Preparing for Section 987: What U.S. Companies Need to Do Now

By John M. Kelleher, CPA-Dallas

After multiple attempts at issuing regulations only to have them withdrawn or delayed, it appears Treasury and the IRS have finalized the long-awaited Section 987 regulations governing foreign currency gain and loss for qualified business units (QBUs). Unless delayed, the regulations will be applicable for tax years beginning after Dec. 31, 2024. Companies will need to take action in order to comply with the regulations and consider the impact in their Dec. 31, 2025, income tax provision. Below is a simplified step plan for preparing to adopt the new rules.

A Long-delayed Rule Set Now Becomes Effective

Section 987 has been on the books since 1986, but operational rules have been repeatedly deferred. Earlier regulations issued in 2016, accompanied by a series of notices, were postponed so consistently that companies effectively never had to adopt them. The 2024 final regulations now replace that framework and are intended to be the operative rules going forward.

While some simplifications were included and certain partnership rules were delayed, most taxpayers with foreign-currency QBUs will face real compliance requirements for the first time. It should also be noted that Treasury has not finalized the application of these regulations to partnerships (generally aggregate vs. entity treatment) and instructed partnerships to choose a reasonable method consistent with the statute.

Identify Your Section 987 QBUs

The starting point is determining which operations are actually QBUs. A QBU generally exists where a branch, division or similar operation:

• Carries on a trade or business; and
• Maintains its own books and records in a functional currency different from its owner.

This includes traditional foreign branches, certain disregarded entities and other business units with their own local books. These rules also apply to branches of controlled foreign corporations.

Determine If Your Historical Method is a Qualified (Eligible) Pretransition Method

One of the most consequential decisions for transition relates to whether the QBU s existing Section 987 method qualifies as an eligible pretransition method. The final regulations provide flexibility here: a method does not need to have been perfectly applied to qualify, so long as it was reasonable, consistently used and reflected on at least one filed U.S. return.

Examples that may qualify include:

• The 1991 proposed earnings-and-capital method;
• Reasonably applied earnings-only methods; and
• Certain balance-sheet-based or hybrid approaches.

Determining eligibility is important because it affects how pretransition gain or loss is computed. QBUs with no qualified method face a more burdensome transition calculation. In addition, companies that have audited financial statements may wish to confer with their attest firms as to whether or not their method can be considered qualified.

Perform Transition Calculations

For most companies, the transition date will be the first day of the 2025 tax year. On that date, each QBU must compute its pretransition Section 987 gain or loss. Conceptually, this approximates what would happen if the QBU liquidated into its owner on the day before transition. The result is the unrecognized pretransition gain or loss. There is additional guidance on how and when this will be recognized.

Understand How the New Rules Work

The final regulations largely adopt the foreign exchange exposure pool (FEEP) method, which focuses on tracking the QBU s balance-sheet items in local currency and recognizing foreign currency gain or loss when amounts are  remitted  to the owner. The rules also introduce two important simplification elections:

• Current-rate election, which treats nearly all QBU items as marked annually at the year-end spot rate; and
• Annual-recognition election, which recognizes all 987 gain or loss every year rather than only upon remittances.

While optional, these elections can substantially change the compliance and volatility profile of the regime.

Model and Choose Elections Strategically

Choosing between the general FEEP rules, the current-rate election and the annual-recognition election requires modeling. Trade-offs include complexity, volatility, tax cash-flow timing, and interaction with other international tax rules such as GILTI, subpart F and foreign tax credit limitations. Many companies will run  side-by-side  models to evaluate both transition-year long-term effects.

Document Decisions 

With a history of regulatory delays and ongoing IRS interest in foreign-currency matters, thorough documentation is essential. Companies should:

• Identify all QBUs;
• Determine pretransition method eligibility;
• Prepare transition calculations;
• Determine which of the available elections should be made; and
• Document any related assumptions and judgments.

Conclusion

The final Section 987 regulations mark the end of a long period of uncertainty. For the first time, most taxpayers must fully adopt a comprehensive foreign-currency regime for their QBUs. With thoughtful planning   identifying QBUs, assessing historical methods, running transition calculations, upgrading systems, and selecting appropriate elections   companies can navigate the transition smoothly and reduce the risk of surprises.

See "Elections under the new Sec. 987 final regs" from The Tax Adviser