In brief
On February 25, 2026, Treasury and the IRS released Notice 2026-17 (“Notice”), which announced their intent to issue proposed regulations under Section 987. Consistent with the Trump Administration’s emphasis on reduction of regulatory burdens, the Notice indicated that the objectives of these new regulations are “to simplify the operation of the regulations under section 987, reduce compliance burdens, and refine the scope of certain rules under section 987 to limit their effect on ordinary course transactions.” As explained in more detail below, one of the main new rules in the Notice is largely a reversion to a Section 987 calculation approach first proposed by Treasury and the IRS in 1991 and that was commonly used by taxpayers given its simplicity.
Background
In 1986, Congress enacted Section 987 and the other provisions of Subpart J, which govern the taxation of foreign currency gains and losses. As enacted, Section 987 provides only limited guidance to taxpayers to determine foreign currency gain or loss with respect to branch transactions. Section 987(3) nebulously provides that taxpayers are to make “proper adjustments” prescribed by Treasury with respect to distributions from qualified business units (QBUs). Only after the passage of almost 40 years, Treasury and the IRS issued final guidance defining what is a “proper adjustment.” In the interim, Treasury and the IRS have issued several iterations of proposed regulations starting in 1991. Treasury and the IRS attempted to issue final regulations in 2016, but such finality was brief – the final regulations were subsequently delayed until similar regulations were eventually finalized in 2024. In addition to a significant delay in the guidance, Treasury and the IRS also revisited their entire conceptual approach to Section 987 guidance several times. As noted above, Treasury and the IRS proposed regulations in 1991 (“1991 Proposed Regulations”). The 1991 Proposed Regulations set forth a relatively simple approach to the Section 987 calculation that determined foreign currency fluctuations based on the earnings and capital of the QBU (the “earnings and capital approach”). Due to some concerns about potential abuse with the earnings and capital approach, in 2006, Treasury and the IRS withdrew the 1991 Proposed Regulations and issued new proposed regulations (“2006 Proposed Regulations”). The 2006 Proposed Regulations introduced a new approach that effectively focused on currency fluctuations only with respect to financial transactions (e.g., cash or notes) as opposed to all assets (e.g., machinery) (the “foreign exchange exposure pool approach” or “FEEP approach”). Treasury and the IRS believed that the FEEP approach was more precise than the earnings and capital approach, and the final regulations issued in 2024 (“2024 Final Regulations”) applied the FEEP approach. Commentators, however, repeatedly criticized the FEEP approach for its complexity compared to the earnings and capital approach. In the 2024 Final Regulations, Treasury and the IRS attempted to address some of the complexity concerns by offering an election whereby all items of the QBU are translated at the current spot rate or yearly average rate, instead of using a historic rate for certain items (the “current rate election”). If a taxpayer makes a current rate election, however, any Section 987 loss recognized during the year is generally suspended. Such suspended loss can then be recognized to the extent the owner of the QBU has Section 987 gain in the same taxable year or during a three-year lookback period and also in the same “grouping” (e.g., source and category) (the “loss-to-the-extent-of-gain rule”). Thus, although Treasury and the IRS attempted to alleviate some of the compliance burdens associated with the FEEP approach, commentators still requested that Treasury and the IRS consider switching back to the earnings and capital approach (and/or its variations, such as the earnings only approach).
Key Notice provisions
The Notice provides guidance in the following areas:
- Section 3
- Introducing an election to apply a Section 987 calculation approach “substantially similar” to the 1991 Proposed Regulations
- Section 4
- Narrowing the scope of the loss suspension rules
- Simplifying the “loss-to-the-extent-of-gain” rule
- Clarifying the definition of a “successor” for purposes of the deferral rules
- Expanding the definition of a Section 987 hedging transaction
- Section 5
- Proposing an election to generally exclude CFCs from the application of Section 987
We address some of the key Notice provisions below.
Election to apply “earnings and capital” approach
The centerpiece of the Notice is the announcement that the proposed regulations will include an election to apply the earnings and capital approach, with some modifications. One modification is a change to the “netting” approach of the 1991 Proposed Regulations. Section 987 gain or loss is generally triggered on a remittance of property from the QBU to the QBU’s owner. In contrast, a contribution of property by an owner to a QBU does not trigger Section 987 gain or loss. Given that a taxpayer may have multiple remittances and contributions between an owner and a QBU, the 1991 Proposed Regulations applied a daily netting approach, whereby all remittances and contributions are netted to a single net remittance or contribution on a daily basis. Treasury and the IRS abandoned the daily netting approach in the 2006 Proposed Regulations (as well as for later versions) and instead shifted to a more manageable annual netting approach. The Notice provides that the earnings and capital approach of the proposed regulations will similarly use an annual netting approach. In addition, taxpayers can only elect to use the earnings and capital approach if they have also made a current rate election.
Simplification of the “loss-to-the-extent-of-gain” rule
The Notice acknowledged that commentators had criticized the loss suspension rules generally and requested “additional flexibility to recognize section 987 losses.” In response to such comments, Treasury and the IRS are proposing to amend the applicable rules in several ways. First, under the Notice, the loss suspension rule would be subject to a de minimis exception whereby the rule would generally only apply if either the remittance proportion exceeds 5% or the total amount of loss that would be treated as a suspended loss exceeds USD 5 million. Second, the Notice would relax the “grouping” restriction such that all of an owner’s Section 987 gain or loss is generally treated as being in a single grouping for purposes of the “loss-to-the-extent-of-gain” rule, with some exceptions for a CFC owner.
Election to exclude CFCs from Section 987
The preamble to the 2024 Final Regulations indicated that Treasury and the IRS were considering amending the regulations to provide that CFCs generally will no longer be subject to Section 987(3). In the Notice, Treasury and the IRS announced that they will proceed with this proposed change in the “near future” and will therefore issue guidance on an election that taxpayers can make to largely exclude CFCs from the scope of Section 987. The Notice did not provide a timeframe but assured taxpayers that they will have sufficient time to determine whether to make the election for the 2025 taxable year on an originally filed return (with extension). Under transition rules, taxpayers making the election would recognize any unrecognized Section 987 gain over a period of 120 months after the election is made.
Applicability date
The Notice indicates the proposed regulations, when finalized, are expected to apply prospectively to taxable years ending on or after final regulations are published. For taxable years ending before the proposed regulations are published (and to which the 2024 Final Regulations apply), the Notice explicitly provides that a taxpayer may rely on Sections 3 (election to apply “earnings and capital” approach) and 4 (other changes to the 2024 Final Regulations) of the Notice if the taxpayer applies the rules in their entirety and consistently, but not Section 5 (election to exclude CFCs from Section 987). Treasury and the IRS, however, “expect” that taxpayers will similarly be permitted to rely on the rules in Section 5 in future guidance.
Conclusion
After 40 years, Treasury and IRS appear poised to issue final guidance that essentially returns to the straightforward approach of the 1991 Proposed Regulations, with an even further reduction in scope excluding CFCs from Section 987. With these and other changes, the Notice brings much-needed simplification to an arcane area of the tax law and welcome relief to taxpayers (and likely IRS auditors).