IRS Code Section 987 provides rules for determining the amount of income or loss recognized by a U.S. taxpayer with a Qualified Business Unit (QBU) whose functional currency is different from the U.S. dollar.
Understanding IRC Section 987
IRC section 987 is crucial for U.S. taxpayers with foreign operations. It dictates how to calculate taxable income when a foreign branch or QBU uses a functional currency other than the U.S. dollar.
Key Aspects of Section 987:
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Functional Currency: A QBU must determine its functional currency, which is generally the currency of the economic environment in which a significant part of the QBU's activities is conducted.
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Separate Computation: Income or loss is calculated separately for each QBU using its functional currency. According to IRC section 987, when calculating foreign income taxes for foreign tax credit purposes, taxpayers with one or more branch or other qualified business unit (QBU) with a functional currency other than the U.S. dollar compute income or loss separately for each QBU using the QBU's own functional currency.
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Translation to U.S. Dollars: After calculating income or loss in the QBU's functional currency, it's translated into U.S. dollars for U.S. tax purposes.
Examples of How Section 987 Applies:
Let's say a U.S. company has a branch in the Eurozone (a QBU) whose functional currency is the Euro. The branch's income and expenses are tracked in Euros.
- Income Calculation: The branch calculates its income in Euros based on Euro-denominated sales and expenses.
- Translation: That Euro-denominated income is then translated into U.S. dollars using specific exchange rates, as determined by IRS guidelines.
Why is Section 987 Important?
Without Section 987, there could be significant complexities and potential tax avoidance opportunities in translating foreign currency transactions. It ensures that the economic reality of a foreign QBU's operations is reflected in the U.S. tax return.
Considerations
- Complex Rules: The regulations under Section 987 are complex and require careful analysis.
