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Highlights of the proposed regulations on elections relating to foreign currency gains and losses
August 2024
Updated September 10, 2024
In brief
What happened?
Treasury and the IRS on August 19 issued proposed regulations (the 2024 proposed regulations) that modify the procedures for making and revoking certain elections relating to foreign currency gain or loss that were provided for in the proposed regulations issued in 2017 (2017 proposed regulations). The new proposed regulations change the ability to elect and revoke elections under Reg. 1.954-2(g)(3), Reg. 1.954-2(g)(4), and Prop. Reg. 1.988-7 (the FX Elections) that are (or previously had been) made or revoked with a timely filed tax return. They also partially withdrew certain provisions in the 2017 proposed regulations regarding the same.
The 2024 proposed regulations generally apply to tax years ending on or after the date the final regulations are published in the Federal Register. The 2024 proposed regulations were published in the Federal Register on August 20, 2024. Comments are due October 21, 2024.
Why is it relevant?
The 2024 proposed regulations impact taxpayers revoking the Prop. Reg. 1.988-7 election for tax years for which returns have not yet been filed (i.e., 2023 and 2024) and taxpayers revoking either the Reg. 1.954-2(g)(3) or Reg. 1.954-2(g)(4) elections for 2024.
As originally drafted, as of August 19, 2024, taxpayers could no longer rely on the 2017 proposed regulations to make or revoke the Prop. Reg. 1.988-7 election by attaching it to the tax return for the year to which the election relates. The 2024 proposed regulations require the election to be made by the unextended due date for the immediately prior tax year (for example, March 15, 2024 for certain calendar-year taxpayers). However, Treasury and the IRS have since issued corrections modifying the reliance language in the 2024 proposed regulations so that taxpayers may rely on the 2017 proposed regulations election procedures for making the Prop. Reg. 1.988-7 election in their 2023 or 2024 filings and revoking the Reg. 1.954-2(g)(3) or Reg. 1.954-2(g)(4) elections with their 2023 tax return.
Actions to consider
Companies should consider whether to submit comments on the new proposed regulations. Comments are due October 21, 2024. Companies also should determine how the applicability dates of the proposed regulations may impact upcoming compliance responsibilities.
Background
Subpart F foreign currency elections and revocations
Foreign personal holding company income (FPHCI) includes the excess of foreign currency gains over foreign currency losses attributable to any Section 988 transactions. Under Reg. 1.954-2(g)(3) and (4), two different elections are available to United States shareholders (US shareholders) that are controlling US shareholders (controlling US shareholders) of a controlled foreign corporation (CFC) with respect to the CFC’s computation of its FPHCI.
First, controlling US shareholders may elect to exclude foreign currency gain or loss otherwise includible in the CFC’s FPHCI computation and instead include such foreign currency gain or loss in the category (or categories) of subpart F income to which such gain or loss relates (the Reg. 1.954-2(g)(3) election).
Second, controlling US shareholders may elect to treat as FPHCI all foreign currency gains or losses attributable to any Section 988 transaction (except those described in Reg. 1.954-2(g)(5) relating to capital gains and losses, income not subject to Section 988, or qualified business units using the dollar approximate separate transactions method) and any Section 1256 contract that would be a Section 988 transaction but for the Section 988(c)(1)(D) exception for certain instruments marked to market (the Reg. 1.954-2(g)(4) election) (together with the Reg. 1.954-2(g)(3) election, the Reg. 1.954-2(g) elections).
Controlling US shareholders make either of the Reg. 1.954-2(g) elections on behalf of the CFC by filing a statement with their original income tax return for the tax year of the US shareholders ending with or within the tax year of the CFC for which the election is made, clearly indicating that the election has been made. A CFC’s controlling US shareholders may revoke a Reg. 1.954-2(g) election by or with the consent of the Commissioner.
As part of the 2017 proposed regulations, a CFC’s controlling US shareholders were permitted to revoke the CFC’s Reg. 1.954-2(g) election at any time. The 2017 proposed regulations provided that if the election is revoked, a new election could not be made until the sixth tax year following the year in which the previous election was revoked, and the subsequent election could not be revoked until the sixth tax year following the year in which the subsequent election was made. A CFC’s controlling US shareholders would revoke Reg. 1.954-2(g) elections on behalf of the CFC under the 2017 proposed regulations by filing a statement that clearly indicated that the election had been revoked with their original or amended income tax returns for “the taxable year of [the US shareholders] ending with or within the taxable year of the [CFC] for which the election is revoked.”
Prop. Reg. 1.988-7 election and revocation
The 2017 proposed regulations also provided that a taxpayer, including a CFC, was permitted to elect to use a mark-to-market method of accounting for Section 988 gain or loss with respect to certain Section 988 transactions (the Prop. Reg. 1.988-7 election). Under the 2017 proposed regulations, a taxpayer would make a Prop. Reg. 1.988-7 election by filing a statement that clearly indicated that the election has been made with its timely filed original Federal income tax return for the tax year for which the election is made. In the case of a CFC, the controlling US shareholders would make the Prop. Reg. 1.988-7 election on behalf of the CFC by filing a statement that clearly indicated that the election has been made with their timely filed, original Federal income tax returns for the “taxable year of [the US shareholders] ending with or within the taxable year of the [CFC] for which the election is made.”
Under the 2017 proposed regulations, a taxpayer, including a CFC, was permitted to revoke its Prop. Reg. 1.988-7 election at any time. However, if the election was revoked, a new election could not be made until the sixth tax year following the year in which the previous election was revoked, and a subsequent election could not be revoked until the sixth tax year following the year in which the subsequent election was made.
Proposed rules
Subpart F foreign currency elections and revocations
The 2024 proposed regulations provide that controlling US shareholders make a Reg. 1.954-2(g) election on behalf of a CFC by filing a statement with their original income tax returns for the tax years of the controlling US shareholders in which or with which the tax year of the CFC for which the election is made ends, clearly indicating that the election has been made.
The 2024 proposed regulations also withdraw Prop. Reg. 1.954-2(g)(3)(iii) and (g)(4)(iii) in the 2017 proposed regulations and re-propose them to provide that controlling US shareholders revoke a Reg. 1.954-2(g) election on behalf of a CFC by filing a statement with their original income tax returns for the tax years of the controlling US shareholders in which or with which the tax year of the CFC for which the revocation is made ends, clearly indicating that the Reg. 1.954-2(g) election has been revoked. Under the newly proposed rules, controlling US shareholders would be precluded from revoking a Reg. 1.954-2(g) election made on behalf of a CFC (including an initial election) until the sixth tax year following the year in which the election was made. Also, if a CFC’s controlling US shareholders revoke a Reg. 1.954-2(g) election, they may not make a new Reg. 1.954-2(g) election on behalf of the CFC until the sixth tax year following the year in which the previous election was revoked.
Observation: Per the preamble to the 2024 proposed regulations, the change from filing the statement to make or revoke such elections “with or within the tax year of the CFC” to “in which or with which the tax year of the CFC ends” was to address inconsistencies in the treatment that can arise between a controlling US shareholder that owns a CFC with a matching tax year and a controlling US shareholder that owns a CFC with a short year or whose tax year differs from the controlling US shareholder’s tax year. Specifically, with respect to CFCs with short years, a controlling US shareholder would be prevented from making Reg. 1.954-2(g) elections for those years if no year of the controlling US shareholder ends with or within the CFC’s short year.
Observation: Treasury notes that the change to the revocation rules under Prop. Reg. 1.954-2(g)(3)(iii) and (g)(4)(iii) is intended to limit taxpayers from “opportunistically making or revoking a Reg. 1.954-2(g) election.” Treasury and the IRS have requested comments on this aspect of proposed regulations.
The 2024 proposed regulations generally apply to tax years ending on or after the date the final regulations are published in the Federal Register. For making and revoking Reg. 1.954-2(g) elections for tax years ending before the date the final regulations are published in the Federal Register, taxpayers may rely on the 2024 proposed regulations, provided that they consistently apply the 2024 proposed regulations to such tax years. Taxpayers may no longer rely on the revocation rules for the Reg. 1.954-2(g) elections in the 2017 proposed regulations for tax years ending after August 19, 2024.
Observation: Starting with tax years ending after August 19, 2024, taxpayers that previously made an initial Reg. 1.954-2(g) election may no longer revoke such election at any time and must remain on the election for five years until such election can be revoked.
Prop. Reg. 1.988-7 election and revocation
The 2024 proposed regulations are intended to align the time for making or revoking a Prop. Reg. 1.988-7 election with the time for making or revoking an election permitting a dealer in commodities or a trader in securities or commodities to use the mark-to-market method of accounting as provided under Section 475(e) or (f) (a Section 475 election). As proposed, US taxpayers make the Prop. Reg. 1.988-7 election by filing a statement that clearly indicates the election is being made by the unextended due date of the immediately prior year’s return. For CFCs, the controlling US shareholders make the election on behalf of the CFC by placing a statement in the CFC’s books and records no later than two months and 15 days after the first day of the year for which the election is being made and filing a statement indicating such election is being made with their original income tax returns for the tax year of the controlling US shareholders in which or with which the tax year of the CFC ends.
Under the 2024 proposed regulations, an election made pursuant to Prop. Reg. 1.988-7(c) would be effective for the tax year for which it is made and all subsequent years until a taxpayer obtains IRS consent to revoke such election.
Observation: For tax years beginning after August 19, 2024, taxpayers may no longer make such election on a retroactive basis (i.e., after the end of the tax year). Further, the preamble notes that Treasury and the IRS will require taxpayers to file a change in method of accounting to adopt mark-to-market accounting under Prop. Reg. 1.988-7. When the 2024 proposed regulations are finalized, Treasury and the IRS expect to issue a revenue procedure setting forth the terms and conditions under which a change of method of accounting with respect to the mark-to-market method under Reg. 1.988-7 will be granted (e.g., whether this change should be subject to a cutoff method or another method requiring a Section 481(a) adjustment).
Observation: The 2024 proposed regulations do not provide guidance on how a taxpayer effects either an election on to the Prop. Reg. 1.988-7 mark-to-market method or a revocation of the election. Prior to the issuance of the revenue procedure mentioned in the preamble, taxpayers are required to obtain IRS consent.
Treasury and the IRS are requesting comments regarding all aspects of the rules for making and revoking the Prop. Reg. 1.988-7 election, including the terms and conditions under which a change of method of accounting with respect to the mark to-market method under Reg. 1.988-7 will be granted and whether to require that related parties apply a Prop. Reg. 1.988-7 election in a consistent manner.
The 2024 proposed regulations generally apply to tax years ending on or after the date the final regulations are published in the Federal Register. For making and revoking the Prop. Reg. 1.988-7 election for tax years ending before the date the final regulations are published in the Federal Register, taxpayers may rely on the 2024 proposed regulations, provided that they consistently apply the 2024 proposed regulations to such tax years. For tax years beginning on or before August 19, 2024, taxpayers may still rely on the 2017 proposed regulations election procedures for making the Prop. Reg. 1.988-7 election.
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