Treasury and the IRS on February 25 released Notice 2026-17 announcing proposed regulations that would modify the December 2024 final regulations under Section 987.
The proposed changes are intended to simplify the operation of the Section 987 regulations, reduce compliance burdens, and refine the scope of certain rules under Section 987 to limit their effect on ordinary course transactions. The most significant change would permit taxpayers to determine taxable income or loss and foreign currency gain or loss with respect to a qualified business unit (QBU) using a method that is substantially similar to the method provided in regulations proposed in 1991. Taxpayers may rely on certain provisions of the notice for their 2025 tax returns.
Taxpayers should not treat this notice as a reason for deferring or scaling back Section 987 compliance work. Taxpayers must comply with the 2024 final regulations (modified to the extent permitted by the notice) for taxable years beginning after 2024.
Applicability and Timing
Taxpayers may rely on the rules in sections 3 and 4 of the notice (covering the equity and basis pool method, loss suspension modifications, recognition grouping changes, and hedging) for taxable years to which the 2024 final regulations apply. These provisions must be applied in their entirety and consistently across the Section 987 electing group.
The rules in section 5 (the CFC election to turn off Section 987(3)) are expected to be effective for taxable years ending on or after the date final regulations are published in the Federal Register. Treasury intends to issue guidance as described in this section in time for 2025 originally filed tax returns (with extensions). Until such guidance arrives, the election is not available.
Treasury and the IRS request comments on the rules described in sections 3, 4, and 5 of the notice. Comments are due on April 26, 2026.
What Changed: Modifications to Existing Rules
Change to the Loss Suspension Rules
Under the 2024 final regulations, losses recognized when a current rate election (CRE) is in effect are generally suspended, even if such losses are triggered by small intercompany cash movements. Losses are suspended only if in a taxable year of an owner the total amount of net unrecognized Section 987 loss of the owner and all members of the owner’s controlled group that would (but for the loss suspension rule) be recognized does not exceed the lesser of (i) $3 million and (ii) 2% of the total amount of gross income of the owner and all members of the owner’s controlled group for the taxable year. The notice modifies the threshold. Suspension applies only if (i) the remittance proportion exceeds 5%, or (ii) the loss that would have been recognized (but for the loss suspension rule) exceeds $5 million.
Simplified Recognition Groupings
Suspended losses can be recognized only against gains in the same recognition grouping. Under the 2024 regulations, in the case of a domestic owner, the recognition groupings are U.S.-source income and foreign-source income in each Section 904 category. If the owner of a Section 987 QBU is a CFC, the recognition groupings are further divided between the following subcategories:
- Tentative tested income;
- Income in each separate Subpart F income group described in Reg. §1.960-1(d)(2)(ii)(b);
- Income effectively connected with a U.S. trade or business (ECI) described in Section 952(b); and
- Other income.
The notice provides that domestic owners will have a single grouping, and CFC owners will have four groupings:
- Tested income;
- Subpart F income;
- ECI described in Section 952(b); and
- Other income.
The initial sourcing and characterization of Section 987 gain and loss under the asset method is unchanged.
Hedging Definition Expanded
The current rules provide that a Section 987 hedging transaction must be properly accounted for under GAAP, as well as meet other requirements. The notice provides that the definition of Section 987 hedging transaction would be expanded to cover certain hedges that do not meet the GAAP hedging requirements. Specifically, under the notice, a hedge may qualify even if the GAAP hedging requirement of Reg. §1.987-14(b)(2)(iv) is not met, provided the other requirements of Reg. §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 Section 987 QBU that would be treated as either debt or stock held by the owner if the Section 987 QBU were treated as a separate corporation. Pre-notice hedges can be retroactively identified before April 26, 2026.
What’s New: Elective Regimes
Equity and Basis Pool Method
Taxpayers may now elect to use an earnings and capital method that is similar to the method under the 1991 proposed regulations, with several important modifications:
- Remittances from a Section 987 QBU to its owner are computed annually, not daily.
- A current rate election must be in effect.
- The remittance proportion formula now includes liabilities in the denominator, reducing the amount recognized on a given remittance (in effect, the denominator is equivalent to gross assets).
- Transition rules address opening pool balances, including coordination with pretransition calculations and the 10-year amortization election.
All 2024 final regulation provisions that relate to deferral, suspension, hedging, and termination continue to apply. The election must be filed on an original timely return (with extensions).
The election to use the equity and basis pool method must be filed on the original timely return (with extensions). This method may be used in lieu of the alternative QBU net value method under the CRE.
Partnership Considerations
The equity and basis pool election does not apply to partnerships or S corporations. However, a method that is consistent with the rules of section 3 (or a similar method, such as the method described in the 1991 proposed regulations) will be treated as a reasonable method of applying Section 987 that meets the requirements of Reg. §1.987-7(b).
CFC Election to Discontinue Section 987(3)
The notice provides that Treasury and the IRS intend to issue future guidance that would provide an election under which CFCs generally would not be required to compute or recognize foreign currency gain or loss under Section 987(3) (the CFC election). Income determination and translations under Sections 987(1) and (2) would continue. The election must apply consistently to all CFCs controlled by the taxpayer and related parties. The election will be revocable only with the IRS commissioner’s consent. Existing unrecognized gain or loss would be recognized ratably over 120 months. Inbound transactions would trigger a backstop mechanism to prevent unrealized currency gain from escaping recognition permanently. Treasury is still developing those details and has requested comments on several alternative approaches.
Taxpayers cannot rely on the CFC election for 2025 tax returns, because the election is not operative until Treasury issues the separate guidance referenced in the notice. Taxpayers with CFC-owned QBUs should continue to compute Section 987 gains and losses under the existing final regulations.
Other Provisions
- The successor deferral QBU definition has been narrowed. It now requires a “significant portion” of terminated QBU assets to be reflected on the successor’s books rather than just any assets of the terminated QBU.
- The recurring transfer group election for recurring transfer groups applies for the equity and basis pool method.
- The notice does not modify the pretransition calculation rules under Reg. §1.987-10.
What This Means for Current Compliance
The notice provides an additional election to apply the earnings and capital method, but it does not change the fact that taxpayers must comply with Section 987 for the 2025 tax year. Pretransition calculations are still required for all QBUs. QBU identification and transfer analyses are still required. Election deadlines still apply. The equity and basis pool method is available based on reliance on this notice but requires an affirmative election. Taxpayers should continue Section 987 compliance on current timelines.
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