Proposed Racial Nondiscrimination Regulations Could Jeopardize Tax-Exempt Status for Private Schools

On September 3, 2026, the Department of the Treasury and the IRS released a Notice of Proposed Rulemaking (REG-119986-25) that would introduce Proposed Treas. Reg. §1.501(c)(3)-2. The proposed regulations would broaden the rules for determining whether a private school’s policies and practices are consistent with Internal Revenue Code Section 501(c)(3), including policies and practices aimed at achieving remedial or diversity-related objectives. Under the proposal, a private school that adopts, maintains, or enforces policies or practices that discriminate on the basis of race, color, national origin, or ethnic origin would not qualify for tax-exempt status under Section 501(c)(3), regardless of the intent behind, or the legality of, such discrimination.

The proposal would require private schools exempt under Section 501(c)(3) to review admissions, scholarships, financial aid, donor-restricted funds, and other school-administered programs for race-conscious criteria. Organizations potentially affected by the rules should consider using the 60-day comment period, which ends November 3, 2026, to identify operational questions and donor-restriction issues, assess whether existing programs can be administered using race-neutral criteria, and highlight areas where additional IRS guidance would be helpful before the regulations are finalized.

Overview of the Proposed Racial Nondiscrimination Rules

The proposed regulations provide guidance on how the IRS would evaluate whether a private school qualifies as a charitable organization. Under Section 501(c)(3), an organization must be operated exclusively for a “charitable” purpose. The IRS has long taken the position that racial discrimination is fundamentally contrary to public policy, meaning a discriminatory school cannot be considered charitable for federal tax-exemption purposes.

For purposes of the proposed regulations, a “private school” would include organizations described in Section 170(b)(1)(A)(ii), i.e., schools that have a regular faculty and curriculum and normally have a regularly enrolled body of pupils or students in attendance at the place where their educational activities are regularly carried on. The definition would exclude a governmental unit, an agency or instrumentality of a governmental unit, or an organization owned or operated by an agency or instrumentality of a governmental unit.

The nondiscrimination rule would apply broadly across a school’s operations, including administration of educational policies, admissions policies, scholarship and loan programs, athletic programs, and other school-administered or supported programs.

The preamble states that the proposed regulations respond to current federal case law, including the Supreme Court’s ruling in Students for Fair Admissions v. Harvard. The government’s position is that racial classifications in private school policies and programs are contrary to fundamental public policy, regardless of the purpose for which they are adopted.

Removal of Old IRS Safe Harbors

A significant shift in the proposed regulations is the proposed removal of prior IRS administrative exceptions (safe harbors) to racial nondiscrimination rules for private schools, specifically as reflected in Revenue Procedure 75-50. The following language would be eliminated:

• Section 3.02 language that historically permitted certain race-conscious affirmative policies intended to promote racial nondiscrimination among students. The proposal reflects the IRS’s position that these racial preferences may be inconsistent with Section 501(c)(3) tax-exempt status.
• Language in Section 4.05 that provides operational exceptions for certain minority-targeted financial aid and scholarships. As a result, existing race-exclusive scholarships, fellowships, or financial aid programs may be treated as racially discriminatory under the proposed guidance, placing a school’s federal tax exemption at risk.

Permitted Activities

The proposed regulations clarify that schools may continue to pursue diverse student bodies and fulfill distinct missions using legally permissible, race-neutral methods.

The proposed regulations do not restrict protections for schools with religious missions. According to the preamble, religious schools may continue to select students based on genuine religious affiliation or membership consistent with federal law. However, a religious school may not use race-conscious criteria in a manner that violates the proposed nondiscrimination rule.

In addition, private schools would still be able to assist disadvantaged or underrepresented students using non-racial criteria. Under the proposed regulations, permissible factors may include:

• Family income and socioeconomic status;
• Geographic location and/or specific zip codes;
• First-generation college student status; and
• Academic achievement and merit markers.

What Organizations Should Do Now

The proposed regulations would apply to taxable years beginning after May 31, 2027, giving schools time to evaluate their policies and operations during the comment period. Organizations should use this period to identify race-conscious criteria in admissions, scholarships, financial aid, and restricted funds; assess whether those criteria can be modified using race-neutral alternatives; and determine whether comments to Treasury and the IRS may be appropriate. Action steps include:

• Conduct an internal restricted fund audit: Review historical endowments, donor agreements, and active scholarship criteria to identify any funds that require a student's race or ethnicity as an eligibility factor.
• Consult legal counsel for potential modifications: For finalized donor agreements that require race-conscious or race-based selections, consult legal counsel to evaluate options for transitioning to permissible race-neutral criteria. Depending on the terms of the agreement and applicable law, organizations may need to contact donors or their heirs or pursue court-approved modifications to eliminate race-based restrictions.
• Overhaul admissions and financial aid rubrics: Remove any point-allocations, checkboxes, or evaluative criteria that track or favor race in admissions software and manual evaluation processes.
• Prepare recordkeeping for audits: Update internal recordkeeping processes to show that admissions, scholarship, financial aid, and program selections are based on objective, race-neutral criteria. If the proposed safe harbors are eliminated, clean and consistent records will be important for demonstrating compliance in a future IRS examination.

BDO’s Nonprofit Tax Practice will continue monitoring the regulatory process and related developments.