The U.S Department of the Treasury (Treasury) and the Internal Revenue Service (IRS) released proposed regulations on August 20, 2024, regarding elections relating to foreign currency gains and losses. The proposed regulations would significantly restrict the time for making — and a taxpayer's ability to revoke — the section 988 mark-to-market election provided under 2017 proposed regulations and certain elections relating to foreign currency gains and losses of controlled foreign corporations (CFCs). The preamble in the notice of proposed rulemaking states that Treasury and the IRS intend for these changes to prevent taxpayers from selectively recognizing losses. A subsequent correction to the proposed regulations clarifies that taxpayers may rely on the filing dates and election procedures from the 2017 proposed regulations to make the section 988 mark-to-market election for taxable years beginning before August 20, 2024, and to make certain elections relating to foreign currency gains and losses of a CFC for taxable years ending before August 20, 2024. Another subsequent correction provides that comments on the proposed regulations are due by October 21, 2024.

Under Treas. Reg. § 1.954-2(g)(3) and (4), controlling U.S. shareholders are permitted to elect to (1) attribute their CFC's foreign currency gain or loss to the category of subpart F income to which the gain or loss relates, instead of to the CFC's foreign personal holding company income (FPHCI) and (2) treat all foreign currency gains or losses arising from section 988 transactions as FPHCI. Proposed regulations from 2017 would have permitted controlling U.S. shareholders to revoke these elections at any time, although a new election could not be subsequently made until the sixth taxable year following the year in which the previous election was revoked, and this new election could not be revoked until the sixth taxable year following the year in which the new election was made. The new proposed regulations would require that a revocation be made on the U.S. shareholders' original income tax returns for the taxable year of the U.S. shareholders in which or with which the taxable year of the CFC for which the revocation is made ends. The new proposed regulations would also preclude U.S. shareholders from revoking a Treas. Reg. § 1.954-2(g) election (including an initial election) until the sixth taxable year following the year of the election and from making a new Treas. Reg. § 1.954-2(g) election until the sixth taxable year following a revocation.

The 2017 proposed regulations also permitted taxpayers to elect a mark-to-market method for certain section 988 transactions. This mark-to-market election was to be made on the original tax return for the taxable year for which the election is made and could be revoked at any time, although a new election could not be subsequently made until the sixth taxable year following the year in which the previous election was revoked. The new proposed regulations modify the filing dates for these section 988 mark-to-market elections to align with the procedures for section 475 mark-to-market elections for dealers in commodities and traders in securities. For tax years beginning on or after August 20, 2024, taxpayers must make a section 988 mark-to-market election on a timely filed (excluding extensions) original tax return for the taxable year preceding the year for which the method would take effect (or if applicable, with a request for an extension of time to file that return). In addition, taxpayers must obtain IRS consent to revoke the mark-to-market election.

The preamble to the notice of proposed rulemaking for the proposed regulations explains that when the proposed regulations are finalized, Treasury and the IRS expect to issue a revenue procedure providing the terms and conditions under which an accounting method change to the section 988 mark-to-market method will be granted. Treasury and the IRS anticipate that these terms and conditions will address, among other things, "the appropriate circumstances under which a taxpayer must establish a substantial business reason for the change." The reference to a "substantial business reason" is surprising in this context as accounting method changes generally are made only for federal income tax reasons and not for non-tax business reasons. A requirement that a taxpayer establish a substantial business reason as a condition to obtaining IRS consent to an accounting method change would be a stark departure from current IRS practice in this area. The exact contours of any such requirement in this context — and whether it portends a potential change in the way the IRS approaches taxpayer-initiated accounting method change requests in general — remains to be seen.

For more information, please contact:

Layla J. Asali, lasali@milchev.com, 202-626-5866

James R. Gadwood, jgadwood@milchev.com, 202-626-1574

Caroline R. Reaves, creaves@milchev.com, 202-626-5939

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