On Feb. 25, 2026, the Treasury and the IRS released Notice 2026-17 (The Notice) that announces the intention to release forthcoming regulations that relaxes some of the more strenuous rules that were provided by the 2024 final section 987 regulations (Final Regulations). Key takeaways are included below, and continue reading for a deeper dive into the impacts of the foreign currency rule simplifications.
Key takeaways
The Notice would allow in-scope taxpayers with a current rate election (CRE) in effect to further elect to use an equity and basis pool methodology that is “substantially similar” to that of the earnings and capital method from the 1991 withdrawn regulations for taxable years beginning on or after the transition date, which is the first day of the first taxable year beginning after Dec. 31, 2024 (e.g., Jan. 1, 2025, for calendar year taxpayers).
Applicable taxpayers that are using the earnings and capital method, which is an eligible pretransition method under the Final Regulations, and intend to elect the equity and basis pool method post-transition must still compute pretransition gain or loss as of the transition date.
For taxable years beginning on or after the transition date (e.g., taxable years beginning Jan. 1, 2025, for calendar year taxpayers), the Notice also lessens the severity of the section 987 loss suspension rules by potentially allowing for the recognition of section 987 losses when a remittance meets the new qualified business unit (QBU)-by-QBU de minimis test and simplifies the loss-to-the-extent-of-gain rule by treating most recognition groupings of a QBU owner as a single recognition grouping.
The Notice gives clarification on the term “successor” for purposes of the deferral rules and modifies and allows for greater flexibility in the treatment of “section 987 hedging transactions” by expanding the definition that may include hedging transactions that do not qualify as such for generally accepted accounting principles (GAAP) purposes. Both rules would generally apply to taxable years beginning on or after the transition date (e.g., taxable years beginning Jan. 1, 2025, for calendar year taxpayers) with some exceptions.
Future regulations may allow for an election that, if made, would eliminate the requirement for controlled foreign corporations (CFCs) that own section 987 QBUs to compute and recognize foreign currency gain or loss. Additional guidance is expected soon in order to allow applicable taxpayers to make such an election on their 2025 tax returns and it is expected that taxpayers will be able to rely on the proposed regulations.
The information provided here is of a general nature and is not intended to address the specific circumstances of any individual or entity. In specific circumstances, the services of a professional should be sought. Tax information, if any, contained in this communication was not intended or written to be used by any person for the purpose of avoiding penalties, nor should such information be construed as an opinion upon which any person may rely. The intended recipients of this communication and any attachments are not subject to any limitation on the disclosure of the tax treatment or tax structure of any transaction or matter that is the subject of this communication and any attachments.
Overview
The changes discussed in the Notice are as follows:
In-scope taxpayers can elect to use an equity and basis pool method of calculating unrecognized section 987 gain or loss, a method that is “substantially similar” to that of earnings and capital method specified in the 1991 withdrawn regulations but with certain modifications.
Additional relief is provided in easing the loss suspension and loss-to-the-extent of gain rules that may allow in-scope taxpayers a greater probability in recognizing section 987 losses.
The definition of a “section 987 hedging transaction” is expanded to include certain hedging transactions that may not qualify as hedging transactions under GAAP.
The definition of a “successor deferral QBU” has been relaxed in the application of the deferral rules for in-scope taxpayers.
Additional guidance in the form of proposed regulations is expected that would provide for an election that would, in some cases, relieve CFCs from computing or recognizing foreign currency gain or loss under section 987(3).
Equity and basis pool method
As a refresh, the Final Regulations generally require in-scope taxpayers to use the more daunting foreign exchange exposure pool (FEEP) method to calculate unrecognized section 987 gains and losses for taxable years beginning on or after the transition date. The Final Regulations provide certain simplifications (i.e., the CRE, the annual recognition election (ARE), the alternative method of calculating QBU net value under a CRE, etc.) previously not offered in earlier iterations of section 987 regulation packages that allow for greater flexibility in applying the FEEP method. In order for in-scope taxpayers to transition to their chosen FEEP-based approach, these taxpayers must calculate section 987 pretransition gain or loss for each QBU either by using their existing method, if it’s an eligible pretransition method (for which the earnings and capital method qualifies), or a modified FEEP method.
The Notice proposes another election that would allow taxpayers to use an equity and basis pool method of calculating section 987 gain or loss that it refers to as “substantially similar” to that of the earnings and capital method but only in taxable years the CRE is in effect. This election will substitute the alternative calculation of QBU net value under the Final Regulations. While the two aforementioned methods are similar in the calculation and maintenance of equity and basis pools, the two methods diverge in a few ways, but most notably is the calculation of a remittance. While the earnings and capital method required daily netting of transfers between a section 987 QBU and its owner to determine a remittance, the equity and basis pool method aggregates all amounts transferred between the QBU and its owner for the taxable year (annual netting). While daily netting is no longer required for purposes of determining a remittance, in the absence of a recurring transfer group election, which would allow certain transfers related to the sale of inventory, payments for services, rents and royalties to be translated at the yearly average annual rate under the 2024 proposed regulations, transfers to and from a section 987 QBU are generally translated at the spot rate on the date of transfer for purposes of establishing pools under the equity and basis pool method.
The election to use the equity and basis pool method can be made in conjunction with other “section 987 elections” (i.e., the CRE (required election when electing the equity and basis pool method), the ARE and the section 988 mark-to-market election). While the equity and basis pool election can be made on a timely filed original tax return (including extensions) without the Commissioner’s consent, other section 987 elections, such as the CRE, generally require the Commissioner’s consent with limited exceptions, such as elections lodged before the first day of the first taxable year the election takes effect, or lodged on a timely filed tax return (including extensions) for the first taxable year in which the Final Regulations apply. Section 987 elections are subject to consistency requirements, and, once made, may only be revocable with the Commissioner’s consent or, as is the case with the CRE, the ARE and the section 988 mark-to-market election, may only be revocable after a 60-month period without the Commissioner’s consent.
S corporations and partnerships generally fall outside the scope of the Final Regulations as do the changes provided by the Notice, including the election to use the equity and basis pool method. These entities must use a reasonable method consistent with statute and using a method consistent with the rules of the Notice will be considered as a reasonable method of applying section 987.
Baker Tilly takeaways
It is important to note that while the Notice provides an election to use a method similar to the earnings and capital method, it does not belay the necessary exercise of calculating pretransition gain or loss as of the day before the transition date. In other words, in-scope taxpayers that had previously utilized the earnings and capital method and intend to elect to use the equity and basis pool method (and by necessity, the CRE), must still calculate section 987 pretransition gain or loss.
While the calculation between the earnings and capital, and the equity and basis pool methods are similar, the latter method will still require incremental work for electing taxpayers. In addition to the differences in how remittances are calculated under each method (as described above), the adjustments to the pools under the equity and basis pool method are slightly modified in comparison to the predecessor method (e.g., adjustments for tax-exempt income items, non-deductible expense items, and, with respect to the basis pool alone, certain previously recognized section 987 gains and losses). Further, electing the new method will compel in-scope taxpayers to refresh opening balances in the equity and basis pools, an exercise that will require tax basis balance sheets as of the day before the transition date, including an adjustment to the basis pool for net accumulated unrecognized section 987 gain or loss calculated as of the transition date (i.e., the balances from the earnings and capital method do not simply rollover). The Notice also appears to provide taxpayers an option of recasting opening balances as of the transition date by rebuilding the pools under the new method from a QBU’s inception (in contrast with a limited lookback period in the case of taxpayers not having an eligible pretransition method and using a modified FEEP approach to the build) for which additional guidance might be provided in forthcoming proposed regulations.
Additional considerations and calls to action with regards to the equity and basis pool election:
In-scope taxpayers need to carefully consider the impact of making the equity and basis pool election as well as other “section 987 elections.” For elections to be valid for taxable years beginning on or after Jan. 1, 2025, to which the Final Regulations first apply, these elections (including the CRE that is prerequisite to the equity and basis pool election) need to be made on timely filed original tax returns (including extensions). Applicable taxpayers, especially those considering the equity and basis pool election, should consider extending tax returns for taxable years for which those regulations first apply to allow time for the Treasury and the IRS to issue further guidance and to adequately model and analyze the effects of making any section 987 elections. For early filers who cannot (prefer not) wait, extending tax returns might allow for the possibility of later filing superseding tax returns through which section 987 elections considered timely filed in obviating need for later Commissioner consent should they subsequently come to a different, but more fully informed, decision as to the making of any such elections.
A calendar year taxpayer that misses their window to elect the CRE for 2025 may not be able to make the CRE (and, therefore, the equity and basis pool election) in the absence of the Commissioner’s consent (through ruling process) until 2027, which may lend itself to further complexities such as applying a FEEP-based methodology.
Taxpayers may also need time to assess the application of the various consistency requirements as they relate to the various elections, especially those with complex controlled group structures, which could potentially prohibit certain authorized persons from making the preferred elections.
Loss suspension and loss-to-the-extent-of-gain rules
The Final Regulations substantially curbed the recognition of section 987 losses by suspending losses for in-scope taxpayers that make a CRE (the CRE loss suspension rule) and for partnerships and S corporations with eligible QBUs (the partnership loss suspension rule) subject to certain exceptions. Losses that are suspended are generally recognized in a future taxable year in which there is a section 987 gain in the same recognition grouping, or rather the same section 904 limitation category. With respect to CFCs that are owners of section 987 QBUs, the recognition groupings are further divided into separate subcategories for tentative tested income, each separate subpart F income group, income effectively connected with a U.S. trade or business (effectively connected income, or ECI) and other income.
The Notice provides for some leniency in the above loss suspension rules, particularly in providing for a QBU-by-QBU level de minimis exception, which specifies that the CRE loss suspension and the partnership loss suspension rules will only apply in a taxable year in which either:
The remittance proportion with respect to a section 987 QBU (or successor deferral QBU) exceeds 5%, or
The suspended loss (absent this modification) with respect to a section 987 QBU (or successor deferral QBU) exceeds $5 million.
If a termination event occurs in which there is a “successor deferral QBU,” the recognition of section 987 gain or loss (and in the case of loss, potential suspension) is deferred if certain requirements are met such as a significant portion of the assets of the terminating QBU being reflected on the successor deferral QBU’s books. The Notice clarifies the “significant portion” qualifier to, while still being a facts and circumstances-based test, include transferee QBUs as successor deferral QBUs if greater than 30% of a transferor QBU’s assets are reflected on its books after the transferor QBU terminates. If less than 10% of a transferor QBU’s assets are reflected on the books and records of the transferee QBU, the transferee cannot be treated as a successor deferral QBU.
Baker Tilly takeaways
While the changes made by the Notice with respect to “successor deferral QBUs” generally can be relied on (and applied) to taxable years to which the Final Regulations apply (i.e., taxable years beginning on or after the transition date, or rather, taxable years beginning on or after Jan. 1, 2025), it’s worth noting that the Final Regulations accelerated the transition date for section 987 QBUs that terminated on or after Nov. 9, 2023, but before the date the Final Regulations take effect. This may provide relief for taxpayers that recognized section 987 gain or loss resulting from terminating QBUs that accelerated the application of the Final Regulations should they wish to amend previously filed tax returns (e.g., calendar years 2023 and 2024).
The Notice modifies the loss-to-the-extent-of-gain rule so that all section 987 gains and losses of a non-CFC QBU owner are treated as being in a single recognition grouping. This may allow such QBU owner with a suspended loss in the foreign branch category to offset a section 987 gain in, for example, the passive category. With regards to section 987 QBUs whose owners are CFCs, the subpart F income group is collapsed into a single recognition grouping rather than requiring separate subcategories for each type of subpart F. However, the single subpart F, tentative tested income, ECI and other income recognition groupings will not be treated as a single recognition grouping for purposes of the loss-to-the-extent-of-gain rule.
Baker Tilly takeaways
Taxpayers with pretransition losses (in the case of taxpayers not electing the amortization election or the CRE as of the transition date) that are treated as suspended under the Final Regulations may benefit from the relaxation of the loss-to-the-extent-of-gain rule.
For financial reporting purposes, in-scope taxpayers that may have deferred income taxes (and potentially, valuation allowances) recorded with respect to their section 987 methodology (including potential deferred tax assets recorded resulting from suspended losses if not permanently reinvested assuming application of the indefinite reversal assertion to a foreign QBU) should determine if they will rely on the Notice and adjust any deferred taxes with respect to the changes herein in the period for which there is the enacted law change (e.g., Q1 2026 for calendar year financial statement filers). Similarly, there might be need for true-up of current tax expense/(benefit) attributable to gain or loss recognition on remittances recorded in a prior period (e.g., 2025 for calendar year financial statement filers) as discreet item in the period of enactment (e.g., Q1 2026). Furthermore, consideration might be given to the potential need for subsequent event disclosure for 2025 calendar year financials issued after the Feb. 25, 2026 issuance of the Notice for financial statement filers that expect the new guidance to have a material impact on their financials.
Section 987 hedging transactions
Per the Final Regulations, taxpayers are allowed to adjust unrecognized section 987 gain or loss by the amount of the owner’s hedging gain or loss attributable to a section 987 hedging transaction. A section 987 hedging transaction must be identified and meet the GAAP hedging requirement.
The Notice may allow for certain hedging transactions to be treated as section 987 hedging transactions even if the GAAP hedging requirement is not met provided certain other requirements are met. Generally, the primary purpose of the hedge must be to manage foreign currency exchange risk of an interest in a section 987 QBU if that interest were treated as either equity or debt if the QBU were regarded.
Section 987 hedges are subject to an identification requirement. The Notice provides that hedges meeting the more relaxed requirements entered into before Apr. 26, 2026, will be treated as timely identified if the owner identifies the hedge before Apr. 26, 2026, and identifies substantially all hedges with respect to the QBU as section 987 hedging transactions. Taxpayers should take care in identifying and documenting section 987 hedging transactions to meet the identification requirement.
Proposed CFC election
The Final Regulations make clear that section 987 does apply with respect to section 987 QBUs held or operated by CFCs, requiring CFCs to calculate and recognize foreign currency gain or loss with respect to any section 987 QBUs owned.
In response to comments on the Final Regulations, the Notice announces the intention to issue proposed regulations to be released that would allow for a CFC election under section 987. If made, the CFC would not have to recognize foreign currency gain or loss related to section 987 QBUs, absent certain inbound transactions. The election would be revocable only with the Commissioner’s consent and must be made consistently across all CFCs controlled by either the taxpayer or its related parties. Note that the rules under section 987 that relate to calculating taxable income and earnings and profits of the CFC do still apply (i.e., sections 987(1) and (2)). Any unrecognized section 987 gains or losses attributable to years before the CFC election is made are expected to be recognized pro rata over a 120-month period that begins with the first month of the taxable year the election is made.
Baker Tilly takeaways
Incremental future guidance on this proposed CFC election is still expected, which further emphasizes the need for impacted taxpayers (those taxpayers with CFCs with section 987 QBUs) to consider extending their tax returns for the first taxable year beginning on or after the transition date (e.g., taxable years beginning Jan. 1, 2025, for calendar year taxpayers) to which the Final Regulations first apply in order that a proper analysis be completed and to ensure this and other section 987 elections desired are included on original timely filed tax returns (including extensions) so as to obviate any potential need for later Commissioner consent.
Applicability and reliance
Most of the changes discussed herein can be relied upon and can be applied for taxable years beginning on or after the transition date, which is the first day of the first taxable year beginning after Dec. 31, 2024, (e.g., taxable years beginning on or after Jan. 1, 2025) to which the Final Regulations first apply if all members of a section 987 electing group apply the rules consistently for each taxable year.
While proposed regulations are promised that would permit a CFC election to be made for taxable years beginning after Dec. 31, 2024, the Notice does state that it is expected that taxpayers can rely on the future guidance once first published in the Federal Register.
The Treasury and the IRS request comments on the Notice to be submitted by Apr. 26, 2026.
If you have questions about how the simplifications of foreign currency gain or loss rules may impact your tax situation, please contact your Baker Tilly tax advisor.
