On December 11, 2024, the Department of the Treasury (Treasury) and the Internal Revenue Service (IRS) published final regulations under section 987, addressing foreign currency translation gains and losses from a qualified business unit (QBU) that operates in a foreign currency different than the functional currency of its owner. Consistent with the 2023 proposed regulations, the final regulations generally apply to tax years beginning after December 31, 2024. For certain earlier years, taxpayers may opt to apply the final regulations or elect to apply the 2016 and 2019 regulations, subject to a consistency requirement. 

The final regulations follow the structure of the 2023 proposed regulations, discussed in our prior coverage, with transition rules that account for unrecognized foreign currency gain or loss accrued before December 31, 2024. Accordingly, for tax years to which the final section 987 regulations apply, taxpayers may no longer use the historic "earnings and capital" method, in place since 1991. Instead, in line with the proposed regulations, the default rule is the Foreign Exchange Exposure Pool (FEEP) method, with two potential elections: a "current rate election" that permits foreign currency translation of all QBU items at the current tax year's exchange rate, subject to a loss suspension rule, and an "annual recognition election" to recognize all unrecognized section 987 foreign currency gain or loss each year. Changes include a new small business election to avoid pretransition gain or loss recognition and a de minimis rule with respect to suspended pretransition losses. The final regulations generally apply only to corporations and individuals; however, certain parts of the regulations, including the rules relating to suspension of losses, apply to partnerships and S corporations. 

Concurrently, Treasury and the IRS published proposed regulations that would permit taxpayers to elect to allow a QBU and its owner to use the yearly average exchange rate, rather than the spot rate, for certain frequently recurring transfers. The election is intended to simplify the computation of unrecognized section 987 gain or loss and applies to routine ordinary business transactions involving sales of inventory, payments for services, or rent or royalty transactions. The election is available for tax years in which the final regulations apply, subject to a consistency requirement. The proposed regulations request comments on the appropriate approach to partnerships for purposes of section 987 and section 989(a), as well as ways to simplify the application of section 987 to CFCs and partnerships with foreign partners that have QBUs. Comments are requested by March 11, 2025.

For more information, please contact:

Jeffrey M. Tebbs, jtebbs@milchev.com, 202-626-1480

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

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