Faith Communities and Section 25F: The Compliance Tensions Unique to Religious Organizations

Faith communities are among the best-positioned organizations to take advantage of Section 25F. They have established giving relationships, community trust, and a natural alignment between their mission and the income-eligible student population the statute is designed to serve. They are also, in practice, the organizations that most frequently run into compliance problems — not because of bad intent, but because the federal compliance requirements for SGOs are in direct tension with the cultural norms of congregational giving.

This post examines the four compliance tensions that are specific to faith-community SGOs, why each one is more acute in a religious organization context than in other SGO structures, and what organizations need to do to address them before the first contribution is received.

The Earmarking Tension: When Congregational Giving Meets Federal Law

The no-earmarking requirement is the most universally understood compliance rule in Section 25F. What is less understood is how difficult it is to actually implement in a congregation that has been giving to its school community for decades.

In most faith communities, giving is relational. A parishioner donates because of a personal connection — to the school, to the families in the school community, to the mission of faith-based education specifically. That connection is often the thing that makes them a donor at all. When an SGO tells a donor that their contribution cannot be directed toward the school they care about or the families they know, it creates friction that can cause the donor to withdraw entirely.

Why this is harder in faith communities than elsewhere. A community foundation SGO or a civic nonprofit starting an SGO has a more transactional donor relationship — donors give because they support the mission generally, not because of a specific personal tie to specific recipients. Faith communities have the opposite structure. The giving is deeply personal by design.

What makes it a legal problem, not just a relationship problem. The no-earmarking prohibition applies to implicit earmarking as well as explicit requests. An SGO that only markets to one congregation's community, only accepts applications from families who attend that congregation's school, and awards all scholarships to students at that school has created structural earmarking — even if no donor ever explicitly requested it. The distribution of the applicant pool, not just what donors say when they give, determines compliance.

The solution is communication before, not correction after. The most effective approach is to set donor expectations correctly before the first contribution is received. Donors who understand the no-earmarking requirement and the reason for it — that the federal tax credit is only possible because the program is genuinely arm's-length — accept it more readily than donors who learn about it after they expected to direct their gift. The SGO's donor onboarding process should explain this clearly, in plain language, as a feature of how the tax credit works rather than as a bureaucratic restriction.

The Single-School Problem: When Your Community All Attends One School

Section 25F requires that scholarships be awarded to students at ten or more schools. This requirement is straightforward for a large diocesan network with twenty campuses. It is genuinely difficult for a congregation that has one school, whose entire community sends children to that school, and whose scholarship program is naturally oriented toward helping those families.

The single-school distribution requirement is not just a technical hurdle. It is a structural feature of the program designed to ensure that SGOs are operating as genuine scholarship programs rather than as tuition assistance mechanisms for a single institution. An SGO that awards all scholarships to students at one school is, in substance, a tuition assistance program — and the federal tax credit is not available for tuition assistance to a specific school.

How this plays out operationally. An SGO formed by a single church to support families at its attached school can technically open its application to students at other schools. But if the only outreach is to the congregation's community, the only applicants will be from that school. An application process that generates a diverse applicant pool requires outreach that goes beyond the congregation — to neighboring schools, through community organizations, through the income-eligible population more broadly. This is not optional; it is a prerequisite for compliant operation.

The governance implication. An award committee made up entirely of congregation members, using scholarship criteria written to favor the congregation's school community, will tend to produce award decisions that concentrate at that school — even without explicit intent. The committee structure and criteria must be designed to produce genuinely distributed awards, not just to avoid explicit earmarking.

For smaller single-school communities, the partnership option is worth evaluating. An organization that cannot realistically achieve multi-school distribution may be better served by partnering with an existing SGO that already operates across multiple schools, rather than forming its own. The scholarship dollars can still flow to the community's students, but through an existing infrastructure that handles the multi-school distribution requirement. See our earlier post on forming your own SGO versus partnering with an existing one.

Qualified Expenses and Faith-Integrated Curriculum

The qualified expense definition for Section 25F scholarships comes from the Coverdell Education Savings Account rules (IRC §530(b)(4)). Coverdell expenses include tuition, fees, books, tutoring, academic enrichment, and educational technology — but they do not include non-educational religious programming.

In most private K-12 schools, the line between education and other activities is clear enough. In a faith-integrated school — where Scripture is woven through the academic curriculum, where theology is part of the standard course sequence, where the school's academic mission and its religious mission are intentionally inseparable — that line is genuinely ambiguous.

The questions that need answers before the scholarship launches. Does the cost of a full-year enrollment at a faith-integrated school qualify entirely as a Coverdell expense? Does the qualification depend on whether the school separates religious instruction from secular academic instruction in its schedule? Is the cost of a mandatory chapel program that includes academic components a qualified expense? Is a tutoring program that uses Scripture as instructional text a qualified academic tutoring expense?

Why this matters at formation, not operation. An SGO that awards scholarships for tuition at a faith-integrated school without having worked through the qualified expense analysis is taking a position without a written rationale. If the IRS later determines that some portion of the tuition does not qualify under Coverdell definitions, the organization may have awarded scholarships for non-qualified expenses — a compliance failure that could affect its approved status and donors' ability to claim their credits.

The practical approach. Work with qualified tax counsel before the first scholarship is awarded to develop a written analysis of how your specific school's or program's costs map to the Coverdell expense categories. Document the methodology. Where the analysis is uncertain — components that might or might not qualify — note the uncertainty and the position you are taking. This documentation is the foundation of a good-faith compliance record.

Governance Independence in Close Communities

The scholarship award committee is the most compliance-sensitive governance structure in an SGO. Its decisions — who receives scholarships, how much, for what expenses — are the output of the entire system. If those decisions are not genuinely independent, the SGO's compliance foundation is compromised.

In faith communities, the governance challenge is structural. The people who are most qualified to serve on a scholarship committee — who know the community, the families, the school — are often the same people who are major donors to the SGO, whose children attend the school, or who have close relationships with specific families in the applicant pool. Excluding them entirely may not be realistic. Allowing them to participate without safeguards creates independence problems.

What arm's-length independence actually requires. The committee's decisions must be made on the basis of the established scholarship criteria, not on the basis of committee members' knowledge of specific families or preferences about where scholarship funds should flow. This does not require that committee members be strangers to the community — but it does require that the committee's process be structured so that personal relationships cannot drive award decisions.

Practical structure options. Several structural approaches can achieve independence within a faith community context:

A blind review process — in which scholarship applications are reviewed without the applicant's name, school, or identifiable information during the initial scoring phase — prevents personal relationships from influencing the initial selection. Only after initial scoring are identities revealed, for conflict-of-interest checking.

A community advisory committee that includes members from outside the founding congregation — educators, community members, or professionals with no direct relationship to the school — adds external perspective and reduces the appearance of a closed process.

Recusal policies that require committee members to disclose relationships with applicants or their families, and to abstain from decisions where a relationship exists, provide a documented process for managing conflicts that cannot be fully avoided in a small community.

Documentation of the process — what criteria were applied, who was recused, how the final decisions were made — is the evidentiary foundation for demonstrating independence if the SGO's award process is ever questioned.

The Common Thread

The compliance challenges facing faith-based SGOs are not fundamentally different from the challenges any SGO faces. The same no-earmarking rule applies. The same multi-school distribution requirement applies. The same arm's-length award standard applies. What is different is the community context in which those requirements must be implemented.

A compliance framework designed for a community foundation SGO will not work, without modification, for a parish SGO. The donor communication needs to speak to donors who have personal stakes in the outcome. The applicant outreach needs to go genuinely beyond the congregation. The award committee needs structural safeguards appropriate to a tight-knit community.

Getting the faith-community compliance framework right requires understanding both the regulatory requirements and the community they are being applied to. The organizations that do this well — that design their donor programs, their award processes, and their governance around both the statute and the community's culture — build scholarship programs that are genuinely sustainable. The organizations that apply a generic compliance template to a faith community context are the ones that discover, mid-operation, that the template does not fit.

For Christian schools and churches specifically, see our dedicated guide to Christian school SGO formation. For all faith traditions, see our faith-based SGO overview.