IRS proposal could ease section 987 compliance for CFCs

For taxable years beginning after Dec. 31, 2024, and ending on or before Dec. 31, 2026, the authorized person, within the meaning of Reg. section 1.987-1(g)(1), makes the CFC exemption election by attaching an election statement to the taxpayer’s original, timely filed federal income tax return, including extensions. For taxable years beginning in 2025, taxpayers may make the election on an amended return filed by Oct. 15, 2027.

Different filing procedures apply to elections beginning in 2027 or later, including advance-filing requirements in certain circumstances.

In updated post-release guidance (Updated rules regarding section 987 taxable income or loss and Updated rules related to CFC exemption election), the IRS instructed that, to make a CFC exemption election in reliance on the 2026 proposed regulations, the authorized person must attach a statement to Form 8964-ELE indicating the election with respect to the QBUs identified in Part I or Part II of the form. The statement should be titled “Section 987 CFC Exemption Election.”

Section 987 elections must be made consistently for all members of a section 987 electing group. A section 987 electing group generally includes all CFCs in which the same U.S. shareholder owns, within the meaning of section 958(a), a majority of the stock by vote or value. In addition, affiliated domestic corporations generally are treated as a single U.S. person for purposes of the consistency rule under the principles of Reg. section 1.904(i)-1(b). When a CFC joins a section 987 electing group, the CFC is deemed to make or revoke any section 987 election as necessary to conform to the elections in effect for the other members of the group. As a result, taxpayers generally cannot apply the CFC exemption election selectively to some members of a section 987 electing group while excluding others.

Under Prop. Reg. section 1.987-15, a CFC subject to a CFC exemption election would be treated as an exempt CFC. The rules for determining and recognizing section 987 gain or loss generally would not apply to an exempt CFC for taxable years in which the election is in effect. Instead, the applicable rules would apply as if a current rate election (CRE) were in effect for each exempt CFC. As a result, exempt CFCs generally would not be required to track historical exchange rates. A section 987 QBU’s taxable income or loss would be translated into the owner’s functional currency at the yearly average exchange rate, and transfers between a section 987 QBU and its owner would be translated at the spot rate on the date of transfer.

The election also involves an important tradeoff. Because an exempt CFC generally does not compute or recognize section 987 gain or loss while the election applies, it generally will not recognize future section 987 losses arising during that period. Taxpayers should therefore consider their expected currency exposure and potential future losses when evaluating whether to make the election.

An exempt CFC generally would not recognize section 987 gain or loss in taxable years for which the CFC exemption election applies. However, the election does not eliminate pre-election section 987 gain or loss, meaning section 987 gain or loss that accumulated before the CFC exemption election became effective. An exempt CFC generally must compute and amortize pre-election section 987 gain or loss and may be required to recognize section 987 gain in connection with an inbound reorganization or liquidation.

Pre-election section 987 gain or loss is distinct from pretransition gain or loss under the 2024 final regulations. Pretransition amounts relate to the initial application of the 2024 final regulations, while pre-election amounts relate to section 987 gain or loss accumulated before the CFC exemption election becomes effective.

The election generally cannot be revoked without the IRS commissioner’s consent and therefore should be evaluated as a long-term, group-wide decision rather than an annual compliance election. If the CFC exemption election is revoked or ceases to apply within 60 months, any unrecognized pre-election section 987 loss generally is treated as suspended loss. This rule is intended to prevent taxpayers from using the election to accelerate recognition of section 987 losses.

Prop. Reg. section 1.987-15(e)(2)(iii) provides an exception to the general rule requiring an exempt CFC to compute pre-election section 987 gain or loss for certain smaller QBUs. The preamble explains that Treasury and the IRS recognized that, depending on the size of a QBU, the burden of performing the computation may outweigh the policy rationale for requiring the computation.

Under this exception, an exempt CFC is deemed to have zero pre-election section 987 gain or loss for a QBU with average assets of less than $50 million for the three-year period preceding the first taxable year for which the CFC exemption election is made. The three-year averaging requirement is intended to prevent taxpayers from inappropriately shifting assets between QBUs to qualify for the exception. For this purpose, a QBU’s assets for each relevant year equal the total assets reflected on the QBU’s U.S. generally accepted accounting principles balance sheet on the last day of the taxable year, as reported annually on Form 8858, Schedule F.

For purposes of applying the less-than-$50-million asset test, the proposed regulations include an aggregation rule. All section 987 QBUs, successor deferral QBUs and successor suspended loss QBUs of an exempt CFC that have the same country of residence are treated as a single QBU. As a result, taxpayers should evaluate the asset threshold on an aggregated same-country basis rather than separately for each QBU.

The proposed regulations generally require an exempt CFC to apply the transition rules of Reg. section 1.987-10 to determine pretransition gain or loss with respect to its section 987 QBUs for the taxable year beginning on the transition date. However, if a CFC exemption election is made for the year the 2024 final regulations first apply, the CFC generally is treated as having no pretransition gain or loss for any QBU that satisfies the less-than-$50-million average asset test.

The IRS has indicated that a separate Form 8964-TRA should be filed for each exempt QBU that qualifies for the less-than-$50-million asset exception. For those QBUs, the taxpayer should state in Part I that the QBU is deemed to have no pretransition gain or loss and report the QBU’s asset amount, while leaving Parts II and III blank.

For QBUs that do not qualify for the less-than-$50-million asset exception, Form 8964-TRA remains the mechanism for reporting the required Reg. section 1.987-10 transition calculation, including pretransition gain or loss when required. Taxpayers should maintain records supporting their determinations, including QBU asset amounts and any transition calculations reflected on Form 8964-TRA.

Separate from transition reporting, taxpayers also should consider the Form 8964-ELE reporting mechanics for making the CFC exemption election. The authorized person makes the election by attaching a statement to Form 8964-ELE, and taxpayers generally have additional flexibility to make the election for taxable years beginning in 2025 on an amended return filed by Oct. 15, 2027.

Because an exempt CFC is deemed to have a CRE in effect under Prop. Reg. section 1.987-15(b)(3), the interaction between the deemed CRE rule and Form 8964-ELE reporting requirements remains unclear. Additional IRS guidance may be needed to clarify the required election mechanics and related Form 8964-ELE reporting.

The proposed regulations also include rules for certain inbound nonrecognition transactions involving exempt CFCs. Under Prop. Reg. section 1.987-16, a transferor CFC generally must compute and recognize section 987 gain, but not loss, immediately before certain inbound liquidations or reorganizations described in section 381(a). The rule is intended to prevent the importation of untaxed currency-related basis into the U.S. tax system.

Taxpayers also should be aware that these rules may apply even if the CFC exemption election is no longer in effect at the time of the inbound transaction.

Common examples may include a section 332 liquidation of a foreign subsidiary into a domestic parent corporation or certain inbound asset reorganizations described in section 368(a)(1). Only transactions that fall within the scope of the proposed inbound nonrecognition transaction rules are affected. Taxpayers should evaluate whether an applicable inbound transaction could require section 987 gain recognition, particularly when a CFC exemption election is in effect.