The Treasury Department Has Entered the Chat: New Proposed Regulations Aim to Strip Private Schools of Tax-Exempt Status Over DEI Policies

The Internal Revenue Service (“IRS”) published a Notice of Proposed Rulemaking (“Notice”) on September 4, 2026, that has the potential to adversely impact the tax-exempt status of thousands of private schools, including not only institutions of higher education but also primary and secondary schools. Under the Notice, entitled “Racial Nondiscrimination in Private Schools,” the IRS proposes to amend the Treasury regulations promulgated under Section 501(c)(3) of the Internal Revenue Code of 1986, as amended (the “Code”) to provide that a private school cannot qualify for exemption from federal income tax “if it discriminates on the basis of race, color, or national or ethnic origin in administration of its educational, admissions, scholarship, athletic, or other policies,”[1] reasoning that such programs and practices are “contrary to a fundamental public policy of the United States.”[2]

A loss of federal tax exemption under Section 501(c)(3) has far-reaching implications for private schools. Not only would income become subject to federal income taxation, but contributions to private schools that lose their Section 501(c)(3) status would not be eligible for a charitable contribution deduction for income or estate tax purposes, which can reasonably be expected to have an adverse impact on fundraising efforts to support scholarships, capital improvements, and the like. Further, access to grants from private foundations and government sources may be limited. Additionally, many state tax benefits are dependent on the private school obtaining Section 501(c)(3) status, including real property tax and sales tax exemptions.

If adopted, the proposed regulations would be effective for tax years beginning after May 31, 2027. For most private schools operating on a fiscal year that coincides with their academic year, the proposed regulations would be in effect as of the start of the 2027-28 academic year. Comments to the proposed regulations and requests for a public hearing may be submitted in writing or electronically at https://www.regulations.gov (indicate IRS and REG-119986-25) on or before November 3, 2026.

Background

Section 501(c)(3) of the Code makes federal tax exemption available for any corporation organized and operated exclusively for one or more exempt purposes, including educational purposes. In order to obtain tax exemption, Section 501(c)(3) further requires that no part of the net earnings of the corporation inure to the benefit of any private shareholder or individual, the corporation engage only in an insubstantial amount of lobbying, and that the corporation does not participate in any amount of political activity. The Treasury regulations define “educational” as relating to the instruction of individuals for the purpose of improving or developing their capabilities. Treasury Regulation 1.170A-9(c)(1) further defines an “educational organization” for purposes of the charitable contribution deduction as an organization whose primary function is the presentation of formal instruction, that normally maintains a regular faculty, curriculum, and a regularly enrolled body of students in attendance at the place where educational activities are carried out.

While neither the Code nor the Treasury regulations base qualification for tax exemption on a private school’s adoption or implementation of a policy of nondiscrimination, the courts and the IRS have interpreted Section 501(c)(3) to include such a requirement since the 1970s. In 1971, the IRS issued Revenue Ruling 71-447 which found that a private school that does not have a “racially nondiscriminatory policy as to students” does not qualify for exemption from federal income taxation.[3] For purposes of the Revenue Ruling, a “racially nondiscriminatory policy as to students” required that the school admit students of any race to “all the rights, privileges, programs, and activities generally accorded or made available to students at that school and that the school does not discriminate on the basis of race in administration of its educational policies, admissions policies, scholarship and loan programs, and athletic and other school-administered programs.” The IRS based its determination on the common law concept that all charitable trusts must be operated for a purpose that is neither illegal nor contrary to public policy, and while the Code would not prohibit an educational institution from operating on a discriminatory basis, doing so would be contrary to the policy of the United States.

The IRS would later clarify in Revenue Procedure 75-50 that a “policy . . .that favors racial minority groups with respect to admissions, facilities and programs, and financial assistance will not constitute discrimination on the basis of race when the purpose and effect is to promote the establishment and maintenance of that school’s racially nondiscriminatory policy as to students.”[4] The United States Supreme Court upheld the IRS’s interpretation of the requirements for federal income tax exemption in its decision in Bob Jones University v. United States, where the Court concluded that “entitlement to a tax exemption depends on meeting a ‘charitable’ standard under common law, that is, serving a public purpose and not being contrary to established public policy.”[5]

However, in 2023, in Students for Fair Admissions, Inc. v. President & Fellows of Harvard College (SFFA), the United States Supreme Court held that race-conscious admissions programs at Harvard University and the University of North Carolina violated the Equal Protection Clause and Title VI of the Civil Rights Act of 1964.[6] The Court based its decision, in part, on its finding that diversity did not constitute a sufficiently compelling interest to justify the use of race-conscious admissions as well as its determination that admissions were zero-sum, and that a benefit given to some applicants was a negative applied to others, which violates the Equal Protection Clause.

Following SFFA, the Department of Education (DOE) and the Department of Justice (DOJ) issued administrative guidance targeting diversity, equity and inclusion (DEI) initiatives, which increased institutional concerns about whether these agencies would deem race- and gender-based scholarships illegal. While the DOE’s February 14, 2025 Dear Colleague Letter was vacated by a federal court,[7] the DOJ memorandum titled “Guidance for Recipients of Federal Funding Regarding Unlawful Discrimination” (the “DOJ Guidance”) remains in effect.[8] While explicitly nonbinding, the DOJ Guidance adopts an expansive view of Titles VI, VII, and IX, emphasizing that recipients of federal funding must avoid both direct and indirect discrimination based on protected characteristics. The DOJ Guidance states that race- and gender-based scholarships are “unlawful.” It emphasizes that restricting eligibility for scholarships or fellowships based on protected characteristics is considered illegal “preferential treatment,” even if framed as promoting diversity. The DOJ Guidance has not been enjoined and continues to inform federal enforcement priorities. The Trump Administration has repeated these enforcement priorities in the last year through additional guidance. For example, in October 2025, the Administration released the Compact for Academic Excellence in Higher Education,[9] and on August 3, 2026, DOE released “A National Call to Action to University Presidents and Governing Boards.”[10] These materials similarly address race-neutral admissions, scholarships, and “intellectual pluralism.”

In a related action reflecting this broader enforcement trend, on July 23, 2026, DOE removed the disparate-impact standard from Title VI regulations. DOE contended that “demographic data alone” should not establish that a school violated federal civil rights law, and that applying the disparate-impact standard has “effectively required educational institutions to consider race and engage in racial balancing in order to comply with federal civil rights law.”[11]

Taken together, these developments provide context for the IRS’s proposed modification to the Treasury Regulations, which is consistent with the decision in SFFA and with the DOE’s and DOJ’s more expansive view of which higher education practices and programs constitute unlawful discrimination. Unlike the related guidance, however, the proposed regulations target only private institutions and do not address gender-based preferences.

The Notice and the Proposed Treasury Regulations

Under the Notice, the Treasury regulations promulgated under Section 501(c)(3) of the Code would be amended to add new sections applicable to private schools which would require that all private schools be operated “exclusively for exempt purposes.” A private school would not be deemed to operate “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 the administration of any educational policy, admissions policy, scholarship and loan program, athletic program, or other school-administered or school-supported program.

The Notice specifically notes that the proposed regulations would not preclude a private school from maintaining a religious mission, curriculum or program of observance or selecting students on the basis of religious affiliation or membership, so long as the criteria for admission was based solely on religion and not race or national or ethnic origin.

The minority-preference exception established in Rev. Proc. 75-50, discussed above, which permitted schools to adopt policies that would promote diversity and ameliorate the effects of historic discrimination, would be eliminated by the proposed regulations which include a blanket prohibition on policies that discriminate on the basis of race, color, or national or ethnic origin. The proposed regulations include the addition of a new regulation section that states that racially discriminatory policies include any policy or practice that discriminates based on race, color, or national or ethnic origin for any purpose.[12]

Note also that the proposed regulations would apply not only to the programs and policies directly adopted by the private school but also to any other “school-administered or school-supported” program. Accordingly, if the private school facilitates race-conscious scholarship programs that are controlled and administered by a third party, doing so could run afoul of the proposed regulations.

The Notice states that the proposed regulations would not prevent a private school from adopting policies or taking actions intended to eliminate discrimination or prejudice so long as they are race neutral. The Notice provides that permissible race-neutral criteria that schools may use include family income, geographic location, and first-generation status. It further suggests that donor-directed scholarships and loan programs that previously utilized racially discriminatory criteria instead shift to use these types of race-neutral criteria. Importantly, the Notice does not include any information on how the IRS will evaluate such race-neutral criteria to determine whether they are used as a proxy for race.

Potential Impacts and Next Steps

The Treasury Department concluded in the Notice that it anticipates that most private schools will comply with the new regulations and will not lose tax-exempt status, although it does recognize that there will be some costs involved with compliance. For private schools located in New York State, for example, modifying donor-imposed race- or national origin-based scholarship preferences requires either the donor’s written consent or authorization from the New York State Supreme Court in the county in which the private school is located. To obtain such authorization, the private school must submit a petition for cy pres relief under Not-for-Profit Corporation Law Section 555(c) and the Estates Powers and Trusts Law Section 8.1-1(c) on notice to the New York State Attorney General.

Whether the proposed regulations will be adopted in their current form, or at all, remains to be seen. The Notice acknowledges that the Treasury Department’s justification for the proposed regulation is not based in statutory law and instead rests on the notion that any policy that takes race into account, regardless of the intent behind such policy, “violates fundamental [United States] public policy.” Such justification leaves the proposed regulations open to a potential legal challenge that the Treasury has overstepped its authority by creating new law rather than interpreting existing law.

Further, because the decision in SFFA did not address non-admissions programs, it is unclear whether courts would uphold an extension of its reasoning to areas such as financial aid, donor-directed scholarships, and athletics. Under the proposed rules, discrimination on the basis of race, color, or national or ethnic origin would be prohibited “for any purpose, such as ameliorating the effects of past discrimination or promoting diversity.” This goes further than the holding in SFFA, which focused on whether diversity constituted a compelling interest sufficient to justify race-conscious admissions under strict scrutiny analysis, rather than imposing a blanket prohibition on all race-conscious policies regardless of the intent behind them.

While the changes enumerated by the Notice are prospective in effect, private schools should begin examining their practices and policies with respect to admissions, financial aid, loan programs, and athletics to determine whether such practices and policies need to be revised in order to comply with the changes proposed in the Notice and developing a plan for making such adjustments if and when final regulations are adopted. In addition, private schools should review their scholarship criteria and financial aid policies to determine whether eligibility criteria may be considered racially discriminatory under current guidance. Where scholarships are subject to donor-imposed restrictions on use, private schools should evaluate options for modifying or releasing those restrictions, if necessary. Moreover, schools cannot rely solely on SFFA compliance as a measure of conformity with the proposed regulations. A school that revised its admissions practices following SFFA but maintained race-conscious scholarship programs, for example, would still face potential loss of tax-exempt status under the proposed rules. Private schools should therefore evaluate all programs and policies, not only admissions, against the broader nondiscrimination standard proposed in the Notice.

Finally, private schools should consider whether they wish to comment on the proposed regulations during the public comment period, which ends November 3, 2026.

We will continue to monitor the Notice and provide updates as additional information becomes available. For private schools interested in more information on the Notice, the impact of the proposed regulations on their tax-exempt status, or submitting comments on the proposed regulations, please contact Deirdre Mitacek (dmitacek@cullenllp.com), Nicole Donatich (ndonatich@cullenllp.com) or Jordan Milite (jmilite@cullenllp.com).

This advisory does not constitute legal advice. Nothing herein creates an attorney-client relationship between the sender and recipient.

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Footnotes

[1] 26 CFR Part 1 [REG-119986-25] (September 3, 2026).

[2] Id.

[3] Rev. Rul. 71-447, 1971-2 C.B. 230.

[4] Rev. Proc. 75-50, 1975-2 C.B. 587, modified by Rev. Proc. 2019-22, 2019-22 IRB 1260. As will be discussed more fully below, the Notice would reverse this interpretation and would modify Rev. Proc. 75-50 to remove this language.

[5] 461 U.S. 574, 586 (1983).

[6] 600 U.S. 181 (2023).

[7] American Federation of Teachers et al. v. Dep’t of Ed., Case No. 25-cv-00628-SAG (D. Md. 2025).

[8] U.S. Dep’t of Justice, Guidance for Recipients of Federal Funding Regarding Unlawful Discrimination (July 29, 2025) (available at: https://www.justice.gov/ag/media/1409486/dl?bcs-agent-scanner=0f6819cd-17cd-4942-8134- 625cf083d203)

[9] Compact for Excellence in Higher Education, available at https://www.washingtonexaminer.com/wpcontent/uploads/2025/10/Compact-for-Academic-Excellence-in-Higher-Education-10.1.pdf.

[10] A National Call to Action to University Presidents and Governing Boards (Aug 3, 2026), available at https://www.ed.gov/media/document/national-call-action-university-presidents-and-governing-boards-114351.pdf.

[11] U.S. Department of Education Removes Disparate-Impact from Title VI Regulations (July 23, 2026), available at https://www.ed.gov/about/news/press-release/us-department-of-education-removes-disparate-impact-title-vi-regulations.

[12] Prop. Reg. 1.501(c)(3)-(2)(c).