Tax Exemption at Risk: The Legal Implications of the IRS’s Proposed Regulations for Private Schools

The Internal Revenue Service (“IRS”) proposed regulations on September 4, 2026, that would revoke tax-exempt status from private schools maintaining any race-based policies, regardless of the policies’ intent. (IRS). Tax exemption for private schools and other Section 501(c)(3) organizations rests on the idea that donated money should go directly to a public purpose and is therefore not taxable. (The Association of American Universities). The IRS originally required private schools have a racially nondiscriminatory policy to qualify for tax-exemption. Rev. Rul. 71-447, 1971-2 C.B. 230. The proposed regulations depart from the original standard requiring nondiscriminatory education polices and expand the scope of race-based polices. (Richard Rubin, Wall Street Journal). This article explores the consequences for private schools that fail to comply with the IRS’s proposed regulations, the legal precedent underlying the IRS’s reasoning for the proposed regulations, and the cost of compliance for private schools seeking to maintain their exemption status.

Before diving into the legal precedent and the IRS’s reasoning behind the proposed regulations, it’s important to understand the requirements to qualify for tax exemption as a Section 501(c)(3) organization. Section 501(c)(3) organizations must operate exclusively for a charitable or educational purpose, ensure net earnings are not distributed for the benefit of private shareholders, and refrain from attempting to influence legislation and political campaigns. 26 U.S.C. § 501(c)(3). The proposed regulations add an additional requirement: private schools cannot maintain any race-based policies. Racial Nondiscrimination in Private Schools, 91 Fed. Reg. 56,811 (proposed Sept. 4, 2026) (to be codified at 26 C.F.R. pt. 1). Because the proposed regulations extend to any race-based policy, schools will need to examine any programs and organizations supported by the school that limit participation or provide benefits to students based on race, color, or nationality. (Melanie Bartlett, et al., Legal500).

If a private school loses its exemption, the donors will not be able to deduct their gifts, schools will have to pay income tax, and schools would not be required to reinvest into furthering the organization’s public purpose. (Richard Rubin, Wall Street Journal). This would leave schools with fewer funds for financial aid, scholarships, and other programs. Id. The IRS estimates the proposed regulations would affect roughly 18,000 private institutions and 750,000 students. (Federal Register). The IRS relies heavily on the Supreme Court’s decision in Students for Fair Admissions, Inc. v. President and Fellows of Harvard College, which analyzed race-based considerations in college admissions under the Equal Protection Clause of the Fourteenth Amendment. 600 U.S. 181, 213 (2023). The Supreme Court held that the “[the] programs lack sufficiently focused and measurable objectives warranting the use of race, unavoidably employ race in a negative manner, involve racial stereotyping, and lack meaningful end points.” Id. at 230. The holding was based on the strict scrutiny standard of the Equal Protection Clause, not in the tax law framework governing 501(c)(3) organizations. (Richard Rubin, Wall Street Journal).

Compliance with the proposed regulations would impose significant cost on private schools and their students because the proposed regulations extend beyond universities’ admissions policies addressed in Students for Fair Admissions, to any school policies at any private school, not just university admissions. (Cindy Strom Arellano and Evan J. Gautier, AALRR; Valerie L. Makarewicz and James M. Sconzo, Carlton Fields). The IRS implies that schools may continue to use nonracial criteria that indirectly support racial minorities, but the U.S. Department of Justice (“DOJ”) warns that facially neutral policies built around income, geography, or individual experience may serve as proxies for race. (Andrew Duehren and Michael C. Bender, New York Times; Memorandum from Pamela Bondi, Att’y Gen., Guidance for Recipients of Federal Funding Regarding Unlawful Discrimination (July 29, 2025), https://www.justice.gov/ag/media/1409486/dl). The inconsistency between the IRS and DOJ leaves schools without a clear compliance standard. (Valerie L. Makarewicz and James M. Sconzo, Carlton Fields). Changing policies that might be considered proxies for race is detrimental to many current and prospective students, not just racial minorities. (Sarah Wood, U.S. News). Private scholarship donors often set specific criteria to align with their personal values or experiences, and changing those criteria may lead donors to withdraw the scholarships entirely. (Valerie L. Makarewicz and James M. Sconzo, Carlton Fields). Schools may need to initiate a cy pres proceeding, which is used when it becomes impracticable or impossible to comply with the original terms of a charitable gift.  (Legal Information Institution).

The proposed regulations seem to be a clear departure from the IRS’s original guidance on race-based policies and well-established precedent, warranting further examination of the legal authorities the interpretation is based on. (Richard Rubin, Wall Street Journal). The IRS originally claimed that policies which aim to assist racial minorities were acceptable if their purpose was to promote a school’s nondiscriminatory policy. Rev. Proc. 75-50, 1975-2 C.B. 587. The Supreme Court later addressed the importance of nondiscriminatory policies, holding that schools do not qualify for tax-exemption if their conduct contravenes public policy. Bob Jones Univ. v. United States, 461 U.S. 574, 591 (1983). The IRS does not deny that racial discrimination is against established public policy. Racial Nondiscrimination in Private Schools, 91 Fed. Reg. 56,811, 56,813 (proposed Sept. 4, 2026) (to be codified at 26 C.F.R. pt. 1). However, the proposed regulations state that “all forms of racial discrimination in education, regardless of the intent behind or the legality of such discrimination . . . are against a fundamental public policy.” Id. at 51,815. The goal is to eliminate any ambiguity and consistently apply the law to any race-based polices. Id.

The IRS proposed regulations would go into effect for taxable years beginning on or after May 31, 2027. However, the regulations are not finalized; comments on the proposed regulations were due November 3, 2026, and a public hearing is scheduled for December 2, 2026. (Federal Register). Ultimately, the IRS’s proposed regulations seek to eliminate any ambiguity about racial discrimination in private schools, but the broad interpretation and unclear compliance standards could have significant legal and financial ramifications for private schools, their donors, and their students.