Federal tax credit could add another layer to Arizona's school choice system if state opts in

By Stacy Mantle
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A new federal education tax credit scheduled to launch in 2027 could become another source of education funding for Arizona families, but only if the state chooses to participate.

The Federal Scholarship Tax Credit, also called the Education Freedom Tax Credit by school-choice advocates, allows individual taxpayers to receive a dollar-for-dollar federal income tax credit of up to $1,700 for qualifying cash donations to Scholarship Granting Organizations, or SGOs. Those nonprofit organizations would then award scholarships to eligible students for approved education expenses.

A new analysis from the American Federation for Children estimates about 51.7 million students nationwide would qualify under the program, including more than 1.12 million students in Arizona — about 89.2% of the state's K-12 population.

"This report provides the first state-by-state estimates of how many students are eligible to receive scholarships under the Education Freedom Tax Credit, finding that roughly nine in ten children nationwide meet the income and enrollment criteria,” said Patrick Graff, senior fellow at the American Federation for Children.

Under federal law, students are eligible if their household income does not exceed 300% of the area median gross income and they are eligible to enroll in a public elementary or secondary school.

Arizona has not opted into the program. Gov. Katie Hobbs vetoed legislation this year that would have authorized participation, citing concerns that federal regulations and oversight requirements had not yet been finalized.

“We have seen what happens when these types of programs lack accountability, transparency, and oversight,” Hobbs wrote. “I hope the administration ensures any federal school choice program will have the much-needed guardrails Arizona’s ESA program lacks.”

Unlike Arizona's STO scholarships, the federal program has broader eligible uses and could potentially benefit students attending public, charter and private schools.

How the program works

Unlike Arizona's Empowerment Scholarship Account program, the federal program would not provide families with a direct state-funded account. Instead:

• A taxpayer makes a qualifying cash donation to an approved Scholarship Granting Organization.

• The taxpayer may claim a federal income tax credit equal to the qualifying contribution, up to $1,700.

• The SGO awards scholarships to eligible private school students.

• Families use those scholarships for qualified elementary and secondary private education expenses.

Federal law allows scholarships to cover qualifying expenses associated with public, private and religious schools, including certain tuition, books, supplies, academic tutoring, special-needs services and other approved education costs.

The credit is nonrefundable, meaning it can reduce a taxpayer's federal income tax liability but cannot generate a refund beyond the amount owed. Unused portions generally may be carried forward for up to five years.

The program takes effect Jan. 1, 2027.

How it fits with Arizona's existing programs

If the state eventually participates, the federal credit would join a state that already has one of the nation's broadest school choice systems. Arizona families currently have access to:

• Empowerment Scholarship Accounts, which provide state education dollars to eligible families for approved educational expenses.

• School Tuition Organization tax-credit scholarships (STOs), funded through Arizona income tax credits for donations to nonprofit organizations that provide scholarships to students attending private schools.

• Open enrollment, which allows students to attend public schools outside their attendance boundaries when space is available.

• Charter schools, which are tuition-free public schools funded largely based on enrollment but operate independently of traditional school districts.

The new federal program would operate alongside rather than replace those existing options.

Taxpayers could take advantage of both Arizona's STO tax credits and the new federal credit, but they could not claim the full state and federal credits for the same donation. If a taxpayer receives an Arizona tax credit for a contribution, the amount of federal credit available for that same contribution would be reduced accordingly.

A taxpayer could, however, make separate qualifying contributions under the state and federal programs.

For students, overlapping eligibility is more complicated. A child could potentially qualify for assistance through more than one program, but qualification does not necessarily mean the same expense could be reimbursed more than once. Additional federal guidance could further clarify how the new program will be administered alongside existing state education programs.

Potential impact

According to the American Federation for Children, nearly 948,000 Arizona taxpayers have enough federal income tax liability to claim the full $1,700 credit.

The organization estimates:

• If 10% participate, about $161.2 million could be generated annually for scholarships.

• If 30% participate, scholarship funding could reach about $483.5 million per year.

Those figures are projections based on taxpayer participation rather than guaranteed funding. Scholarship availability would depend on how many taxpayers choose to donate and how participating SGOs distribute the money.

Supporters argue the program could expand educational options without requiring a new Arizona state appropriation because the tax credit applies to federal income taxes.

“Nearly 31 million eligible students live in states that have already signaled they will participate in the EFTC, while over 20 million eligible students live in states that have not yet opted in. The estimates in this report provide data for families, advocates, scholarship organizations, and lawmakers to use as they discuss the scale of this opportunity for K-12 students across the country," Graff said.

Tommy Schultz, CEO of AFC, urged governors in states that have not yet opted in to participate, saying Arizona students could benefit if the state joins.

"Dr. Patrick Graff's new analysis shows exactly what is at stake: 51.7 million children across the country stand to benefit from the Education Freedom Tax Credit, but every governor needs to opt in so that all of them can benefit,” Schultz said. “In Arizona, 1,124,713 – 89.2% of the state's K-12 student population – would be eligible to receive scholarships under the EFTC but only if Governor Hobbs opts in, which she absolutely should. This is a no-brainer, and we at AFC are seeking to ensure the EFTC reaches as many families as possible, as soon as possible."

The debate over the federal tax credit is also becoming part of a broader national political campaign. Former Virginia Gov. Glenn Youngkin recently launched Empowering America's Parents, a multimillion-dollar effort aimed at encouraging states that have not joined the program to opt in.

The campaign is targeting several states led by Democratic governors, including Arizona, Michigan, Wisconsin and Pennsylvania. Its first advertisement criticizes Democratic governors who have declined to participate. However, Youngkin has said the campaign is intended to raise awareness of the scholarships and encourage governors to make them available to families.

Critics raise questions

Critics, including Hobbs, have said Arizona should wait until federal regulations are more fully developed before participating.

In her veto message, Hobbs wrote that joining before federal regulatory guidance was available would be irresponsible and pointed to concerns about accountability and oversight in Arizona's existing ESA program.

Education groups that oppose expanding private-school choice have also argued that tax-credit scholarship programs reduce government revenue that otherwise could be available for public purposes, including education. Supporters counter that donations are voluntary and that the new program affects federal rather than Arizona tax collections.

"Arizonans have seen full well what an unaccountable, uncapped private school voucher program does to our public schools and to taxpayer dollars,” said Tyler Kowch, communications director for SOS Arizona. “With skyrocketing costs, well-documented fraud and abuse, and significant loss of funding from neighborhood public schools, Arizona's universal state vouchers have served as a cautionary tale for the nation of what not to do. Opting into Trump's federal voucher scam would only double down on this unaccountable system that’s already failing taxpayers and students."

The federal program has also prompted questions about how scholarships would interact in practice with existing ESA awards and Arizona tax-credit scholarships. Treasury and the IRS are developing additional regulations and guidance for implementation of the program.

How does this impact Arizona families?

If Arizona opts into the federal scholarship tax credit, eligible families could gain another potential source of money for education expenses beginning in 2027. The program would not replace Arizona's existing school choice programs.

For families, the biggest differences involve where the money comes from, how it is distributed and what expenses it can cover.

Traditional district schools: Students attend tuition-free public schools funded primarily through state, local and federal revenue. Arizona's open enrollment law also allows families to apply to district schools outside their assigned attendance area, subject to capacity and other requirements. Eligible public-school students could potentially receive federal SGO scholarships for qualifying supplemental expenses such as tutoring.

Charter schools: Charter schools are also tuition-free public schools. They receive public funding based largely on enrollment but operate independently of traditional school districts. Eligible charter-school students could potentially receive federal scholarships for qualifying education expenses beyond the tuition-free education provided by the school.

Empowerment Scholarship Accounts: Arizona's ESA program uses state education funding and provides participating families with accounts that can be used for approved expenses such as private-school tuition, tutoring, curriculum and certain educational services. Universal eligibility was enacted in 2022.

Arizona STO scholarships: Arizona taxpayers can receive state income tax credits for qualifying donations to certified School Tuition Organizations. STOs use those donations to provide scholarships to students enrolled in Arizona private schools. Individual taxpayers have access to two separate STO credits, with annual limits established under state law.

Federal Scholarship Tax Credit: The federal program has some similarities to Arizona's STO system but operates through the federal income tax. Taxpayers may receive a federal credit of up to $1,700 for qualifying cash donations to approved SGOs, which then award scholarships to eligible students. Unlike Arizona's STO scholarships, the federal program may benefit eligible students attending public, charter, private and religious schools for qualifying expenses.

A taxpayer could potentially participate in both Arizona's state tax-credit system and the new federal program by making separate qualifying donations. However, federal law prevents taxpayers from receiving both a full state and federal tax credit for the same contribution.

For families receiving scholarships, the situation is less straightforward. A student could potentially qualify for more than one form of educational assistance, but that does not necessarily mean an ESA, an Arizona STO scholarship and a federal scholarship could all be used to pay the same expense.

The federal program also differs from an ESA in another significant way: eligibility does not guarantee a scholarship. Qualified ESA participants receive a state-funded account under the program's rules. Under the federal scholarship program, available scholarship money first depends on taxpayers choosing to donate and SGOs subsequently awarding those funds to students.

Editor’s note:   A grant from the Arizona Local News Foundation made this story possible. The foundation awarded 15 newsrooms to pay for solutions-focused education reporters for two years. Please submit comments at yourvalley.net/letters or email them to AzOpinions@iniusa.org. We are committed to publishing a wide variety of reader opinions, as long as they meet our Civility Guidelines.

Stacy Mantle
Education Solutions Reporter

smantle@iniusa.org

Meet Stacy
Stacy Mantle is joining the team at Independent Newsmedia, Inc. as an Education Solutions journalist, thanks to a grant from the Arizona Community Collaborative. She has a long history in education that ranges from teaching junior high and middle school to developing curriculum and standards-based assessments.

Community: A longtime advocate for animal welfare, Stacy is deeply involved in rescue efforts and volunteers with several nonprofit organizations.

Random Fact: Once upon a time, she shared her home with a pet coyote and two wolf hybrids. The experiences were wild enough to become the subject of her first book!

Education: She holds a BA in English with a minor in Political Science, a Post-baccalaureate in Secondary Education, and an MBA with a emphasis on Marketing.

Hobbies: In her spare time, Stacy writes fast-paced urban fantasy novels, crafts small-batch artisan soap, and is always up for hiking or off-roading through the Arizona wilderness with her husband of 23 years.