Treatment of Foreign Currency Transactions under §988 and §987
- Graziano Stefanelli
- Aug 16
- 2 min read
U.S. tax rules under §988 and §987 govern the recognition and character of gains and losses from foreign currency transactions and branch operations, affecting both timing and sourcing of taxable income for multinational corporations.
§988 applies to foreign currency transactions and debt instruments.
A §988 transaction includes acquiring or disposing of debt instruments, accruing or paying interest, or entering into forward contracts denominated in a nonfunctional currency. Functional currency is generally the U.S. dollar for domestic corporations, or the local currency for qualified foreign subsidiaries.
Gains and losses from §988 transactions are generally treated as ordinary income or loss, preventing capital-loss limitation issues. They are recognized when the transaction is disposed of, settled, or otherwise terminated.
Example — foreign currency loan repayment.
U.S. corporation borrows €10 million when €1 = $1.20.
Repays loan when €1 = $1.10.
Dollar repayment decreases from $12 million to $11 million → $1 million ordinary §988 gain.
§987 addresses foreign branch currency translation.
When a qualified business unit (QBU) maintains its books in a functional currency different from its owner’s, §987 requires annual translation of branch income into the owner’s functional currency. It also recognizes gain or loss on the branch’s net investment when remittances occur, based on changes in exchange rates since earnings were generated.
Deferred §987 regulations and transition rules.
Final §987 regulations, initially effective in 2018, have been deferred multiple times, with temporary rules allowing taxpayers to use a reasonable method for translating QBU income and remittances until the regulations become effective. Compliance often requires detailed tracking of historic exchange rates for branch assets and liabilities.
Journal entries — recognizing §988 gain and §987 translation adjustment.
§988 gain on loan repayment:
Dr Foreign Loan Payable $12 000 000
Cr Cash $11 000 000
Cr §988 Gain $1 000 000
§987 branch remittance adjustment:
Dr Cash $5 000 000
Cr §987 Translation Gain $300 000
Cr Intercompany Receivable $4 700 000
Planning considerations for foreign currency exposure.
Match currency of income and expenses: Reduce §988 volatility by aligning transaction currency with functional currency.
Use natural hedges or derivatives: Offset exposure while maintaining ordinary treatment.
Track branch net investment precisely: Ensure accurate §987 gain/loss computation on remittances.
Monitor regulatory changes: Be prepared for mandatory adoption of §987 final rules.
Consider sourcing rules: §988 gains/losses generally sourced by residence of taxpayer, affecting FTC limitation calculations.
Coordinated management of §988 transaction exposure and §987 branch translation effects can stabilize taxable income, reduce volatility in effective tax rates, and align currency results with broader corporate treasury strategies.
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