• California’s SB 574 establishes the nation’s first statutory framework governing attorneys’ use of generative AI.
• The central compliance question is no longer whether attorneys use AI but how they use it.
• Rather than regulating AI technology itself, SB 574 focuses on professional responsibility obligations, imposing requirements relating to verification, confidentiality, disclosure, citation review and attorney oversight.

California Becomes the First State To Statutorily Regulate Lawyers’ Use of Generative AI

California has become the first state to expressly regulate attorneys’ use of generative AI by statute. Signed into law on Sept. 30, SB 574 takes effect Jan. 1, 2027, and establishes new requirements governing attorneys’ use of generative AI, including obligations relating to verification, confidentiality, disclosure, citation review and attorney oversight. The law also restricts arbitrators’ use of generative AI in California proceedings. As a result, SB 574 applies to California-licensed attorneys, attorneys appearing before California courts, and arbitrators subject to California’s arbitration procedures.

GenAI Is Broadly Defined

The law applies generally to “generative artificial intelligence,” which is defined as “an artificial intelligence system that can generate derived synthetic content, including text, images, video, and audio that emulates the structure and characteristics of the system’s training data.” The definition would likely encompass widely used platforms such as ChatGPT, Claude, Gemini, Microsoft Copilot, and similar AI-powered drafting, research and content-generation tools.

The statute’s broad definition may also raise questions about whether AI-enabled features embedded in legal research, document review and productivity tools fall within its scope.

New Obligations for Attorneys Using GenAI

SB 574 addresses several of the risks and concerns that have accompanied the increasing use of AI in legal practice, including hallucinated authorities, privilege concerns and the appropriate role of attorney oversight.

Among other things, attorneys using generative AI must now:

• Not “delegate the practice of law” to generative AI
• Take reasonable steps to verify AI-generated content
• Correct erroneous or hallucinated outputs
• Comply with new confidentiality requirements governing the use of nonpublic, personally identifying and confidential information
• Satisfy applicable disclosure obligations
• Personally verify citations included in California court filings

Of this list, one of the most consequential provisions concerns citations in all filings and other papers submitted to the California courts. In practical terms, attorneys remain responsible for ensuring that cited authorities exist and support the propositions for which they are offered, regardless of whether the citation originated with AI, another attorney, a legal research platform or another source.

Govern, Supervise, Defend

Although SB 574 is California’s first statute specifically addressing attorneys’ use of generative AI, its central premise is not new. ABA Formal Opinion 512 (2024) states that a lawyer’s duties of competence, confidentiality, communication and supervision apply equally when using generative AI. Likewise, courts have repeatedly emphasized that attorneys remain responsible for the work product they submit, regardless of whether AI assisted in creating it.

Beyond these principles, however, SB 574 underscores a broader reality facing legal departments and law firms: Organizations may increasingly need to demonstrate that appropriate safeguards were followed when generative AI is used.

Recent disputes involving privilege, work-product protection, expert discovery and AI-generated content have focused not merely on whether AI was used but how it was used, what controls were in place and whether those controls can be demonstrated after the fact.

As AI adoption accelerates across legal practice, governance procedures, documentation protocols, and meaningful human oversight must evolve to ensure that AI-assisted work product can be explained, validated, and defended when challenged. Recent case law illustrates why.

• United States v. Heppner (S.D.N.Y. Feb. 2026): The court declined to apply privilege protections to communications with a public AI tool under the facts presented.
• Warner v. Gilbarco, Inc. (E.D. Mich. Feb. 2026): The court reached a different result in assessing work-product protections, finding a pro se plaintiff’s use of a public AI tool did not waive work-product protection because the information had not been disclosed to an adversary or otherwise placed at substantial risk of reaching one, demonstrating that outcomes may depend heavily on the facts and the platform used.
• Conservation Law Foundation, Inc. v. Shell Oil Co. (D. Conn. May 2026): The court compelled discovery concerning an expert’s use of generative AI, raising the possibility that prompts and outputs may become discoverable portions of an expert’s methodology.

These decisions underscore a simple but important point: AI governance extends well beyond whether an organization permits the use of AI. The critical question is how that use is governed. Organizations using AI should be prepared to explain what tools are being used and for what purposes, how associated risks are managed, and what safeguards are in place. Accordingly, an effective AI policy should do much more than authorize AI use; it should establish a clear governance framework for its oversight and deployment.

As AI becomes increasingly integrated into legal and business workflows, organizations should evaluate whether appropriate governance structures are in place. This includes determining who approves AI tools, what information may be entered into those tools, how outputs are reviewed and validated, what safeguards exist for confidential information, and whether those controls can be demonstrated if challenged in litigation, discovery, regulatory inquiries or disciplinary proceedings.

Organizations should also revisit:

• AI governance policies
• Vendor agreements and confidentiality provisions
• Litigation and discovery protocols
• Expert engagement letters
• Attorney and employee training

Success in the age of AI will belong to organizations that pair innovation with accountability, supported by governance frameworks and documentation practices capable of withstanding scrutiny.

Conclusion

California may be the first state to enact attorney-specific legislation governing the use of generative AI, but it is unlikely to be the last. More importantly, SB 574 signals a broader evolution in AI regulation: the focus is shifting away from the technology itself and toward accountability for its use. The statute does not prohibit generative AI or attempt to regulate the underlying tools. Instead, it reinforces a principle that is likely to shape future legislative and regulatory efforts: professionals remain responsible for the accuracy, reliability, and integrity of work produced with AI assistance.

For legal departments and law firms, the lesson is clear: The question is no longer whether generative AI will be used in legal and business workflows but whether that use is properly governed, supervised and defensible. Organizations that establish thoughtful AI governance frameworks before they are called upon to explain them to courts, regulators or other stakeholders will be best positioned to realize AI’s benefits while managing its risks.

BakerHostetler’s White Collar, Investigations and Securities Enforcement and Litigation team and Intellectual Property team include experienced practitioners with deep knowledge of AI governance, compliance and risk management. If you have any questions about this alert or its implications for your business, please feel free to contact any of our experienced professionals.

The conference brings together leading in-house compliance officers and other ethics and compliance professionals to discuss how organizations and their compliance professionals can navigate this rapidly changing environment.

BakerHostetler is a sponsor of the conference.

More information.

More information.

More information.

More information.

• As discussed in a prior BakerHostetler Insight,[1] earlier this year the Department of Justice (DOJ or the Department) created the National Fraud Enforcement Division (Fraud Division or the Division), which thereafter released a memorandum that outlined its key enforcement priorities.
• On Oct. 1, Assistant Attorney General Colin M. McDonald released a follow-up memorandum (the Memorandum) that further details the Fraud Division’s corporate enforcement priorities, including its focus on health care, government, tax and trade fraud.[2]
• The Memorandum highlights the creation of a Corporate Enforcement Section and provides additional factors prosecutors should consider when deciding whether to prosecute a company or resolve a matter through a negotiated agreement.
• The Memorandum emphasizes the Fraud Division’s intent to proactively generate new individual and corporate fraud investigations, including through whistleblowers and corporate self-reporting.
• DOJ continues to invest resources in the new Fraud Division. Companies should consider reviewing risk assessments and compliance policies and procedures, particularly those concerning healthcare, government contracts, tax and trade.

Key Details

This spring, the Department of Justice (DOJ or the Department) announced its creation of the National Fraud Enforcement Division (Fraud Division or the Division) and tasked the Division to “zealously investigate and prosecute those who steal or fraudulently misuse taxpayer dollars.”[3] On Aug. 13, Assistant Attorney General Colin M. McDonald released an initial memorandum that described the actions DOJ has taken to adequately resource the Division and that outlined the Division’s enforcement priorities. This memorandum noted that “fraud schemes have grown in complexity” because of “technological innovation[s] and economic expansion”[4] and sought to combat the same by building a comprehensive team that spans the many constituent parts of effective fraud investigations and prosecutions.

On Oct. 1, McDonald issued another memorandum (the Memorandum) to the Fraud Division that provides additional guidelines for the investigation and prosecution of corporate entities.[5]

First, notably, the Corporate Enforcement Section within the Fraud Division will oversee all the Division’s investigations and prosecutions of corporate entities. The Memorandum stresses that the Corporate Enforcement Section will work closely with Division prosecutors in other sections to leverage the Department’s resources and investigative tools. The Corporate Enforcement Section will also be responsible for evaluating companies’ compliance with the terms of corporate criminal resolutions.

Second, the Memorandum directs prosecutors to prioritize the investigation and prosecution of four types of cases. These priority offenses involve:

• Healthcare industry frauds, including the distribution of controlled substances and violations of the Federal Food, Drug, and Cosmetic Act
• Frauds involving public trust or financial integrity related to government contracts and procurement
• Schemes related to the evasion of internal and/or external revenue
• Tariff evasion frauds[6]

Third, in addition to the “Principles of Federal Prosecution of Business Organizations” guidelines in the Justice Manual, the Memorandum instructs prosecutors to consider certain factors when deciding whether to bring charges against corporate entities and when negotiating pleas or other agreements. Specifically, the Memorandum lists the following considerations for Division prosecutors:

• Management’s knowledge of or participation in the conduct
• Efforts to conceal conduct from the government or auditors, or to otherwise impede or obstruct a government function or oversight
• Conduct furthering the scheme lasting three or more years
• Conduct that threatens the safety or security of American citizens, including military readiness
• Conduct that causes substantial financial hardship to a taxpayer-funded program or other government function
• Conduct that affects multiple taxpayer programs or government functions
• Conduct that affects three or more federal districts
• Conduct that harms 25 or more individuals or that involves $25 million or more in loss
• Acts to send money abroad to support American adversaries
• Conduct that involves violations of immigration laws[7]

Finally, the Memorandum highlights the Fraud Division’s proactive stance in generating leads and opening individual and corporate fraud investigations. It emphasizes the role of whistleblowers and corporate self-reporting in helping the Department combat fraud, and it underlines that the Division’s policies “must encourage and protect the disclosure of information by whistleblowers, including by those who participated in the criminal conduct.” Accordingly, it directs Division leadership to consult with law enforcement partners and design and implement whistleblower policies and programs that bring credible, fraud-related information to light.[8]   

Practical Considerations for Companies and Executives

The Memorandum reiterates that DOJ will take an “all tools approach,” including hiring additional resources and using technology to investigate potential frauds.[9] Given DOJ’s commitment to rooting out fraud, companies and executives should consider incorporating the Memorandum into their risk assessments and reviewing their policies and procedures to ensure current compliance with the law. In light of the Memorandum, prudent organizations will specifically review, among other things, policies, procedures and practices related to (1) tax compliance; (2) healthcare compliance, including billing and the marketing of goods and services; (3) import and export compliance; (4) government contracting and procurement compliance; (5) antitrust compliance; (6) sanctions compliance; (7) accounting and disclosure; and (8) employee conduct and investigations.[10]

The BakerHostetler White Collar, Investigations and Securities Enforcement and Litigation team is composed of dozens of experienced individuals, including numerous attorneys who have served in the DOJ and at the Securities and Exchange Commission (SEC). Our attorneys include four former U.S. attorneys, several former assistant U.S. attorneys and unit chiefs, and attorneys who have served in the SEC’s Division of Enforcement. Our team has extensive experience in defending regulatory investigations and litigation; conducting enterprise-wide, business-line and regulatory area-specific risk assessments; and providing compliance counseling.

BakerHostetler’s Cartel and Government Antitrust Investigations Task Force (Task Force) consists of attorneys with extensive experience in proactive antitrust compliance counseling and regulatory investigations and litigation. The Task Force includes former DOJ prosecutors as well as attorneys who are part of both the Antitrust and Competition and the White Collar, Investigations and Securities Enforcement and Litigation teams.

Please feel free to contact any of our experienced professionals if you have questions about this alert.

[1] BakerHostetlerInsights: “Assistant Attorney General Memorandum to Fraud Division Outlines Division’s Key Enforcement Priorities,”available at https://www.bakerlaw.com/insights/assistant-attorney-general-memorandum-to-fraud-division-outlines-divisions-key-enforcement-priorities/. 

[2] Memorandum from Assistant Att’y Gen. Colin M. McDonald, “Directive 26-12 – Corporate Enforcement in the Fight Against Fraud”(Oct. 1, 2026), available at https://www.justice.gov/opa/pr/assistant-attorney-general-colin-m-mcdonald-issues-memorandum-national-fraud-enforcement-0.

[3] Memorandum from Acting Att’y Gen. Todd Blanche, “Creation of the National Fraud Enforcement Division” (Apr. 7, 2026), available at https://www.justice.gov/opa/pr/acting-attorney-general-todd-blanche-issues-memorandum-creation-national-fraud-enforcement.

[4] Id.

[5] Memorandum from Assistant Att’y Gen. Colin M. McDonald, “Directive 26-12 – Corporate Enforcement in the Fight Against Fraud”(Oct. 1, 2026), available at https://www.justice.gov/opa/pr/assistant-attorney-general-colin-m-mcdonald-issues-memorandum-national-fraud-enforcement-0. While the Fraud Division notes that it will continue to work closely with U.S. Attorneys’ Offices across the county and other DOJ components, the directives in the new Memorandum apply only to matters supervised by the Fraud Division.

[6] Memorandum from Assistant Att’y Gen. Colin M. McDonald, “Directive 26-12 – Corporate Enforcement in the Fight Against Fraud”(Oct. 1, 2026), available at https://www.justice.gov/opa/pr/assistant-attorney-general-colin-m-mcdonald-issues-memorandum-national-fraud-enforcement-0.

[7] Id.

[8] Id.

[9] Id.

[10] Importantly, the statutes of limitations for employee misconduct continue to run notwithstanding DOJ’s current priorities. Companies should continue to be diligent about compliance in all areas and forms.

Read Newsletter.

In addition to receiving the equity investment, Summit entered into a clinical collaboration agreement with AstraZeneca to evaluate sonesitatug vedotin (Sone-ve) in combination with ivonescimab with the intent to start studies in certain gastrointestinal (GI) cancer settings imminently. Sone-ve is a potential global first-in-class Claudin 18.2-targeting ADC with several ongoing trials underway in GI cancers. Ivonescimab is a novel, potential first-in-class investigational PD-1 / VEGF bispecific antibody.

The transaction closed on Oct. 5, 2026.

Read the press release.

• On Oct. 1, the IRS and Treasury Department issued temporary and proposed regulations implementing the Federal Scholarship Tax Credit ($1,700 per individual; $3,400 for those filing jointly) for donations to scholarship-granting organizations (SGOs). Certain government press materials refer to the credit as the “Education Freedom Tax Credit.”
• With the Jan. 1, 2027 launch date just 90 days away, now is the time for schools, donors and SGOs to prepare for what is estimated by Treasury to be the transfer of more than $26 billion annually in federal tax dollars to support K-12 private and public education.
• 95 percent of students nationally (private and public school students) are expected to qualify for scholarships of any amount needed for qualified educational expenses.

Temporary and Proposed Regulations

In 2027, taxpayers are eligible to receive a nonrefundable full federal income tax credit for cash contributions to SGOs, limited to $1,700 per individual per taxable year, with a five-year carryforward. The proposed regulations allow a married couple filing jointly to claim up to $3,400 if each spouse makes a qualified contribution. Companion Section 139K excludes qualifying SGO scholarships from the gross income of the student and the student’s family.

Comments are due Dec. 1, 2026.

On Oct. 2, Treasury and the IRS published Temporary regulations (T.D. 10057; Temp. Treas. Reg. §§ 1.25F-1T, 1.25F-4T and 1.25F-5T) setting forth the rules for state elections and SGO lists, SGO registration with the IRS, and donor acknowledgment and reporting. They apply as of Sept. 1 and expire by Oct. 1, 2029.

Proposed regulations (REG-117199-25; Prop. Treas. Reg. §§ 1.25F-0 through 1.25F-5) issued the same date repeat those rules and add others addressing the computation of the credit, the state-credit reduction, married-filing-jointly taxpayers, the 90 percent test and a segregated-account safe harbor, the meaning of “located in a state,” multistate SGOs, income verification, student residence, disqualified persons, an annual audit requirement with a small-organization alternative, unique-donor-number reporting, and the definition of “school.” The proposed rules may change before finalization. States, SGOs and taxpayers may rely on the proposed regulations for contributions made on or after Jan. 1, 2027, until final regulations are published, if they follow the portions that apply to them in their entirety and consistently.

The tax credit is available to every taxpayer through participating states, beginning Jan. 1, 2027. Scholarships are available to students who live in states that elect to participate.

The credit is available only for contributions to SGOs on the list submitted by a state that elects to participate. An Advance Election by a state is not enough by itself; the state must also submit its SGO list with the required certification by the deadline. For 2027, a state must file its Advance Election by Jan.1, 2027, and submit its SGO list by Feb. 15, 2027. As of Sept.14, the IRS listed 30 states that have made the election. Maryland and the District of Columbia have not elected in yet. A taxpayer in a nonparticipating state may still use the credit by making a contribution to an SGO listed by any participating state. However, an SGO listed by a state may only give scholarships to students who reside in that state.

Scholarships may benefit public and private school students.

Any student who is eligible to enroll in a public elementary or secondary school, whether or not actually enrolled in one, and whose household income does not exceed 300 percent of area median gross income is eligible for a scholarship to help cover qualified educational expenses. For example, an SGO may fund academic tutoring or special needs services for public school students and full or partial tuition for private school students.

Treasury and the IRS intend to issue regulations under Section 530(b)(3) to clarify the definition of “qualified elementary and secondary education expenses.”

A state credit reduces the federal credit only for designated contributions.

The proposed regulations subtract a state credit from the donor’s qualified contributions before applying the $1,700 cap and treat a state credit as allowed first for cash that the donor did not designate. Many donors therefore may claim both a state credit and the full federal credit.

Key Positions in the Temporary and Proposed Regulations

• 90 percent test and safe harbor. The 90 percent test is generally measured against the organization’s total gross receipts from all sources, unreduced by expenses. A single-state SGO with at least 85 percent of its activities in scholarship-granting activities may instead use a safe harbor that measures the “income of the organization” by the qualified contributions received by, and earnings credited to, its Section 25F segregated account during the year. A multistate SGO must meet the 85 percent threshold and must satisfy the test separately for each state-specific account. An SGO has until the end of the following taxable year to spend 90 percent of a year’s income, and amounts count when paid out in cash.
• “Located in a state.” For Section 25F(g), an organization is located in a state if it is authorized to do business in that state and complies with generally applicable state charitable organization rules, including rules for transparency, accountability and fraud prevention. States will list SGOs operating in their state and may not impose substantive SGO-specific requirements more restrictive than Section 25F, such as limits on the type of school a recipient may attend or the types of qualified expenses. An SGO may appear on more than one participating state’s list if it is located in each state and maintains a separate Section 25F account for each state.
• Income verification. Household income may be verified directly through pay stubs, tax returns, IRS transcripts, Form W-2 or other relevant data sources, or categorically through recent documentation that a household member is approved for or participates in one of five specified federal programs (SNAP, TANF, WIC, Section 8 housing, or SSI). Foster children satisfy the income requirement without separate verification.
• Audit. Each SGO must obtain an annual financial and programmatic audit by a qualified independent third party and provide it to each covered state on whose list it appears. Smaller SGOs may instead use an audit by a committee unrelated to management, signed under penalties of perjury.
• Donor identification. The SGO provides each donor, by Jan. 31 of the following year, a timely written acknowledgment of annual contributions, including the total amount and a unique donor number that the SGO creates under IRS instructions. The SGO reports each donor’s name, address and total qualified contributions to the IRS by Feb. 28 using that number, and the donor generally reports the number on their federal return. The donor does not provide a Social Security number to the SGO.
• Definition of “school.” Consistent with Tax Code Section 530, “school” means any school providing K-12 education as determined under state law. The proposed regulations do not separately address home schools, microschools or tribal schools. Treasury intends to issue guidance under Section 530 on the meaning of “school” and of qualified expenses.
• Qualified expenses. The proposed regulations do not add to or narrow the Section 530 list, which includes academic tutoring and special needs services. They prescribe how an SGO pays: Expenses charged by a school must be paid directly to the school, other vendors may be paid directly or through a qualified digital wallet, and a family may be reimbursed only against receipts. Guidance on eligible expenses under Section 530 is expected separately, as noted above.
• State list deadline for 2027. For 2027 only, a state must submit its Advance Election on Form 15714 on or before Jan. 1, 2027, and must perfect the election by submitting its SGO list on or before Feb. 15, 2027. SGOs that have not yet been granted exempt status by the IRS may be included on a state list as long as their exempt status will be effective no later than Jan. 1, 2027.
• Married couples. Spouses who file a joint return are treated as separate taxpayers. The joint return may show a credit of up to $3,400 if each spouse makes a qualified contribution of $1,700. This interpretation of the statute seems correct; the Joint Committee on Taxation previously stated that the “same $1,700 limit applies to single and joint filers.”
• State tax credits. The federal credit equals the donor’s qualified contributions, reduced by any state credit allowed for those contributions, and then capped at $1,700. A state credit is treated as allowed first for cash contributions that the donor did not designate as qualified contributions.
• Donor designation and reliance. A cash contribution is a qualified contribution only to the extent the donor designates it as one when making it. A donor may give to an SGO on any state’s list, regardless of where the donor lives, and may rely on the IRS SGO list at the time of the gift. A contribution made through a partnership or S corporation does not qualify for any credit.
• Student residence. “Solely within the State” refers to where the student resides under state law, not where the school is located. Exceptions apply to dependents of members of the Armed Forces and to dependents of individuals residing on Indian lands.
• Disqualified persons. An SGO may not award a scholarship to a substantial contributor (more than $5,000 and more than 2 percent of the year’s contributions), an officer, a director, a trustee, an individual who participates in selecting recipients, or a family member of any of them.

Key Features of Section 25F

Credit Rather Than Deduction

Section 25F allows a 100 percent credit for qualified cash contributions to SGOs. The credit is available only to individuals who are U.S. citizens or residents within the meaning of Section 7701(b). The credit is reduced by any amount allowed as a credit on a state tax return for the same contributions, as discussed below. Cash includes checks, credit and debit card payments, electronic transfers, and after-tax payroll deductions but not digital assets. An individual may not claim the credit for a contribution made by a partnership or S corporation. A contribution for which the credit is allowed may not also be deducted as a charitable contribution; the part of a qualified contribution that exceeds the credit may be deductible under Section 170.

The proposed regulations treat spouses who file a joint return as separate taxpayers, so a couple filing jointly may claim up to $3,400, as discussed below.

SGO Requirements

Qualifying SGOs must be exempt as a Section 501(c)(3) public charity and maintain separate accounts exclusively for qualified contributions and appear on a list of SGOs submitted by their state. The Section 25F(d) operational requirements for SGOs include:

• Providing scholarships to 10 or more students who do not all attend the same school
• Spending not less than 90 percent of the income of the organization on scholarships for eligible students
• Providing scholarships only for qualified elementary or secondary education expenses
• Giving priority to students awarded a scholarship the previous school year, and then to eligible students who have a sibling previously awarded a scholarship by the organization
• Not earmarking contributions for a scholarship for any specific student
• Verifying the annual household income (measured for the calendar year prior to the date of the scholarship application) and family size of applicants and limiting awards to eligible students within the income ceiling
• Not awarding scholarships to disqualified persons

The 90 Percent Test and Segregated-Fund Safe Harbor

The proposed regulations provide that an SGO must spend at least 90 percent of its income on scholarships. If an SGO’s activities are at least 85 percent scholarship-granting activities (generally, whether or not pursuant to Section 25F), then the SGO may apply the 90 percent test to its segregated Section 25F account.

Audit, Reporting and Fraud Prevention

The proposed regulations require each SGO to obtain an annual financial and programmatic audit by a qualified independent third party and to provide it to each covered state on whose list the SGO appears. An SGO whose total receipts for the year did not exceed $500,000 may have the audit conducted by a committee of independent persons unrelated to the organization’s management, with the report signed under penalties of perjury.

Qualified Expenses

Qualified expenses are defined by cross-reference. Section 25F(c)(4) adopts the expenses described in Section 530(b)(3)(A), relating to Coverdell education savings accounts. That provision has three parts. Clause (i) covers tuition, fees, academic tutoring, special needs services, books, supplies and other equipment incurred in connection with enrollment in or attendance at a public, private or religious school. Clause (ii) covers room and board, uniforms, transportation and supplementary items and services, including extended-day programs, but only if required or provided by the school in connection with enrollment or attendance. Clause (iii) covers computer technology or equipment, Internet access and related services used by the student and the student’s family during school years, excluding sports, game or hobby software unless predominantly educational.

The proposed regulations define “school” consistent with Section 530, to mean any school providing K-12 education as determined under state law. The IRS and Treasury have stated that they intend to issue clarifying regulations under Section 530 as soon as possible.

Prohibition on Awards to Disqualified Persons

The proposed regulations generally prohibit scholarships to a disqualified person or disqualified person’s family member. Disqualified persons generally include substantial contributors (more than $5,000 contributed to the SGO during the taxable year if such amount is more than 2 percent of the SGO’s contribution income); officers, directors or trustees of the SGO; scholarship committee members; and family members of the foregoing.

Coordination with State Tax Credits

The federal tax credit is reduced by “the amount allowed as a credit on any State tax return of the taxpayer for qualified contributions made by the taxpayer during the taxable year” (Section 25F(b)(2)). The proposed regulations apply the reduction in three steps: (1) total the donor’s qualified contributions for the year, (2) subtract any state credits allowed for those qualified contributions, and (3) take the lesser of the result or $1,700. Two features of the computation favor donors. First, a contribution is a qualified contribution only to the extent the donor designates it as one, and a state credit for a contribution that is not a qualified contribution is not subtracted. If a state credit is allowed for a donor’s cash contributions to an SGO that include both designated and undesignated amounts, the credit is treated as allowed first for the undesignated amount. Second, the state credit is subtracted before the $1,700 cap is applied, so a donor who designates more than $1,700 may absorb a state credit without losing any federal credit.

For example, a Virginia donor contributes $11,700 in cash to an SGO that is on Virginia’s Section 25F list and is also an approved scholarship foundation under Virginia’s credit program. The donor designates $1,700 as a qualified contribution and claims Virginia’s 65 percent credit on the other $10,000. The $6,500 Virginia credit is treated as allowed for the $10,000 that the donor did not designate, and the federal credit is $1,700.

The proposed regulations include two examples. In the first, a donor designates a total of $2,000 to two SGOs and claims a $400 state credit for those contributions; the federal credit is $1,600. In the second, a donor gives $4,000 to one SGO, designates $1,700 and claims a $400 state credit on the full $4,000; the state credit is treated as allowed from the $2,300 that the donor did not designate, and the federal credit is $1,700.

Ohio’s credit under R.C. 5747.73 is allowed only for cash donations to a certified SGO, up to $750 per individual. Under the proposed regulations, an Ohio donor seeking both state and federal credits does not need to direct the Ohio cash gift to a different organization. A donor who gives $2,450 in cash to an SGO that is both state-certified and on Ohio’s federal Section 25F list and designates $1,700 as a qualified contribution has a $750 Ohio credit that is treated as allowed for the undesignated $750 and a federal credit of $1,700. A donor who gives and designates only $1,700 and claims the $750 Ohio credit on that gift has a federal credit of $950.

Donor Eligibility, Student Eligibility and ‘Located in a State’

A qualified contribution is cash to an SGO that uses the contribution to fund scholarships for eligible students solely within the state in which the organization is listed. A state becomes a covered state only by voluntarily electing to participate and submitting a certified list of qualifying SGOs located in the state. The temporary regulations provide that an organization is “located in a state” if it is authorized to do business in that state and complies with generally applicable state charitable organization rules, including rules for transparency, accountability and fraud prevention. At the same time, a state may not impose substantive SGO-specific requirements that are more restrictive than Section 25F’s requirements. The proposed regulations also provide a path for multistate operation: An SGO may be listed on more than one participating state’s SGO list as long as it is located in each such state and maintains a separate Section 25F account for each state. A donor to a multistate SGO chooses the state account or accounts to which the contribution is allocated. The operational requirements apply separately to each state account, and at least 85 percent of the multistate SGO’s activities as a whole must be scholarship-granting activities.

Section 25F(c)(3) requires that contributions fund scholarships for students “solely within the State,” but the statute does not clarify whether that refers to the student’s residence, the school’s location or both. The proposed regulations provide that it is the student’s residence, determined under state law, that must be within the state. Attending school or buying goods or services in the state is not sufficient. Two exceptions apply. A dependent of a member of the Armed Forces is treated as within both the state of the student’s domicile and the state where the member resides. A dependent of an individual residing on Indian lands is treated as within both the state of the student’s residence and the state where the student attends school.

For example, if Maryland elects to participate and the District of Columbia does not, an SGO on Maryland’s list may award a scholarship to a Maryland resident who attends school in the district but not to a district resident who attends school in Maryland. A district resident may still claim the credit for a contribution to the Maryland-listed SGO (or any other SGO on any state list). An organization based in the district may appear on Maryland’s list in such a situation if it maintains a segregated account for Maryland scholarships, is authorized to do business in Maryland and complies with Maryland’s generally applicable charitable organization rules.

Donor Identification and IRS Matching

An SGO must provide each donor with a timely written acknowledgment of the donor’s annual contributions, including the total amount of qualified contributions and a unique donor number. SGOs are required to provide that information no later than the end of January following the calendar year of the donor’s qualified contribution. The SGO also must annually report to the IRS, by Feb. 28 of the year following the year of the qualified contribution, the unique donor number, donor’s address and amount of contribution. Finally, SGOs must make various annual certifications to the IRS.

Technology, Intellectual Property, Privacy and Public Schools

SGOs should confirm in their contract with their technology vendor that either the SGO or the appropriate school or school affiliate entity owns the donor and student data, that the data is portable if the SGO changes vendors and that the SGO has audit rights over the vendor’s records.

Schools that will partner with an SGO should obtain and review the SGO’s vendor agreement for data ownership, security and privacy terms, and consider negotiating cobranded giving pages and acknowledgments that protect the school’s relationship with students, their families and donors. Schools should also consider the SGO’s policy on school designations of donor funds and on redeployment of designated funds as scholarships. Schools should begin donor education on how the credit may work with state programs and how any donation to an SGO for a federal tax credit should be in addition to existing annual giving.

Public school systems and their foundations should assess whether the school district’s foundation or a regional SGO may be used to satisfy the Section 25F(d) operational requirements. A number of public school systems are preparing to use SGO scholarships to fund high-impact tutoring and other programs for public school students.

Current State Participation

As of Oct. 1, the IRS listed 30 states as having made an Advance Election to participate under Section 25F for 2027: Alabama, Alaska, Arkansas, Colorado, Florida, Georgia, Idaho, Indiana, Iowa, Kansas, Kentucky, Louisiana, Mississippi, Missouri, Montana, Nebraska, Nevada, New Hampshire, North Carolina, North Dakota, Ohio, Oklahoma, South Carolina, South Dakota, Tennessee, Texas, Utah, Virginia, West Virginia and Wyoming. Arizona, California, the District of Columbia, Illinois, Maryland, New Jersey, New York and Pennsylvania were not on the list.

Section 139K Income Exclusion

Amounts provided to an individual, or to any dependent of the individual, pursuant to a scholarship from a qualifying SGO for qualified elementary or secondary education expenses of an eligible student are excluded from gross income under companion Section 139K. Parents therefore are not taxed on scholarships that pay their children’s expenses. The exclusion applies to amounts received after Dec. 31.

Married Couples Filing Jointly and the $1,700 Cap

Section 25F(b)(1) limits the credit to $1,700 for “any taxpayer for any taxable year” but does not specifically state whether spouses on a joint return are one taxpayer or two. The proposed regulations treat married taxpayers who file a joint return as separate taxpayers. A couple therefore may claim up to $3,400 on a joint return if each spouse makes a qualified contribution of $1,700. In the regulation’s example, each spouse contributes, designates the contribution and receives an acknowledgment from the SGO. A couple therefore should make and document two separate gifts. This is a proposed rule and could change in the final regulations. We believe the proposed regulations reflect the best interpretation of the statute on this point. The Joint Committee on Taxation’s explanation of the statute states that the $1,700 limit applies on a per-taxpayer basis, “including in the case of a joint return.” Taxpayers may rely on the regulations and take a $3,400 credit on a joint tax return.

Public School Students May Use the Program

Public school students in qualifying households may receive scholarships and may use the funds for school fees, academic tutoring, special needs services, books, supplies and equipment incurred in connection with enrollment or attendance at their school. Room and board, uniforms, transportation and supplementary items and services, including extended-day programs, may be covered when required or provided by the school. Computer technology, Internet access and educational software used by the student and family during school years also may be covered.

Under a safe harbor, an SGO that funds individual academic tutoring, or special needs services for a special needs student, at a school in a low-income area need not verify household income if the school selects the student based on academic or special need. The school must be located in a Department of Housing and Urban Development-qualified census tract or certify that at least 80 percent of its students live in one. The SGO must obtain an annual third-party audit that covers the school’s eligibility, the selection of students, the providers’ qualifications, an independent diagnosis of each student’s need, and the quality and results of the services. For a scholarship based on need for tutoring or special needs services, an SGO may set priority by need for the services instead of by prior-recipient or sibling status.

Issues the Proposed Regulations Leave Unresolved or Fail to Specifically Address

Items not specifically addressed include:

• The detailed scope of Section 530 qualified expenses and the definition of “school,” which Treasury will address in separate guidance before the end of 2026
• Whether a donor may designate a contribution for a particular school, parish, district or program (we believe the answer is clearly yes)
• How an organization should measure whether 85 percent of its activities are scholarship-granting activities
• Whether “gross receipts” is a permissible gloss on the statutory term “income”
• Whether pass-through fundraising organizations may qualify as SGOs
• The treatment of home schools, microschools and nonschool extended-day providers
• Whether state and tribal needs-based programs will be added to the categorical income verification method
• What procedures, beyond a qualified digital wallet, are sufficient to prevent duplicate awards
• The procedure for a state that makes its first election for a year after 2027, which the temporary regulations leave to future guidance

Comment Period

The proposed regulations invite comments received within 60 days after Federal Register publication. A public hearing will be held on Dec. 15 at 10 a.m. EST at the IRS building in Washington, with a telephone option. Comments may be submitted through the federal Rulemaking portal at regulations.gov under docket REG-117199-25. Treasury has requested comments on all aspects of the proposed regulations and specifically on (1) the definition of a qualified digital wallet and whether to add other safe harbors for verifying expenses; (2) how an organization should measure its scholarship-granting activities and whether 85 percent is a reasonable threshold; (3) how the Section 501(c)(3) requirements interact with Section 25F; (4) other needs-based programs, such as state or tribal programs, to include in the categorical income verification method; (5) the certifications states must make, including for multistate SGOs, and whether any is disproportionately burdensome; and (6) whether less burdensome alternatives would adequately mitigate the risk of fraud or improper payment of scholarships.

Prospective SGOs that find a proposed requirement impracticable, such as the cost of a third-party audit for a small or newly formed organization, should provide comments, ideally with an alternative rule. Schools, dioceses and foundations that cannot meet the 85 percent threshold should consider commenting on the gross receipts definition of “income.” Tutors, extended-day and after-school providers, and other education service providers should consider commenting on the treatment of their services as qualified expenses, both in this rulemaking and when Treasury issues the Section 530 guidance.

Effective Date and Reliance

The credit under Section 25F is effective for taxable years ending after Dec.31, and the Section 139K exclusion applies to amounts received after that date. As a practical matter, the program operates on a calendar-year basis beginning in 2027, with state election and SGO listing required before a donor may claim the credit for a contribution to an SGO in a state.

The temporary regulations apply as of Sept. 1 and expire by Oct. 1, 2029. If finalized, the proposed regulations would apply for taxable years ending on or after the date final regulations are published in the Federal Register. The preamble provides that taxpayers, SGOs and states may rely on the proposed regulations for qualified contributions made on or after Jan. 1, 2027, in taxable years ending before that date, provided they follow the portions of the proposed regulations that apply to them in their entirety and in a consistent manner.

• US Crypto Companies, Banks and Fintechs Announce Crypto Initiatives
• Treasury Rule Addresses GENIUS Act State Regulator Stablecoin Certifications
• GENIUS Act Proposals Address Federally Regulated Payment Stablecoin Issuers
• CFTC Updates Crypto Asset FAQs
• SEC Publishes FAQs on March 2026 Interpretive Release
• Report Addresses Role of USDT in ‘Shadow Banking’
• SEC Charges Multiple Entities in Scams Soliciting Crypto Payments
• Crypto Exploits Continue To Climb with More Than $766M in September Losses Alone

US Crypto Companies, Banks and Fintechs Announce Crypto Initiatives

By Robert Musiala Jr.

A major U.S. crypto exchange recently announced that it is collaborating with a major U.S. bank on two stablecoin infrastructure initiatives. According to a blog post by the crypto exchange, in one initiative, the exchange will integrate its customer accounts with the bank’s Virtual Account Wallet, giving the exchange’s customer accounts with “the ability to accept, hold, and pay funds, with incoming fiat automatically converted into stablecoins.” In the other initiative, the exchange will provide the bank with new functionality that will allow the bank’s institutional clients to accept stablecoin payments at checkout without holding or managing stablecoins directly. 

In related news, a major U.S. fintech and payments company recently announced that it has joined the x402 Foundation, “an open standard for agentic payments, to help build the rails that will let people, businesses, and agents pay and get paid.” As part of the initiative, the company “has contributed Bitcoin Lightning payments to the x402 protocol.”

And in a final notable item, AmericanFortress, a digital asset privacy infrastructure company, recently published a paper proposing a new use case for Zero-Knowledge Proofs (ZKPs). According to reports, the paper describes “a novel means of proving the origin of crypto wallets” using ZKPs and proposes a method to prove that several addresses or credentials belong to the same cryptographic identity without revealing the wallet seed, private keys, derivation paths or the rest of the wallet.

For more information, please refer to the following links:

• [] brings bank-grade fiat and stablecoin payments to businesses, in collaboration with []
• [] Joins the x402 Foundation to Advance Open, Agentic Commerce
• AmericanFortress paper shows how ZKPs can prove crypto wallet ownership
• Zero-Knowledge Proof System Lets Users Prove Crypto Wallet Details Privately
• Provenance Proofs: Linkable Zero-Knowledge Derivation Relations for Hierarchical Deterministic Wallets

Treasury Rule Addresses GENIUS Act State Regulator Stablecoin Certifications

By Robert Musiala Jr.

On Sept. 30, the U.S. Department of the Treasury published an interim final rule (Rule) setting forth “a process to facilitate … approval or denial of certifications submitted by State payment stablecoin regulators under section 4(c)(4) of the GENIUS Act, (Act) and prescribe the form of such certifications.” The Rule “will ensure that interim forms and procedural regulations are in place to facilitate submission of certifications by the effective date of the GENIUS Act.”

As explained by the Rule, “State-qualified payment stablecoin issuers with a consolidated total outstanding issuance of payment stablecoins of not more than $10 billion may opt for State regulation provided that (i) the State payment stablecoin regulator has submitted a certification, including an attestation that the State regulatory regime meets the criteria for substantial similarity established by Treasury, and (ii) the Stablecoin Certification Review Committee (the Committee) has approved the State-level regulatory regime.” (The Committee is chaired by Treasury and includes the chairs of other federal financial regulators.) With respect to the Committee’s review of state-level regulatory regimes, the Act requires states to submit certifications to the Committee, including an attestation “in a form prescribed by the [Committee],” and directs the Committee to follow certain procedures. Accordingly, the Rule prescribes the form of certifications and implements the required procedures.

Among other things, with respect to the state regulator certifications, the Rule defines key terms, sets certain timelines, describes required content and outlines procedures related to the submission, acceptance, approval, denial, resubmission and appeal of the certifications. According to the Rule, “A key benefit of this rule is the transparency it provides regarding the Committee’s procedures for reviewing State certifications and its expectations for what would be submitted by State payment stablecoin regulators.” The Rule includes 39 specific questions on which Treasury is seeking public input. Comments on the Rule must be received on or before Nov. 30.

For more information, please refer to the following links:

• RIN 1505-AC97 Forms and Procedures for Review of State Certifications by the Stablecoin Certification Review Committee
• Treasury Sets Plans For State Stablecoin Regime Reviews

GENIUS Act Proposals Address Federally Regulated Payment Stablecoin Issuers

By Robert Musiala Jr.

On Sept. 24, the board of the U.S. central bank (Board) published two proposed rules (Proposals) related to establishing a regulatory framework for Board-supervised payment stablecoin issuers under the GENIUS Act.

According to a press release, among other things, the first Proposal would: (1) require that Board-supervised payment stablecoin issuers fully back their stablecoins with certain permissible reserve assets, such as short-term Treasury bills and certain other high-quality liquid assets; (2) establish standardized capital requirements to address certain credit and operational risks of payment stablecoin activities, as well as risk management standards; (3) introduce rules for Board-supervised firms that safekeep the assets backing payment stablecoins; and (4) clarify the permissibility of stablecoin and related activities for Board-supervised banks. The first Proposal is 16 pages and includes 23 questions on which the Board is seeking public input.

According to the press release, the second Proposal would: (1) establish a tailored application process for Board-supervised banks applying to issue payment stablecoins; (2) prescribe application requirements, including submission of a business plan and financial information, among other documents; and (3) create a process governing appeals, hearings and final determinations for applications. The second Proposal is 104 pages and includes 254 questions on which the Board is seeking public input. Comments on the Proposals must be received by Nov. 30.

For more information, please refer to the following links:

• Federal Reserve Board requests public comment on two proposals related to establishing a regulatory framework for Board-supervised payment stablecoin issuers under the GENIUS Act
• RIN 7100–AH30 Application Procedures for Board-Supervised Insured Depository Institutions Seeking Approval for a Subsidiary To Issue Payment Stablecoins
• RIN 7100–AH29 Implementing the Federal Reserve Board’s Responsibilities Under the GENIUS Act

CFTC Updates Crypto Asset FAQs

By Robert Musiala Jr.

On Sept. 24, the U.S. Commodity Futures Trading Commission (CFTC) released updates to the CFTC’s FAQs Concerning Registrant and Registered Entity Activities Relating to Crypto Assets and Blockchain Technologies. According to a CFTC press release, the updates are intended “to address investments of customer funds in tokenized forms of permitted investments and the use of blockchain technologies to satisfy a registrant’s recordkeeping requirements.” The FAQs provide answers to 15 specific questions related to crypto asset margin collateral and recordkeeping requirements for CFTC-registered entities. The updated FAQs revise an earlier version published in March.

For more information, please refer to the following links:

• CFTC Staff Releases Updates to FAQs Concerning Registrants and Registered Entity Activities Relating to Crypto Assets and Blockchain Technologies
• CFTC Market Participants Division, Division of Market Oversight, and the Division of Clearing and Risk Respond to Frequently Asked Questions Concerning Registrant and Registered Entity Activities Relating to Crypto Assets and Blockchain Technologies
• CFTC Allows Tokenized Investments, Blockchain Records
  

SEC Publishes FAQs on March 2026 Interpretive Release

By Robert Musiala Jr.

On Sept. 28, the U.S. Securities and Exchange Commission (SEC) published Frequently Asked Questions on the Application of the Federal Securities Laws to Certain Types of Crypto Assets and Certain Transactions Involving Crypto Assets (FAQs). The FAQs consist of three questions and answers under the topic “Questions Regarding Section III of the Interpretive Release (Classification of Crypto Assets)” and six questions and answers under the topic “Questions Regarding Section IV of the Interpretive Release (Crypto Assets That Are Subject to an Investment Contract).”

For more information, please refer to the following link:

• Frequently Asked Questions on the Application of the Federal Securities Laws to Certain Types of Crypto Assets and Certain Transactions Involving Crypto Assets

Report Addresses Role of USDT in ‘Shadow Banking’

By Robert Musiala Jr.

On Sept. 28, the U.S. Senate Permanent Subcommittee on Investigations published a report titled “TETHERED TO TERRORISM: Crypto & Iran’s Shadow Banking Network.” The report addresses Tether, the issuer of the USDT stablecoin. According to the report, “Tether’s role in Iranian shadow banking is unprecedented and pervasive—providing what appears to be a primary and preferred cryptocurrency for the Islamic Republic’s schemes to prop up the regime and sustain its regional security threats.” The report provides three key findings, asserting that Tether: (1) has become a primary illicit international payment system for Iran, allowing it to circumvent international sanctions on its banks; (2) serves as a central payment mechanism that interlinks Iran and its terrorist proxy organizations, undermining U.S. security interests in the region; and (3) has repeatedly failed to freeze illicit wallets and prevent the abuse that created the permissive environment under which Iranian shadow banking has flourished.  

On the same day the report was published, Tether published a blog post stating that it has frozen “approximately $550 million in Iran-linked USDT in 2026 alone.” According to the blog post, “Tether works directly with U.S. authorities, including the Department of Justice, the Federal Bureau of Investigation, the U.S. Secret Service, Homeland Security Investigations, and the Office of Foreign Assets Control.” The blog post notes that “U.S. agencies have repeatedly and publicly acknowledged Tether’s role in major enforcement operations.”

For more information, please refer to the following links:

• Tether’s Stablecoin Is Iran’s ‘Lifeline,’ Senate Report Says
• TETHERED TO TERRORISM: Crypto & Iran’s Shadow Banking Network
• Blumenthal letter to Bessent
• Blumenthal letter to Blanche
• Tether Has Supported Nearly $550 Million in Iran-Linked USD₮ Freezes as U.S. Expands Sanctions Campaign

SEC Charges Multiple Entities in Scams Soliciting Crypto Payments

By Robert Musiala Jr.

The U.S. Securities and Exchange Commission (SEC) recently published a press release announcing it has “charged multiple entities that are likely operated by individuals located overseas for defrauding hundreds of retail investors, including many in the U.S., through so-called investment confidence scams where the perpetrators sought to build online relationships with unsuspecting clients before stealing their money.” According to an SEC press release, “The defendants allegedly directed investors and clients to open accounts on their fake trading platform and manipulated them into transferring crypto assets to the platform.”

For more information, please refer to the following link:

• SEC Charges Multiple Entities in Fraud Schemes Totaling at Least $15 Million That Used [] and Other Platforms to Lure Investors

Crypto Exploits Continue To Climb with More Than $766M in September Losses Alone

By Lauren Bass

According to reports, crypto losses in September exceeded $766 million – the highest monthly total reported in 2026 and a significant increase from August. Two incidents alone accounted for approximately $708 million of the reported losses, although more than $270 million of that was later reportedly recovered and returned. According to a major blockchain security auditor, “September was a stark reminder of how quickly the threat landscape can shift.” 

For more information, please refer to the following link:

• Crypto hacks top $768M in September, worst month of 2026