Editor: Susan Minasian Grais, CPA, J.D., LL.M.
On Aug. 15, 2022, the IRS announced (Notice 2022-34) that it intends to defer by one more year the applicability date of certain foreign currency regulations under Sec. 987. The affected regulations will be amended to apply to tax years beginning after Dec. 7, 2023 (e.g., to 2024 for calendar-year taxpayers).
2016 final, temporary, and proposed regulations: On Dec. 8, 2016, Treasury and the IRS published final (T.D. 9794), temporary (T.D. 9795), and proposed (REG-128276-12) regulations under Sec. 987. The 2016 final regulations provide guidance to corporations and individuals on determining taxable income or loss of a qualified business unit (QBU) whose functional currency differs from that of its owner (a Sec. 987 QBU). They also provide guidance on the timing, amount, character, and source of any Sec. 987 gain or loss arising from such a QBU. The temporary regulations, some of which were finalized in T.D. 9857, provided rules for deferring Sec. 987 gain or loss in connection with certain Sec. 987 QBU terminations and transactions involving partnerships, as well as other related elections and special rules. The proposed regulations cross-referenced the temporary regulations.
The 2016 final regulations’ prescribed approach for computing taxable income or loss and Sec. 987 gain or loss of a Sec. 987 QBU differs entirely from that used by most taxpayers for more than 30 years. The regulations also impose substantial recordkeeping and compliance requirements.
2019 final regulations: In T.D. 9857, effective May 13, 2019, Treasury and the IRS finalized certain provisions of the 2016 temporary regulations. Specifically, Temp. Regs. Secs. 1.987-2T and -4T (on combinations and separations of Sec. 987 QBUs) and Temp. Regs. Sec. 1.987-12T (addressing recognition and deferral of Sec. 987 gain and loss upon certain Sec. 987 QBU terminations and certain other transactions involving partnerships) were finalized with certain clarifications. In addition, Treasury and the IRS withdrew Temp. Regs. Sec. 1.987-7T (regarding the allocation of assets and liabilities of certain partnerships for purposes of Sec. 987).
Previous deferrals of the applicability date: The 2016 final regulations originally applied to tax years beginning on or after one year after the first day of the first tax year beginning after Dec. 7, 2016 (e.g., to 2018 for calendar-year taxpayers). The applicability date of the 2016 final regulations, however, has been deferred every year since they were released.
Notice 2022-34 announces intended amendments to further delay the applicability date of the 2016 final regulations and certain related provisions of the 2019 final regulations by one additional year. Consequently, these regulations will now apply to tax years beginning after Dec. 7, 2023 (e.g., to 2024 for calendar-year taxpayers). The applicability date of Regs. Sec. 1.987-12 was not changed, so the deferral-event and outbound-loss-event rules of Regs. Sec. 1.987-12 generally apply to events occurring on or after Jan. 6, 2017.
Taxpayers may rely on the provisions of Notice 2022-34 before amendments to the final regulations are issued. Taxpayers may also choose to apply the 2016 final regulations, the related temporary regulations (until they were revoked on May 13, 2019, or expired on Dec. 6, 2019, as applicable), and the related 2019 final regulations (beginning on May 13, 2019) to tax years beginning after Dec. 7, 2016, and before Dec. 7, 2023, provided the taxpayer and its related parties consistently apply those regulations to those tax years.
Although the temporary regulations have expired, the notice indicates that taxpayers can rely on certain provisions of the proposed regulations, which cross-reference the temporary regulations, provided the taxpayer and its related parties consistently follow the proposed regulations in their entirety and apply the 2016 final regulations and the related 2019 final regulations for the same tax year. A taxpayer may rely on the annual deemed termination election provisions of the proposed regulations, provided that the taxpayer and its related parties consistently follow those proposed regulations in their entirety. Additionally, taxpayers may rely on Prop. Regs. Secs. 1.987-7 (Sec. 987 aggregate partnerships) and 1.988-2(b)(16) (deferral of loss on certain related-party debt instruments), provided that the taxpayer (and its related parties) consistently follow each section of those proposed regulations on which it relies.
The deferral was expected and is helpful because it gives taxpayers time to create and implement the complex systems and processes necessary to transition to the 2016 final regulations. Notice 2022-34 does not mention that the IRS is considering changes to these regulations to simplify the rules (although it has been mentioned in prior deferral notices).
Until the final regulations are effective, taxpayers must compute Sec. 987 gain or loss under a reasonable method and must also apply the deferral-event and outbound-loss-event rules of Regs. Sec. 1.987-12. Practitioners generally view a reasonable method as including (1) the methodology provided in the 1991 proposed regulations, (2) the “earnings only” methodology, or (3) early adoption of the 2016 final regulations. Such Sec. 987 gain or loss can affect taxable income or global intangible low-taxed income under Sec. 951A, each of which in turn may affect many other current income tax provisions.
Susan Minasian Grais, CPA, J.D., LL.M., is a managing director at Ernst & Young LLP in Washington, D.C. Contributors are members of or associated with Ernst & Young LLP. For additional information about these items, contact Ms. Grais at 202-327-8788 or email@example.com.