On February 25, 2026, the IRS and the Treasury Department issued Notice 2026-17 (the Notice) announcing their intent to issue proposed regulations (forthcoming proposed regulations) that would: (i) simplify the operation of the IRC Section 987 regulations (see Tax Alert 2024-2298), (ii) reduce compliance burdens, and (iii) refine the scope of certain rules to limit their effect on ordinary course of business transactions.

Background

Under IRC Section 987(1) and (2), taxpayers must determine taxable income or loss for an IRC Section 987 QBU in the functional currency of the QBU and translate that amount at the average exchange rate for the tax year. Under IRC Section 987(3), taxpayers must make "proper adjustments" for transfers of property between an IRC Section 987 QBU and its owner. Several regulations under IRC Section 987 have been issued and withdrawn since the IRS and the Treasury Department published proposed regulations in 1991.¹

On December 11, 2024, the IRS and Treasury Department published final regulations (TD 10016) under IRC Section 987 (the Final Regulations) on determining the taxable income or loss and currency gain or loss for a qualified business unit (a QBU) whose functional currency differs from its tax owner (an IRC Section 987 QBU). The Final Regulations generally apply to individuals, domestic corporations, and foreign corporations that are controlled foreign corporations (CFCs). The Final Regulations generally do not apply to partnerships and S corporations; however, certain provisions (including the loss suspension rules) apply to those entities. The Final Regulations generally apply to tax years beginning after December 31, 2024.

The Final Regulations generally require taxpayers to use the foreign exchange exposure pool (FEEP) method to determine IRC Section 987 gain or loss and IRC Section 987 taxable income or loss for an IRC Section 987 QBU. The Final Regulations also provide various elections intended to simplify those computations, including the current rate election and the annual recognition election. The current rate election treats all items of an IRC Section 987 QBU as marked items, subject to loss suspension rules. The annual recognition election generally requires recognition of IRC Section 987 gain or loss on an annual basis.

Concurrently with the publication of the Final Regulations, the IRS and the Treasury Department also published proposed regulations (REG-117213-24) (the Proposed Regulations) addressing the treatment of frequently recurring disregarded transactions.

Key provisions of the Notice

Section 3: Proposed election to use the equity and basis pool method

Section 3 of the Notice allows taxpayers to make an election to use the equity and basis pool method for determining IRC Section 987 taxable income or loss and IRC Section 987 gain or loss for any tax year for which a current rate election is in effect.

If an election to use the equity and basis pool method is in effect, taxpayers would determine IRC Section 987 taxable income or loss, net unrecognized IRC Section 987 gain or loss, and recognized IRC Section 987 gain or loss for an IRC Section 987 QBU as follows:

IRC Section 987 taxable income or loss — In general, taxpayers would determine IRC Section 987 taxable income or loss by computing each item of income, gain, deduction or loss attributable to the IRC Section 987 QBU in its functional currency and then translating the net taxable income or loss into the owner's functional currency at the yearly average exchange rate.

Net unrecognized IRC Section 987 gain or loss — In general, net unrecognized IRC Section 987 gain or loss would equal the equity pool (as determined in the IRC Section 987 QBU's functional currency) on the last day of the tax year translated into the owner's functional currency at the spot rate on the last day of the tax year (or termination date, if applicable) minus the basis pool (as determined in the owner's functional currency) on the last day of the tax year (or termination date, if applicable). Additional adjustments may be required for IRC Section 987 hedging transactions.

Recognized IRC Section 987 gain or loss — Subject to the rules of Treas. Reg. Sections 1.987-11 through 1.987-13, the IRC Section 987 gain or loss recognized for a tax year equals the owner's net unrecognized IRC Section 987 gain or loss multiplied by the "remittance proportion." The remittance proportion generally equals the amount of the remittance divided by the sum of (i) the equity pool on the last day of the tax year, (ii) the aggregate amount of the IRC Section 987 QBU's liabilities on the last day of the tax year (expressed as a positive number), and (iii) the amount of the remittance, each determined in the IRC Section 987 QBU's functional currency. If a taxpayer makes an annual recognition election, the remittance proportion is one.

Importantly, all other rules of the Final Regulations (and the Proposed Regulations to the extent relied upon) generally apply while an equity and basis pool method election is in effect.

The equity and basis pool method election would not apply to IRC Section 987 QBUs that are owned by or through a partnership or S corporation or a partnership that is itself treated as a QBU. However, a method that is consistent with the rules of Section 3 of the Notice (or a similar method such as the method described in the 1991 proposed regulations) is treated as a reasonable method that meets the requirements of Treas. Reg. Section 1.987-7(b).

The equity and basis pool method election would be subject to the general requirements set forth in Treas. Reg. Section 1.987-1(g), including the consistency rules. Taxpayers would make the election by attaching a statement to their original, timely filed return (including extensions) for the tax year in which the election is made. Prior consent from the Commissioner is not required.

Section 4: Proposed modifications to loss limitation rules, deferral rules and IRC Section 987 hedging transactions

To prevent taxpayers from selectively recognizing large IRC Section 987 losses, Treas. Reg. Section 1.987-11 generally suspends recognition of any IRC Section 987 loss when a current rate election is in effect, and an annual recognition election is not in effect. A similar loss suspension rule applies to partnerships and S corporations under Treas. Reg. Section 1.987-7(d). An IRC Section 987 suspended loss is generally recognized in a tax year in which an equal or greater IRC Section 987 gain in the same recognition grouping is recognized or when certain recognition events occur (the loss-to-the-extent-of-gain rule).

Proposed modifications to the loss suspension rules

The Notice narrows the scope of the loss suspension rules to apply only in a tax year in which either (i) the remittance proportion exceeds 5%, or (ii) the total amount of net unrecognized or deferred IRC Section 987 losses that would otherwise become suspended exceeds $5 million.

Proposed modification to the recognition grouping requirement

The Notice simplifies the loss-to-the-extent-of-gain rule by treating all of an owner's IRC Section 987 gain or loss as being in a single recognition group. Accordingly, the Notice permits a domestic corporation to recognize suspended IRC Section 987 loss as a result of recognized IRC Section 987 gain that is assigned to any IRC Section 904 category. For IRC Section 987 QBUs owned by CFCs (or partnerships in which a partner is a CFC), the Notice limits the recognition groupings to tentative tested income, subpart F income, income described in Section 952(b) and other income.

Treas. Reg. Section 1.987-12 generally defers recognition of IRC Section 987 gain or loss upon a termination of an IRC Section 987 QBU in which assets of the terminated IRC Section 987 QBU are transferred to another IRC Section 987 QBU (successor deferral QBU) that is owned by a member of the same controlled group.

Proposed modification to the definition of successor deferral QBU

The Notice clarifies that an IRC Section 987 QBU is treated as a successor deferral QBU only if, among other things, a "significant portion" of the assets of the terminated IRC Section 987 QBU are reflected on the books and records of the potential successor deferral QBU immediately after the termination. For this purpose, the term "significant portion" has the meaning provided in Treas. Reg. Section 1.987-13(l)(5) (i.e., a significant portion of the operating assets, determined based on all the facts and circumstances, provided that more than 30% of the operating assets will constitute a significant portion in all cases and less than 10% of the operating assets will not constitute a significant portion in all cases).

Under the Final Regulations, an owner's unrecognized IRC Section 987 gain or loss is adjusted by the owner's hedging gain or loss attributable to an IRC Section 987 hedging transaction. Among other requirements, the owner must identify an IRC Section 987 hedging transaction on or before the day the owner enters into the hedge and must properly account for foreign currency gain or loss on the hedge as a cumulative translation adjustment to shareholders' equity under US generally accepted accounting principles (GAAP).

Proposed modification to the definition of an IRC Section 987 hedging transaction

The Notice expands the definition of an IRC Section 987 hedging transaction to include hedges that do not meet the GAAP hedging requirement, provided the other requirements of Treas. Reg. Section 1.987-14(b) are met, and the hedge is entered into primarily to manage exchange rate risk with respect to an interest in the IRC Section 987 QBU that would be treated as either debt or stock held by the owner if the IRC Section 987 QBU were treated as a separate corporation. For hedges entered into before April 26, 2026, that do not meet the GAAP hedging requirement, the identification rules in Section 4.05(2) of the Notice treat such hedges as timely identified if identified under Treas. Reg. Section 1.987-14(c) before April 26, 2026, and the owner of the hedged QBU identifies substantially all of the hedges with respect to the hedged QBU for the tax year (including hedges that meet the GAAP hedging requirement) as IRC Section 987 hedging transactions.

Section 5: Proposed regulations to be issued related to CFCs

The Notice states that the IRS and the Treasury Department intend to issue future guidance establishing an election under which CFCs generally would not be required to compute or recognize IRC Section 987 gain or loss. However, the rules of IRC Section 987(1) and (2) would continue to apply for purposes of computing the taxable income and earnings and profits of the CFC with respect to its IRC Section 987 QBUs. In addition, the basis of assets and the amount of liabilities transferred between an IRC Section 987 QBU and its owner would be translated at the spot rate applicable on the date of the transfer after taking into account gain or loss recognized under Treas. Reg. Section 1.988-1(a)(10).

Taxpayers would be permitted to make the CFC election on an originally filed return (including extensions) for any tax year in which the rules in Section 5 of the Notice are applicable. Once made, the taxpayer could revoke the CFC election only with the Commissioner's consent. A taxpayer would be required to make the CFC election consistently for all CFCs controlled by the taxpayer and its related parties. Importantly, any unrecognized IRC Section 987 gain or loss that arose before the CFC election is made would be recognized pro rata over 120 months beginning with the first month of the tax year in which the CFC election is made.

In the case of an inbound asset reorganization or liquidation of a CFC that is subject to the CFC election, rules would be provided to account for IRC Section 987(3) gain (but not loss) that has not been recognized as a result of the CFC election. The gain would be accounted for by computing the amount of the transferor CFC's IRC Section 987 basis increase. In principle, a transferor CFC's IRC Section 987 basis increase would represent the net amount by which the basis in the transferor CFC's assets increased due to currency fluctuations that would have been accounted for under IRC Section 987(3) had the CFC election not been made. To simplify these special rules, taxpayers would compute the IRC Section 987 basis increase under one of several proxies using information that is expected to be readily available to taxpayers.

Section 6: Proposed applicability dates and reliance

The forthcoming proposed regulations, when finalized, are expected to apply to tax years ending on or after the date final regulations adopting the rules are published in the Federal Register. Taxpayers may rely on the rules described in Sections 3 and 4 of the Notice for a tax year ending before the proposed regulations are published in the Federal Register and to which the Final Regulations apply, provided the taxpayer and all members of its IRC Section 987 electing group (as defined in Treas. Reg. Section 1.987-1(g)(2)(ii)) apply the rules in their entirety and in a consistent manner for the tax year and each subsequent tax year ending before the proposed regulations are published in the Federal Register.

Taxpayers may not rely on the rules described in Section 5 of the Notice relating to the application of IRC Section 987(3) to CFCs. However, the IRS and the Treasury Department expect that taxpayers will similarly be permitted to rely on those rules in future guidance, and they "intend to issue this guidance in the near future to provide taxpayers with sufficient time to determine whether to make the CFC election for the 2025 [tax] year on an originally filed return (with extension)."

Section 7: Request for comments

The IRS and the Treasury Department requested comments on the rules described in Sections 3, 4 and 5 of the Notice, including specific requests for comments regarding the determination of the proposed IRC Section 987 basis increase under Section 5 of the Notice, and whether and how the rules of Section 5 should apply to a partnership in which one or more of the partners is a CFC. Written comments should be submitted by April 26, 2026.

Implications

The Notice simplifies the computations of IRC Section 987 taxable income or loss and IRC Section 987 gain or loss by permitting taxpayers to elect the equity and basis pool method, which is substantially similar to the 1991 proposed regulations method previously applied by many taxpayers. The Notice also loosens some of the limitations on recognizing suspended IRC Section 987 losses and expands the definition of an IRC Section 987 hedging transaction. Because taxpayers may currently rely on these provisions, taxpayers should consider:

• Whether to elect the equity and basis pool method, including how the prerequisites to make the current rate election and comply with the general election consistency requirements influence that decision.
• Whether additional IRC Section 987 losses may be recognized as a result of the modifications to the loss suspension and recognition grouping rules and whether that recognition influences their decision to make (or not to make) the 10-year amortization election for pretransition gains and losses.
• Whether any hedges entered into before April 26, 2026, should be identified before April 26, 2026, as IRC Section 987 hedging transactions as a result of the expanded definition of such transactions.

Taxpayers should also consider the proposed CFC election described in Section 5 (which is currently pending future guidance) and provide comments regarding the IRC Section 987 basis increase rules or any other provisions of the Notice.