In newly proposed regulations issued August 19, 2024, under IRC Sections 954 and 988 (the 2024 Proposed Regulations), the Treasury Department and the IRS partially withdrew and modified earlier proposed regulations from 2017 (the 2017 Proposed Regulations) to promote consistency with other filing requirements for controlled foreign corporations (CFCs) and limit taxpayers' ability to make and revoke certain elections related to foreign currency gains or losses.

Background

On December 19, 2017, the Treasury Department and the IRS published the 2017 Proposed Regulations, which provided guidance on the subpart F treatment and timing of foreign currency gain or loss attributable to IRC Section 988 transactions of a CFC. Among other things, the 2017 Proposed Regulations contained Prop. Treas. Reg. Sections 1.954-2(g)(3)(iii) and 1.954-2(g)(4)(iii), which permitted the controlling US shareholders of a CFC to unilaterally and automatically revoke either election at any time by filing a revocation statement with the applicable original or amended income tax return.

The 2017 Proposed Regulations also provided a new election under Prop. Treas. Reg. Section 1.988-7, which permitted, subject to certain exceptions, all taxpayers (including CFCs) to use a mark-to-market method of accounting for foreign currency gains or losses arising from IRC Section 988 transactions, including nonfunctional currency-denominated debt issued by the taxpayer.

Under the 2017 Proposed Regulations, taxpayers, including CFCs, would generally be permitted to make a Prop. Reg. Section 1.988-7 election with the taxpayer's timely filed return for the year in which the election was made. Taxpayers could revoke the election at any time by filing a revocation statement with the applicable original or amended income tax return of the taxpayer or of the controlling US shareholder (in the case of a CFC).

The 2017 Proposed Regulations generally applied to tax years ending on or after the date of publication of final regulations in the Federal Register. A taxpayer, however, generally could have relied on the 2017 Proposed Regulations for tax years ending on or after December 19, 2017, provided the taxpayer consistently applied the proposed amendment for all tax years that ended before the first tax year ending on or after the date the 2017 Proposed Regulations were published as final.

For additional detail regarding the 2017 Proposed Regulations and associated code sections, see Tax Alert 2017-2214.

Key provisions of the 2024 Proposed Regulations

Amendments to the Prop. Treas. Reg. Section 1.988-7 election

The Treasury Department and the IRS specifically noted that the rules for making and revoking a Prop. Treas. Reg. Section 1.988-7 election under the 2017 Proposed Regulations provided an excessive amount of flexibility to taxpayers. Therefore, the 2024 Proposed Regulations withdraw former Prop. Treas. Reg. Section 1.988-7(c) through (e) of the 2017 Proposed Regulations and propose new amendments. In a significant change from the 2017 Proposed Regulations, the 2024 Proposed Regulations generally amend the timing for making a Prop. Treas. Reg. Section 1.988-7 election to accord with the time for making an election under IRC Section 475(e) or (f) (which permits a dealer in commodities or a trader in securities or commodities to use the mark-to-market method of accounting). Consequently, under new Prop. Treas. Reg. Section 1.988-7(c), an existing taxpayer now would make the Prop. Treas. Reg. Section 1.988-7 election by filing a statement that clearly indicates the election has been made with the taxpayer's timely filed (excluding extensions) original federal income tax return for the tax year immediately preceding the year for which the election is made (i.e., by April 15, 2025, for a calendar year taxpayer that is making the election for its 2025 tax year).

Under a slightly different timing rule, a new taxpayer would make the election by:

1. Placing a statement in the taxpayer's books and records by no later than two months and 15 days after the first day of the year for which the election is made, and
2. Filing the statement with the taxpayers' original federal income tax return for the tax year for which the election is made.

Similar to the rule for new taxpayers, in the case of a CFC, the controlling US shareholder would make the election on behalf of the CFC by:

1. Placing a statement in the CFC's books and records by no later than two months and 15 days after the first day of the year of the CFC for which the election is made, and
2. "Filing the statement with their original federal income tax returns for the [tax] year of the US shareholders in which or with which the taxable year of the CFC for which the election is made ends."

Under new Prop. Treas. Reg. Section 1.988-7(d), a taxpayer may only revoke the election with the consent of the Commissioner. In the preamble to the 2024 Proposed Regulations, the IRS indicated that when the 2024 Proposed Regulations are finalized, the IRS expects to issue a revenue procedure setting forth the terms and conditions under which a change of method of accounting with respect to the mark-to-market method under Prop. Treas. Reg. Section 1.988-7 will be granted.

Amendments to Treas. Reg Section 1.954-2(g)(3)(ii) and Prop. Treas. Reg. Section 1.954-2(g)(3)(iii) and (g)(4)(iii)

To address issues and questions raised by practitioners and to promote consistency with other filing requirements with respect to CFCs, the 2024 Proposed Regulations revise the language of current Treas. Reg. Section 1.954-2(g)(3)(ii) (which also controls the timing for a Treas. Reg. Section 1.954-2(g)(4) election) to allow controlling US shareholders to make a Treas. Reg. Section 1.954-2(g) election on behalf of a CFC by "filing a statement with their timely-filed, original federal income tax returns for the [tax] year of the United States shareholders in which or with which the taxable year of the CFC for which the election is made ends, clearly indicating that the election has been made."

Additionally, the 2024 Proposed Regulations withdraw former Prop. Treas. Reg. Section 1.954-2(g)(3)(iii) and (g)(4)(iii) of the 2017 Proposed Regulations. New Prop. Treas. Reg Section 1.954-2(g)(3)(iii) and (g)(4)(iii) provide that controlling US shareholders may not revoke a Treas. Reg. Section 1.954-2(g) election made on behalf of a CFC (including an initial election) until the sixth tax year following the year in which the election was made. Previously, under the 2017 Proposed Regulations, a taxpayer could revoke those elections at any time. If a CFC's controlling US shareholders were to revoke a Treas. Reg. Section 1.954-2(g) election, new Prop. Treas. Reg. Section 1.954-2(g)(3)(iii) and (g)(4)(iii) would preclude them from making a new Treas. Reg. Section 1.954-2(g) election on behalf of the CFC until the sixth tax year following the year of revocation. The preamble to the 2024 Proposed Regulations states the change to the revocation procedures will limit taxpayers from opportunistically making or revoking a Treas. Reg. Section 1.954-2(g) election.

Applicability Dates / Reliance

The 2024 Proposed Regulations generally are proposed to apply to tax years ending on or after the date the final regulations are published in the Federal Register. Importantly, as of August 19, 2024, taxpayers may no longer rely on the withdrawn sections of the 2017 Proposed Regulations. Before the finalization of the 2024 Proposed Regulations, taxpayers may rely on new Prop. Treas. Reg. Section 1.988-7(c) and (d) in making and revoking a Prop. Treas. Reg. Section 1.988-7 election and new Prop. Treas. Reg. Section 1.954-2(g)(3)(ii) and reproposed Treas. Reg. Section 1.954-2(g)(3)(iii) and (g)(4)(iii) in making and revoking Treas. Reg. Section 1.954-2(g) elections, provided they are consistently applied to all tax years.

Implications

The 2024 Proposed Regulations may significantly limit taxpayer flexibility in making or revoking the foreign currency mark-to-market election under Prop. Treas. Reg. Section 1.988-7. In particular, taxpayers may no longer rely on the 2017 Proposed Regulations and thus may be prohibited from making or revoking that election on their 2023 or 2024 tax returns. The 2024 Proposed Regulations limit the ability to revoke an election under Treas. Reg. Section 1.954-2(g), while aligning those procedures with other elections made on behalf of calendar year and fiscal year CFCs. Controlling US shareholders should carefully consider how the elections might affect their long-term US federal income tax determinations.

The Treasury Department and the IRS have requested comments regarding the new rules for making and revoking the Prop. Treas. Reg Section 1.988-7 election and on the changes to the revocation rules under new Prop. Treas. Reg Section 1.954-2(g)(3)(iii) and (g)(4)(iii). Taxpayers are encouraged to provide comments to the extent they had planned on but are no longer able to rely on the 2017 Proposed Regulations.