• The Biden administration threatened to rescind millions of dollars in federal coronavirus aid for Arizona, accusing the state of using the funds to undermine efforts to stop the spread of the virus.
• Republican Gov. Doug Ducey's office has 60 days to either make changes to two federally subsidized state school programs totaling $173 million, or redirect the money toward "eligible uses," the Treasury Department said in a letter.
• If Arizona fails or refuses to comply with its demands, the Biden administration may take back that stimulus money and withhold a second tranche of pandemic relief funding, Treasury said.

The Biden administration on Friday threatened to rescind millions of dollars in federal coronavirus aid for Arizona, accusing the state of using the funds to undermine efforts to stop the spread of the virus.

Republican Gov. Doug Ducey's office has 60 days to either change two federally subsidized state school programs totaling $173 million, or redirect the money toward "eligible uses," the Treasury Department said in a letter.

The programs impose conditions that discourage compliance with wearing masks in schools, contradicting guidance from the Centers for Disease Control and Prevention on how to reduce coronavirus transmission, the letter said.

If Arizona fails or refuses to comply with Treasury's demands, the Biden administration may claw back that stimulus money and withhold a second tranche of pandemic relief funding, Treasury said.

Ducey's office did not immediately respond to CNBC's request for comment on the letter.

The federal funds in dispute come from the Coronavirus State and Local Fiscal Recovery Funds program, or SLFRF, a $350 billion chunk of the multitrillion-dollar Covid relief package, dubbed the American Rescue Plan, that President Joe Biden signed into law last year.

The funds are intended "to mitigate the fiscal effects stemming from the COVID-19 public health emergency, including by supporting efforts to stop the spread of the virus," Treasury noted in the letter to Ducey's Office of Strategic Planning and Budgeting.

But Arizona's two school programs use the federal money to "impose conditions on participating in or accepting a service that undermine efforts to stop the spread of COVID-19 and discourage compliance with evidence-based solutions for stopping the spread of COVID-19," the letter said.

The $163 million Education Plus-Up Grant Program, for instance, allows funds be given only to schools that do not enforce mask requirements, Treasury wrote.

The other program in question, totaling $10 million, provides grant money to help parents move their kids out of schools that are deemed to be imposing "unnecessary closures and school mandates."

That program "is available only to families if the student's current or prior school requires the use of face coverings" during the school day, Treasury's letter said.

The latest letter, sent by acting Deputy Chief Compliance Officer Kathleen Victorino of the Treasury Office of Recovery Programs, follows months of back-and-forth between the Biden administration and Arizona.

The Treasury Department in October had asked Arizona to explain how it would fix the issues identified in the two school programs.

The state responded a month later, detailing its rationale for the anti-mask conditions but failing to "describe any plans for remediation of the issues identified," Victorino wrote.

The latest fight over Covid safety rules comes as the highly transmissible omicron variant fuels an unprecedented surge in cases. The U.S. Supreme Court on Thursday blocked enforcement of the Biden administration's rule for employees in large companies to either get vaccinated or receive weekly testing, but the high court left intact a vaccine mandate for health-care workers.

But the disputes precede omicron. Last year, Arizona's Republican-controlled legislature tried to pass provisions banning mask mandates and other Covid safety measures. In November, the state Supreme Court ruled that those measures were passed illegally.

— CNBC's Tom Franck contributed to this report.