies for race if they track, stand in for, or reproduce a protected characteristic, and the guidance flags socioeconomic status, geography, and first-generation standing as examples. This creates uncertainty between the DOJ guidance and the proposed regulations’ suggestion. That said, the Supreme Court has noted that what cannot be done directly cannot be done indirectly. (Students for Fair Admissions, Inc. v. President & Fellows of Harvard Coll., 600 U.S. 181 (2023))

The proposed regulations do keep a potential path for religious institutions to maintain their exempt status, even where other private schools may not be able to. The proposed regulations would not stop a private school from maintaining a religious mission, curriculum, or observance, or from choosing students by religious affiliation or membership, and religion-based criteria does not necessarily become race discrimination merely because members of that faith community may also share ancestry or ethnicity, so long as the criteria rests on religion alone. However, this guidance is located in the preamble’s explanation of the rule, not in the operative regulatory text, which is silent about religious schools. The proposed regulations do not alter a charity’s ability to work against prejudice and discrimination under the existing definition of “charitable,” provided it does so by means that do not themselves discriminate by race, color, or national or ethnic origin.

The proposed regulations also briefly address athletic programs, noting that the rule is not expected to affect programs where participation turns on athletic ability rather than race or ethnicity.

The penalty for violating the proposed regulations is harsh. A school that violates the standard imposed by the proposed regulations would lose its 501(c)(3) tax-exempt status, and that action would be enforced through the IRS’ ordinary examination and exemption channels rather than a new mechanism. The impacts of a revocation of tax-exempt status are significant. For example, any such organization with its exemption revoked would owe federal income tax and donors would lose the deduction for their charitable gifts. Additionally, if the school borrowed through tax-exempt bonds, interest on those bonds may become taxable to the holders, and grant agreements may require the school to return money already received.

The proposed regulations were published on September 4, 2026, and written comments and hearing requests are due by November 3, 2026, just sixty days later. The IRS plans to finalize the rule before May 31, 2027, and when finalized, it would apply to tax years beginning after that date.

III. What Private Schools Should Consider Now

Before the proposed regulations take effect, private educational institutions should consider carefully reviewing their current policies and practices. Key early steps could include the following:

Map out any programs that implicate race-based considerations. Schools should consider cataloging admissions, scholarship, aid, athletic, and other offerings that use race, color, or national or ethnic origin to set eligibility or that target students by similar characteristics.
Give donor-restricted aid priority. Identify scholarships whose terms hinge on race or ethnicity, decide whether donor consent or a cy pres proceeding will be needed to change them, and start those conversations early.
Closely examine race-neutral criteria. For programs built on income, geography, first-generation status, lived experience, or adversity, schools should consider reviewing whether those programs’ designs or stated goals could be interpreted as a proxy for race under the DOJ guidance.
Record-Keeping. Keep contemporaneous records of why each criteria was adopted and what legitimate educational or institutional purpose(s) they serve, apart from any racial outcome.
Confirm the basis for religious selection. Where a school relies on religious considerations, the school should make sure the criteria rest on religion alone and not on shared ancestry or ethnicity.

The proposed regulations indicate that the federal government is willing to leverage tax-exempt status to encourage compliance with race-conscious practices in private education. That said, the proposed regulations do not forbid schools from seeking a diverse student community or widening access for disadvantaged students, but the proposed regulations do narrow the methods that schools can employ to reach those goals.

AALRR’s attorneys can help your institution review its admissions, scholarship, and donor-restricted programs to assess potential areas of exposure in light of the proposed regulations.