Qualified Business Unit Elections Should Be Prudent but Quick

Last year was a major election year. For taxpayers with qualified business units—a separate and clearly identified unit of a taxpayer’s trade or business maintained in separate books and records—2025 is going to be a significant election year as well.

Taxpayers will need to carefully consider the effect of an election described below, including its interaction with other ones they may make. But they must act quickly if they want to make elections without seeking the IRS commissioner’s consent or having to deal with a change in elections.

The IRS last month issued final and proposed regulations addressing Section 987 of the tax code and other foreign-branch-related issues. The IRS can issue final regulations in a Treasury decision and proposed regulations in a notice of proposed rulemaking. The subject matter can overlap (or even contradict), but only the final regulations have the force and effect of law.

The issuance of final regulations in this area has been a decades-long saga, with multiple rounds of proposed regulations, final regulations, and suspensions of final regulations.

The final regulations address foreign currency gains and losses of taxpayers with QBUs. The final regulations generally provide that a Section 987 gain or loss, and a Section 987 taxable income or loss, are determined under the foreign exchange exposure pool method.

Under the FEEP method, historic items are translated at historic rates—both to determine Section 987 gain or loss and to translate recovery of basis with respect to historic assets in computing Section 987 taxable income or loss. As a result, the FEEP method doesn’t impute Section 987 gain or loss to historic items.

The final regulations aren’t the end of the Section 987 story. The proposed regulations set forth an election for routine transactions, and the preamble to the proposed regulations requests comments on how to address partnerships and controlled foreign corporations, suggesting that future regulations are in store for those areas.

Still, the publication of the final regulations means definitive guidance for QBUs. The regulations’ fundamental approach, the FEEP method, has been controversial. The IRS and the Treasury have generally responded to criticisms of that method by offering elective and constrained departures from it. When a regulation seeks to provide both clarity and flexibility, the cost of that marriage is often complexity.

In the long run, careful selection of elections will reduce complexity relative to the basic regulatory scheme. But in the short term, the elections are an additional source of complexity, as taxpayers must determine the impact of making—or not making—an election and the interaction of potential elections with each other.

For reasons noted below, most of these elections should be made so that they are effective in the first year that the new final regulations apply, as that would avoid the need for IRS approval.

A taxpayer may need to consider up to a dozen elections. Some won’t be applicable, depending on the taxpayer’s circumstances. For example, a taxpayer that holds a single QBU may not need to be concerned with the treatment of partnerships or the Section 987 group election. But any US person or controlled foreign corporation that has a QBU will need to consider at least some of these elections.

The two main elections are whether to depart from the regulations’ default FEEP approach: the current rate election and the annual recognition election.

A taxpayer may elect to treat all assets and liabilities that are properly reflected on the books and records of a Section 987 QBU under Section 1.987-2(b) as marked items. By making a current rate election, the QBU owner wouldn’t be required to track historic exchange rates.

Also, a taxpayer may elect to recognize its net unrecognized Section 987 gain or loss with respect to the QBU on an annual basis. QBU owners that make an annual recognition election wouldn’t be required to calculate the amount of a remittance with respect to a QBU under Section 1.987-5.

Whether to make both elections is also effectively another election.

The final regulations explicitly provide for other elections intended to simplify information collection, recordkeeping, or calculations:

• Section 987 QBU grouping election, which permits an owner to elect to treat all Section 987 QBUs with the same functional currency as a single QBU
• Election to use a spot rate convention, in lieu of using regular Section 988 rules
• Election to use the historic inventory method, instead of the simplified inventory method of Section 1.987-1(c)(3)(i)(B)
• Section 988 mark-to-market election, generally following the timing rules of Section 1256
• Section 988 characterization election for foreign personal holding income, which has better matching of Subpart F income

There are also two transition-related elections: the election to recognize pretransition Section 987 gain or loss ratably over the transition period, and the small business election, which permits an eligible owner to treat all QBUs that meet the requirements of Section 1.987-10(e)(7)(iii) as having no pretransition gain or loss.

Another election, the recurring transfer group election, is only proposed, but taxpayers can make it in anticipation of it becoming final. It permits a taxpayer that has made a current rate election to elect to use the yearly average exchange rate to translate assets that are transferred between a Section 987 QBU and its owner as part of a recurring transfer group.

Finally, some elections are implicit in the regulations. The most significant is how to treat partnerships that directly or indirectly hold QBUs—that is, whether to follow the aggregate or entity approach in applying the new rules to the QBU.

Taxpayers have discretion in making elections during the first year that the Section 987 elections apply. After that, the IRS must approve any decision to make or revoke an election. The exceptions are the current rate, annual recognition, and Section 988 mark-to-market elections, all of which have a separate five-year limitation.

Many of these elections are favorable, depending on the taxpayer’s specific situation. Still, a lot of modeling and “what if” analysis is necessary. Just remember to vote before the polls close.

This article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.

Author Information

John L. Harrington is co-leader of Dentons’ US tax practice and advises on transactions, compliance, and international and domestic tax issues.

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