Proposed Section 987 Regulations Include CFC Exemption Election

The IRS recently issued proposed Section 987 regulations that include a controlled foreign corporation (CFC) exemption election that could materially reduce the ongoing Section 987 compliance burden for qualified business units (QBUs) owned by CFCs. However, the election is not a simple opt out, and taxpayers should not default to making the election for 2025 merely to avoid future calculations.

Depending on the facts, a 2025 election could eliminate historic gain or valuable loss or place significant gain on a mandatory 120-month recognition schedule. There is no one-size-fits-all answer.

General Mechanics

Under the proposed regulations, an electing CFC (exempt CFC) generally would not compute or recognize Section 987 gain or loss under IRC section 987(3) for years in which the election applies. The rules for determining and translating QBU taxable income and transfers under IRC section 987(1) and (2) would continue to apply.

The proposed regulations also would sweep specified CFC-owned partnerships into the category of covered taxpayers. The exemption would apply if:

• An exempt CFC treats a partnership or interest therein as the CFC Section 987 QBU under a reasonable method; and
• An exempt CFC owns a Section 987 QBU indirectly through an exempt partnership, defined as a partnership that is at least 80% directly or indirectly owned by same-group CFCs.

The CFC election is deemed made or revoked, respectively, in the year a partnership becomes or ceases to be exempt.

Those aspects of the proposed regulations generally would apply to tax years ending on or after the final regulations are published. However, the IRS has said taxpayers can rely on the CFC exemption election rules for tax years beginning after December 31, 2024, and before the date the regulations are finalized.

Amortization

Amounts arising before the election must also be addressed. If the election applies beginning in 2025, pretransition gain or loss generally is recognized over 120 months. For a later election, the CFC generally determines a separate pre-election amount that includes its remaining unrecognized, deferred, and suspended Section 987 amounts as of the end of the preceding year. That amount also generally is recognized over 120 months. 

That amortization period is consistent with Notice 2025-72, which addressed the repeal of the one-month deferral election in the One Big Beautiful Bill Act. The notice indicated that the IRS would propose regulations to modify amortization for pretransition foreign gains or losses by replacing 10-year amortization with 120-month amortization. 

The IRS included an exception for QBUs with average assets of less than $50 million over the prior three years (measured using a U.S. GAAP balance sheet). Those QBUs generally are treated as having zero pretransition or pre-election gain or loss. The rule applies to losses as well as gains, and same-country QBUs are aggregated. Because the three-year testing window changes with each election year, a QBU might qualify in one year but not another.

The pretransition amortization provision would apply for tax years beginning December 31, 2024, and ending on or after November 25, 2025.

Inbound Transactions

The proposed regulations also include a special pre-transaction rule for inbound liquidations and reorganizations. An exempt CFC might have to recognize Section 987 gain, but not loss, based on its Section 987 asset basis. Such gain would be recognized immediately before the inbound transaction.  To compute it, taxpayers can use a lookback or excess asset basis method.

Under the lookback methodology (looking to the preceding 72 months), the CFC’s Section 987 asset basis would consider unrecognized Section 987 gain or loss based on using a method similar to the ineligible pretransition calculation found in Treas. Reg. §1.987-10(e)(3)(iii).

The excess basis approach would look to the transferor CFC’s Treas. Reg. §1.367(b)-3(g)(2)(i) excess asset basis, relying on various amounts computed at the time of the inbound transaction instead of historical Section 987 amounts.

The proposed regulations provide an exception for transferor CFCs whose inside asset basis is less than $25 million. If multiple transactions occur under a single arrangement, all transferor CFC assets would be aggregated.

Timing and Consistency

Calendar-year taxpayers generally have until October 15, 2027, to select 2025, 2026, or 2027 as the first election year. A 2025 or 2026 election can be made later on an amended return, giving taxpayers time to understand the consequences before committing. For tax years ending in 2027, the authorized person would make the CFC exemption election by filing the election statement on or before October 15, 2027. Thus, until October 15, 2027, a calendar-year taxpayer would be allowed to make the election for the 2025, 2026, or 2027 tax years.

The election generally must be applied consistently across the relevant CFC group and extends to some partnership-owned QBUs (if such partnership is 80% owned by an exempt CFC). It cannot be revoked without IRS consent. If the election ceases to apply within its first 60 months, remaining pre-election loss generally becomes suspended, while remaining pre-election gain continues to be recognized.

The 2026 proposed regulations would expand the consistency requirements in the 2024 final regulations to include CFCs held through domestic partnerships and affiliated domestic corporations that are not part of the consolidated group. They also include anti-avoidance rules to address transactions entered into principally to avoid the consistency requirements or that would cause an inappropriate deemed revocation. 

Taxpayer Scenarios to Consider

It is important for taxpayers to understand their QBU-level balance sheet items, as well as their pretransition positions. Taxpayers and their advisors should evaluate the various permutations and outcomes, such as those illustrated below.

Scenario A: Election Not Recommended in 2025

A taxpayer with significant pretransition gain in QBUs that do not qualify for the $50 million threshold exception generally should not rush to make the election for 2025. The election would place that gain on a 120-month recognition schedule beginning in 2025, even if the taxpayer otherwise expects few remittances or terminations.

For example, say a Section 987 QBU had pretransition gain of $100 million, all characterized as subpart F income, and its average assets from 2022 through 2024 were above the $50 million threshold exception. 

For this taxpayer, the compliance savings might not justify accelerating recognition of the gain. Waiting — or continuing under the final Section 987 regulations issued in December 2024 — might be the better answer depending on expected future remittances.

Scenario B: Election Recommended in 2025

A 2025 election might be appropriate if the taxpayer’s pretransition gains and losses are known to be immaterial. In that case, the taxpayer is not giving up meaningful losses or accelerating meaningful gains and can obtain the prospective compliance benefit immediately.

For example, say a Section 987 QBU was formed on December 1, 2024. That QBU’s pretransition period would be only one month and is unlikely to generate material pretransition amounts. Further, the QBU’s assets during that period were only $100,000, an initial infusion of capital.

This is the clearest case for making the election for 2025.

Scenario C: Timing Unclear — Model the Alternatives

Often, the answer will not be as obvious as those in the above examples. A taxpayer might have material losses it would surrender under the $50 million threshold exception, gains that would become subject to 120-month recognition, or a mix of QBUs above and below the threshold.

Timing could create additional options. For example, a taxpayer might benefit from making the regular pretransition amortization election for 2025 to preserve favorable pretransition losses and then considering the CFC exemption election in 2026 or later. A 2026 election could also allow amortization of unrecognized Section 987 loss generated in 2025 if the QBU generating the loss is above the $50 million threshold and the loss is included in the pre-election calculation.

The taxpayer would then need to account separately for any pre-election amounts arising before the later election, assuming the $50 million threshold is not met in later years.

These taxpayers should model a 2025 election, a later election, and no election before deciding.