So, You Want to Start an SGO . . .
Some of the SGOs that distribute the federal choice scholarships will be existing organizations that elect to participate in the program; others will be new organizations specifically created to administer the scholarships.
Either way, SGOs will need to follow a series of steps to comply with the law. These five steps delineate what implementation will look like.
Step 1: Get a 501(c)(3) designation. The law requires all SGOs to have 501(c)(3) status. In most states, acquiring this designation requires filing incorporation paperwork with the secretary of state, obtaining a federal employer identification number, applying for federal 501(c)(3) status, applying for state tax exemptions, and registering for charitable solicitation. The organization also needs to establish a board of directors, adopt bylaws and elect officers, open a bank account, and draft key policy documents. This process can take weeks to months.
Step 2: Get state approval to solicit donations and give scholarships. Once an SGO becomes an established 501(c)(3), it needs to become eligible to receive donations and give scholarships. While the state must approve every SGO that meets federal requirements, those requirements are actually more robust than many observers expected. SGOs must provide organizational information like their address and EIN number; evidence of their 501(c)(3) status; governing documents like articles of incorporation and bylaws; a list of policies and procedures, including separate-account procedures that demonstrate that FSTC funds are not co-mingled with other organizational funds; and student eligibility determination and scholarship-selection procedures, as well as financial information and records.
Step 3: Recruit donors. Representatives of many SGOs say they see this as the most challenging step. Donors do not have to reside in the state where the SGO operates. They can even live in states that have not opted into the program. But, because each credit is capped at $1,700, SGOs are going to need a large number of donors. For example, an organization offering scholarships of $5,000 per child would need to recruit at least 30 donors in order to meet the 10-student minimum.
Donors can contribute in three ways. They can give directly to an SGO, they can contribute via monthly withholding from their paycheck, or they can allocate funds when they file their tax return. These three options are not equally easy to access.
Several organizations are trying to crack this nut. Rob Kremer has started up the National Scholarship Organization to work with employers on making FSTC donations easier. He said that when he first heard about the choice program, “my immediate thought was, SGOs are going to have to find a way to scale the fundraising part of this equation.”
If employers were to include FSTC donations in their withholding documentation each year, employees could make a monthly contribution of $141.67 and have their federal tax withholding reduced by the same amount so as not to feel the pinch. Employers could establish their own scholarship funds that donate to employees’ children or to students in aligned schools. Think of a university like Notre Dame encouraging employees to donate to an SGO that grants scholarships to Catholic school students or Eli Lilly working with an SGO to offer scholarships to students at schools with strong STEM programs.
Sean Clifford of the AFC Scholarship Fund says the question to tackle is: “How can we fight the friction?” His organization is taking a three-pronged approach. It is working on the regulatory front to ensure that the government isn’t placing unnecessary burdens on financial entities, with tax preparers and payroll processors to get the FSTC included in their workflows, and on tech platforms to create solutions for donors, families, and schools alike. It will take effort on all three fronts to make participating in the program as frictionless as possible.
Donor education will also be key. Not everyone understands the distinction between a $1,700 tax credit and a tax deduction. Those who confuse the two or think that a dollar-for-dollar credit is too good to be true risk leaving money on the table.
Step 4: Recruit families. Once an SGO has secured enough funding to distribute scholarships, it will need to find recipients. The central administrative concern will be verifying family income to ensure that a student is eligible. The Treasury Department created three ways to verify income: direct verification, categorical eligibility verification, and two safe harbors. Under direct verification, SGOs would use W-2s, pay stubs, tax returns, and reports from crediting agencies. Under categorical verification, SGOs could use award letters for means-tested federal programs like SNAP or TANF as qualification for scholarships, because qualification for those programs indicates an income below the threshold for the FTSC. Finally, the Treasury Department identified specific safe harbor provisions for children in foster care and those who attend schools in low-income areas. Both can be used as streamlined evidence of eligibility to receive an FTSC scholarship.
Step 5: Distribute funds. Two key regulatory elements affect the distribution of funds. First, the SGO must ensure that scholarships are only going to eligible uses. Second, it must be able to prove this.
Most SGOs are looking for financial-technology solutions to help them keep track of spending and compliance. One provider of such services is Odyssey, which currently manages education savings accounts (ESAs) and scholarship tax credit programs in 10 states. Lauren May, head of federal scholarship tax credit and partnerships at Odyssey, said her company’s software solutions can “make sure that we can track every dollar [given] to every kid to an eligible expense.” By streamlining the collection of this information, Odyssey “can ensure that [SGOs] have everything they need for an IRS audit.”
