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A Closer Look at Foreign Currency Gains & Losses of QBUs

The 2024 final regulations and proposed regulations released by Treasury on December 10 provide guidance for taxpayers calculating taxable income or loss and §987 foreign currency gains and losses with respect to a QBU.

The final regulations under Internal Revenue Code Section 987 include rules for taxpayers calculating the §987 gain or loss of a qualified business unit (QBU), enacting the application of the foreign exchange exposure pool (FEEP) method, and implementing various elections that are intended to reduce the burden of compliance on taxpayers.

Background

The 2024 final regulations and proposed regulations released by Treasury on December 10 provide guidance for taxpayers calculating taxable income or loss and §987 foreign currency gains and losses with respect to a QBU.1 Section 989 and the regulations thereunder define a QBU as a “separate trade or business of a taxpayer that maintains separate books and records.”

While the 2024 final regulations implement various provisions from the November 2023 proposed regulations, notably, the 2024 final regulations apply the FEEP method that was included in the December 2016 final regulations. Given the complexities of applying the FEEP method, the IRS has repeatedly delayed the effective date of the December 2016 final regulations (see Notices 2019-65 and 2022-34).

Mechanics of the FEEP Method

First proposed in 2006 regulations, the FEEP method requires a taxpayer to determine and track net unrecognized §987 gain or loss by:

  1. Translating “marked” and “historic” assets and liabilities to the taxpayers’ functional currency at either the historic rate or spot rate.
  2. Translating taxable income or loss, tax exempt income, and nondeductible expenses to the taxpayers’ functional currency at the yearly average exchange rate.

The resulting unrecognized §987 gain or loss for the year is tracked by the taxpayer in an unrecognized §987 pool. Upon remittance, a portion of the unrecognized §987 gain or loss is realized based on the percentage of a QBU’s assets remitted.

Forvis Mazars Insight: The 2023 proposed regulations brought entities previously excluded from the provisions of the 2016 final regulations into scope of the FEEP method, such as banks, insurance companies, leasing companies, finance coordination centers, RICs, and REITs.

Other Provisions Enacted

The 2023 proposed regulations introduced the following elections which were enacted in the 2024 final regulations. These elections are intended to reduce the burden of compliance on taxpayers:

  • An annual rate election: a taxpayer may elect to recognize unrecognized §987 gain or loss on an annual basis.
  • A current rate election: a taxpayer may elect to translate all balance sheet items at the year-end spot rate and all income statement items at the yearly average rate.

Forvis Mazars Insight: If a current rate election is made, detailed tax basis balance sheets may not be required.

The 2023 proposed regulations also detailed application of loss limitation rules under which a §987 loss, recognized from a termination or remittance, may be suspended until the taxpayer recognizes an equal amount of §987 gain of the same source and character. The final regulations retain this rule and provide a lookback rule for gain recognized in a previous year. Further, the final regulations provide guidance concerning treatment of remittances between members of a consolidated group, clarifying that a transaction between two QBUs of a consolidated group may be treated as two separate transactions

Finally, unless the “fresh start” transition rule from the 2016 final regulations has been applied, taxpayers are required to compute a “pretransition” §987 gain or loss using the spot rate on the day prior to the transition date. If a taxpayer did not use an eligible pretransition method,2 the pretransition gain or loss must be determined on a yearly basis starting with the tax year beginning on or after September 7, 2006.

Forvis Mazars Insight: This may result in an 18-year lookback rule which could prove difficult to calculate. There is a de minimis rule that allows QBU owners with gross receipts of $25 million or less to make an election to treat a QBU as not having pretransition gain or loss provided the QBU has assets of less than $10 million.

Partnerships

The IRS has indicated that further study is required in applying the methods and rules laid forth in the 2024 final regulations to QBUs of partnerships and S corporations, stating that the 2024 final regulations generally do not apply to partnerships (and S corporations which are treated in the same manner as partnerships for purposes of the §987 regulations). A partnership would use a reasonable method “consistent with the statute” that is consistently applied year over year.

2024 Proposed Regulations: Disregarded Transactions Between a QBU and Its Owner

The 2024 proposed regulations are intended to clarify questions around accounting for disregarded transactions between a QBU and its tax owner and include a recurring transfer group election, whereby in cases where transfers between a QBU and its owner are frequently made, the frequently occurring transfer may be translated using the yearly average exchange rate instead of the spot rate.

How Forvis Mazars Can Help

The 2024 final regulations are generally effective for taxpayers with tax years beginning after December 31, 2024. Please reach out to a Forvis Mazars professional for assistance with assessing the impact of applying the 2024 final regulations.

  • 1Section 988 transactions are addressed as they relate to the taxable income or loss of a QBU. The 2024 final regulations provide a taxpayer with the option to recognize a §988 gain or loss using a mark-to-market method to result in a consistent treatment of §988 transactions for tax and financial reporting. The 2024 final regulations also provide guidance when applying §988 to transactions that are not in the functional currency of the QBU.
  • 2An eligible pretransition method is defined in §1.987-10(e)(4) and includes the earnings and capital method, and other reasonable methods.

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