New prop. regs. limit taxpayers’ foreign currency elections

Editor: Susan M. Grais, CPA, J.D., LL.M.

In proposed regulations issued Aug. 19, 2024, under Secs. 954 and 988 (REG-111629-23, the 2024 proposed regulations), Treasury and the IRS partially withdrew and modified earlier proposed regulations from 2017 (the 2017 proposed regulations) to promote consistency with other filing requirements for controlled foreign corporations (CFCs) and limit taxpayers’ ability to make and revoke certain elections related to foreign currency gains or losses.

Background

On Dec. 19, 2017, Treasury and the IRS published the 2017 proposed regulations, which provided guidance on the Subpart F treatment and timing of foreign currency gain or loss attributable to Sec. 988 transactions of a CFC. Among other things, the 2017 proposed regulations contained Prop. Regs. Secs. 1.954-2(g)(3)(iii) and (g)(4)(iii), which permitted the controlling U.S. shareholders of a CFC to unilaterally and automatically revoke either election at any time by filing a revocation statement with the applicable original or amended income tax return.

The 2017 proposed regulations also provided a new election under Prop. Regs. Sec. 1.988-7, which permitted, subject to certain exceptions, all taxpayers (including CFCs) to use a mark-to-market method of accounting for foreign currency gains or losses arising from Sec. 988 transactions, including nonfunctional-currency-denominated debt issued by the taxpayer.

Under the 2017 proposed regulations, taxpayers, including CFCs, would generally be permitted to make a Prop. Regs. Sec. 1.988-7 election with the taxpayer’s timely filed return for the year in which the election was made. Taxpayers could revoke the election at any time by filing a revocation statement with the applicable original or amended income tax return of the taxpayer or of the controlling U.S. shareholder (in the case of a CFC).

The 2017 proposed regulations generally applied to tax years ending on or after the date of publication of final regulations in the Federal Register. A taxpayer, however, generally could have relied on the 2017 proposed regulations for tax years ending on or after Dec. 19, 2017, provided the taxpayer consistently applied the proposed amendment for all tax years that ended before the first tax year ending on or after the date the 2017 proposed regulations were published as final.

Key provisions of the 2024 proposed regulations

Amendments to the Prop. Regs. Sec. 1.988-7 election: Treasury and the IRS specifically noted that the rules for making and revoking a Prop. Regs. Sec. 1.988-7 election under the 2017 proposed regulations provided an excessive amount of flexibility to taxpayers. Therefore, the 2024 proposed regulations withdraw former Prop. Regs. Sec. 1.988-7(c) for tax years beginning after Aug. 19, 2024, and former Prop. Regs. Secs. 1.988-7(d) and (e) of the 2017 proposed regulations as of Aug. 19, 2024, and propose new amendments. In a significant change from the 2017 proposed regulations, the 2024 proposed regulations generally amend the timing for making a Prop. Regs. Sec. 1.988-7 election to accord with the time for making an election under Sec. 475(e) or (f) (which permits a dealer in commodities or a trader in securities or commodities to use the mark-to-market method of accounting).

Consequently, under new Prop. Regs. Sec. 1.988-7(c), an existing taxpayer would now make the Prop. Regs. Sec. 1.988-7 election by filing a statement that clearly indicates the election has been made with the taxpayer’s timely filed (excluding extensions) original federal income tax return for the tax year immediately preceding the year for which the election is made or with a request for an extension of time to file that return if applicable (e.g., by April 15, 2025, for a calendar-year taxpayer that is making the election for its 2025 tax year).

Under a slightly different timing rule, a new taxpayer would make the election by:

1. Placing a statement in the taxpayer’s books and records by no later than two months and 15 days after the first day of the year for which the election is made; and
2. Filing the statement with the taxpayer’s original federal income tax return for the tax year for which the election is made.

Similar to the rule for new taxpayers, in the case of a CFC under new Prop. Regs. Sec. 1.988-7(c)(3), the controlling U.S. shareholder would make the election on behalf of the CFC by:

1. Placing a statement in the CFC’s books and records by no later than two months and 15 days after the first day of the year of the CFC for which the election is made; and
2. Filing the statement with their original federal income tax returns for the tax year of the U.S. shareholders in which or with which the tax year of the CFC for which the election is made ends.

Under new Prop. Regs. Sec. 1.988-7(d), a taxpayer may only revoke the election with the IRS’s consent. In the preamble to the 2024 proposed regulations, the IRS indicated that when the 2024 proposed regulations are finalized, it expects 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 Prop. Regs. Sec. 1.988-7 will be granted.

Amendments to Regs. Sec. 1.954-2(g)(3)(ii) and Prop. Regs. Secs. 1.954-2(g)(3)(iii) and (g)(4)(iii): To address issues and questions raised by practitioners and to promote consistency with other filing requirements with respect to CFCs, the 2024 proposed regulations revise the language of current Regs. Sec. 1.954-2(g)(3)(ii) (which also controls the timing for a Regs. Sec. 1.954-2(g) (4) election). New Prop. Regs. Sec. 1.954-2(g) (3)(ii) would allow controlling U.S. shareholders to make a Regs. Sec. 1.954-2(g) election on behalf of a CFC by filing a statement with their timely filed, original federal income tax returns for the tax year of the U.S. 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.

Additionally, the 2024 proposed regulations withdraw former Prop. Regs. Secs. 1.954-2(g)(3)(iii) and (g)(4)(iii) of the 2017 proposed regulations for tax years ending after Aug. 19, 2024. New Prop. Regs. Secs. 1.954-2(g)(3)(iii) and (g)(4)(iii) provide that controlling U.S. shareholders may not revoke a Regs. Sec. 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.

Previously, under the 2017 proposed regulations, a taxpayer could revoke those elections at any time. Further, if a CFC’s controlling U.S. shareholders revoke a Regs. Sec. 1.954-2(g) election, new Prop. Regs. Secs. 1.954-2(g)(3)(iii) and (g)(4)(iii) would preclude them from making a new Regs. Sec. 1.954-2(g) election on behalf of the CFC until the sixth tax year following the year of revocation. The preamble to the 2024 proposed regulations states the change to the revocation procedures will limit taxpayers from opportunistically making or revoking a Regs. Sec. 1.954-2(g) election.

Applicability dates, reliance

The 2024 proposed regulations generally are proposed to apply to tax years ending on or after the date the final regulations are published in the Federal Register. Before the finalization of the 2024 proposed regulations, taxpayers may rely on new Prop. Regs. Secs. 1.988-7(c) and (d) in making and revoking a Prop. Regs. Sec. 1.988-7 election and new Prop. Regs. Sec. 1.954-2(g) (3)(ii) and reproposed Prop. Regs. Secs. 1.954-2(g)(3)(iii) and (g)(4)(iii) in making and revoking Regs. Sec. 1.954-2(g) elections, provided they are consistently applied to all tax years.

As a result of corrections issued by Treasury and the IRS on Sept. 3, 2024 (REG-111629-23, the corrections), taxpayers may make (but not revoke) the Prop. Regs. Sec. 1.988-7 election for tax years beginning on or before Aug. 19, 2024, under the procedures described in the 2017 proposed regulations. Thus, taxpayers generally may make that election for their 2023 and 2024 tax years on their timely filed (including extensions) original return for the 2023 and 2024 tax years. For tax years beginning after Aug. 19, 2024, taxpayers (including CFCs) must follow the procedures specified in the 2024 proposed regulations to make the mark-to-market election under Prop. Regs. Sec. 1.988-7.

Additionally, as a result of the corrections, the controlling U.S. shareholder(s) of a CFC may revoke the Regs. Sec. 1.954-2(g) elections for tax years beginning on or before Aug. 19, 2024, based on the procedures specified in Prop. Regs. Secs. 1.954-2(g) (3)(iii) and (g)(4)(iii) of the 2017 proposed regulations. For tax years beginning after Aug. 19, 2024, the controlling U.S. shareholder(s) of a CFC must follow the procedures specified in the 2024 proposed regulations to revoke the Regs. Sec. 1.954-2(g) elections.

Implications

The 2024 proposed regulations significantly modify the procedures for making or revoking the foreign currency mark-to-market election under Prop. Regs. Sec. 1.988-7. Additionally, the 2024 proposed regulations limit the ability to revoke an election under Regs. Sec. 1.954-2(g), while aligning those procedures with other elections made on behalf of calendar-year and fiscal-year CFCs. Taxpayers and controlling U.S. shareholders should carefully consider these new procedures and how the elections might affect their long-term U.S. federal income tax determinations.

Editor Notes

Susan M. Grais, CPA, J.D., LL.M., is a managing director at Ernst & Young LLP in Washington, D.C. For additional information about these items, contact Grais at susan.grais@ey.com. Contributors are members of or associated with Ernst & Young LLP.

The views expressed are those of the authors and are not necessarily those of Ernst & Young LLP or other members of the global EY organization. This information is provided solely for the purpose of enhancing knowledge on tax matters. It does not provide accounting, tax, or other professional advice.