New IRS Section 987 Rules: What Every Business Owner With Foreign Operations Needs to Know

Key Takeaways:

• The IRS’s new Section 987 regulations introduce updated foreign currency reporting requirements that take effect beginning with the 2025 tax year.

• Businesses should begin gathering historical financial records now to calculate required transition amounts and determine whether the simplified election under IRS Notice 2026-17 is beneficial.

• Taking proactive steps before filing your 2025 tax return can help reduce administrative burden, avoid penalties, and support compliance with the new rules.

—

The IRS has finalized significant foreign currency regulations that may affect you if your business operates overseas through a foreign branch, office, or hybrid entity — which the IRS refers to as a qualified business unit (QBU). Compliance generally begins for tax years starting after December 31, 2024 (calendar year 2025 for most taxpayers). 

What’s Changing? 

The new regulations modernize how taxpayers calculate and report foreign currency gains and losses under Section 987 of the Internal Revenue Code. Historically, many taxpayers struggled to apply the longstanding Section 987 rules because of their complexity and limited implementation guidance.

The final regulations establish a comprehensive framework for calculating taxable foreign currency gains and losses, introduce new reporting requirements, and include transition rules that require taxpayers to establish a beginning balance for the new methodology. At the same time, IRS Notice 2026-17 provides an elective simplified method that may reduce the administrative burden for qualifying taxpayers.

When your foreign QBU keeps its books and records in a local currency (such as euros, pounds, or pesos for instance) that differs from the functional currency of its owner, fluctuations in exchange rates can create taxable foreign currency gains or losses — even when no cash changes hands. The IRS requires you to track these exchange rate movements and report certain gains or losses on your tax return.

As part of the transition to the new rules, taxpayers generally must calculate their cumulative Section 987 gain or loss through December 31, 2024 (for calendar-year taxpayers) and establish a beginning balance under the new methodology for 2025.

The Risks of Non-Compliance

Failing to comply with the new Section 987 requirements can result in penalties, additional IRS scrutiny, and increased compliance burdens. Key risks include:

• Information return penalties (Forms 8858, 8964-TRA, 8964-ELE): Missing, incomplete, or inaccurate foreign entity information returns may result in statutory penalties, depending on the circumstances.

• Misstated taxable income: Foreign currency gains/losses directly impact your taxable income. Miscalculating them may mean underreporting (or overreporting) taxable income.

• Incomplete tax return filings: Missing prescribed schedules or forms can cause the IRS to deem your entire tax return incomplete, which could keep the audit window open.

• Failure to disclose: An incomplete or uncertain tax position may require disclosure analysis, In such a situation, your tax preparer may be required to attach Form 8275 (Disclosure Statement) or 8275-R (Regulation Disclosure Statement) to your income tax return.

Relief Available for Complex Calculations

Recognizing the complexity of the new Section 987 rules, the IRS has provided a simplified election for certain taxpayers. Before making an election, you should understand both the benefits and the potential tradeoffs.

Computing Section 987 foreign currency gain or loss generally requires historical information dating back to the inception of the foreign QBU or to 2006 (whichever is later). If these calculations have not been maintained historically, the supporting workpapers may need to be recreated using prior accounting records and tax filings.

To reduce this administrative burden, IRS Notice 2026-17 offers two forms of relief for eligible taxpayers:

• Simplified tracking method: Under the equity and basis pool method, you can generally use annual average exchange rates rather than tracking exchange rate movements for every individual asset acquisition, cash transfer, or transaction throughout the year.

• Loss suspension relief: The notice also relieves certain Section 987 loss suspension rules for routine transfers between a U.S. owner and its foreign QBU, provided applicable de minimis thresholds and other requirements are satisfied.

Taxpayers should evaluate whether this election produces a favorable result based on their specific facts and circumstances.

Key Action Items for Business Owners

Preparing now can help reduce compliance challenges and avoid last-minute surprises during your 2025 tax filing. Consider taking the following steps:

1. Identify your foreign QBUs: Inventory each foreign QBU you own and confirm the functional currency used by each operation to determine which are subject to the new rules.
 
2. Gather historical records: Collect bank statements, balance sheets, general ledger information, and prior tax filings (Forms 8858) dating back to the entity’s inception (or 2006, whichever is later). This information is required to calculate the baseline after the “reset” for tax year 2025.
 
3. Evaluate the Notice 2026-17 election: Determine whether the simplified equity and basis pool method could reduce administrative complexity while producing an acceptable tax result for your business.

How MGO Can Help

Navigating these new foreign currency rules does not have to disrupt your business operations.

Our International Tax team helps business owners evaluate their foreign QBUs, gather required historical data, and model the impact of IRS Notice 2026-17 elections to minimize your administrative burden and reduce the penalty exposure. We handle the complex calculations, prepare any required statements for elections made, and review consistency in compliance across your tax return.

Reach out to our team today to discuss your foreign operations. The earlier we review your foreign entity structure and historical accounting records, the more effectively we can streamline your 2025 reporting and evaluate optimal tax positions for your business.

---

Disclaimer: This article is for general informational purposes only and does not constitute legal, tax, accounting, or other professional advice. The information provided may not reflect the most current legal or regulatory developments and should not be relied upon as a substitute for advice from a qualified professional based on your specific facts and circumstances. You should consult your tax advisor before taking any action based on this information.