IRS Reproposes Regulations on Foreign Currency Elections to Clarify, Tighten Rules

The IRS on August 19 released proposed regulations (REG-111629-23) that would adopt a less flexible approach to the rules regarding making and revoking certain elections related to foreign currency gains and losses. 

The proposed rules would affect both: 

1. Elections made under Treas. Reg. §1.954-2(g)(3) and (g)(4) by controlling U.S. shareholders of a controlled foreign corporation (CFC) with respect to foreign currency gains and losses attributable to Internal Revenue Code Section 988 foreign currency transactions.
2. Elections made under Treas. Reg. §1.988-7 to use a mark-to-market method of accounting for foreign currency gains and losses with respect to Section 988 transactions.
   
   
   

Elections Under Treas. Reg. §1.954-2(g)

Section 954(c)(1)(D) generally provides that foreign personal holding company income includes the excess of foreign currency gains over foreign currency losses attributable to any Section 988 foreign currency transactions. There is an exception for those transactions directly related to the business needs of a CFC.  For those transactions that do not meet the business needs exception, however, two applicable elections are available for controlling U.S. shareholders of a CFC under Treas. Reg. §1.954-2(g)(3) and (g)(4). 

Under Treas. Reg. §1.954-2(g)(3), taxpayers may make an election to characterize foreign currency gain or loss that arises from a subpart F generating transaction as gain or loss in that same category. For example, assume a CFC records a non-functional currency account receivable associated with a foreign base company sales transaction. Under the general rule, the foreign currency gain or loss would be passive subpart F income in the foreign currency category and a loss in such category cannot be used to offset any other type of subpart F income. The Treas. Reg. §1.954-2(g)(3) election would allow a foreign currency loss in the example to reduce the foreign base company sales income.  

An election under Treas. Reg. §1.954-2(g)(4) allows a taxpayer to characterize all foreign currency gains and losses within a CFC as foreign personal holding company income. For example, assume a CFC holds non-functional currency receivables that give rise to foreign currency gains and losses that are not excepted out of subpart F under the business needs exception. Further assume that the CFC holds a note that generates passive subpart F interest income. Under the general rule, foreign currency gain or loss on the receivables would be passive subpart F income or loss within the foreign currency subcategory. The election under Treas. Reg. §1.954-2(g)(4) would allow a foreign currency loss on the receivables to reduce the passive interest income related to the note. 

After making either election, controlling U.S. shareholders of a CFC can revoke the elections under Treas. Reg. §1.954-2(g) with the consent of the Commissioner. Proposed regulations issued in 2017 (the 2017 Proposed Regulations) would have permitted the controlling U.S. shareholders of a CFC to revoke the CFC’s Treas. Reg. §1.954-2(g) election at any time, although the taxpayer would not be able to make another election for five years post-revocation.

Elections under Treas. Reg. §1.988-7

The second election addressed by the proposed regulations relates to an election included in the 2017 Proposed Regulations under Prop. Treas. Reg. §1.988-7 to mark-to-market all of a CFC’s Section 988 transactions at year-end. Under the 2017 Prop. Treas. Reg. §1.988-7, taxpayers could make the election when filing the tax return including extensions, and then they could revoke the election at any time, understanding that a new election couldn’t be made for five years. This allowed taxpayers to evaluate at year-end if they were in a net Section 988 loss position with the benefit of hindsight and accelerate the loss deduction and then perhaps revoke the election in the future when they are in a gain position.  

Modified Election Rules Under New Proposed Regulations

The new proposed regulations would withdraw the election and revocation rule provisions under the 2017 Proposed Regulations and make changes affecting elections under Treas. Reg. §§1.954-2(g) and 1.988-7.

With respect to elections under Treas. Reg. §1.954-2(g), the proposed rules would specify that the CFC with respect to which an election is being made must have a year-end that is included in the tax year of the electing controlling US shareholder. In addition, they would provide that once the election is made, it cannot be revoked for five tax years. To revoke an election once eligible, the newly proposed rules state that the controlling U.S. shareholders would have to file a statement with their original income tax returns for the tax years of the controlling U.S. shareholders in which or with which the tax year of the CFC for which the revocation is made ends. 

For elections under Treas. Reg. §1.988-7, the proposed regulations would change the timing of making the election to be the original due date without extension of the tax return for the year prior to the year of change. This means that if a taxpayer wants to make the election for 2025, then an election statement must be filed with the extension for the 2024 tax return. Accordingly, any taxpayer that has yet to file its 2023 tax return would be precluded from making this election under the proposed rules. Further, the proposed regulations provide that the Treas. Reg. §1.988-7 election can only be revoked with permission from the Commissioner and is no longer automatic. The preamble to the proposed regulations states that the IRS expects to issue a revenue procedure setting out the terms under which a change of method of accounting with respect to the mark-to-market method under Treas. Reg. §1.988-7 will be granted.

The proposed regulations are generally proposed to apply to tax years ending on or after the date of publication of final regulations. However, for tax years ending before that date, taxpayers may rely on the election and revocation provisions in the new proposed regulations, provided they consistently apply the applicable provisions to such tax years.