- Rules for determination of amount, timing, character and source of foreign currency gains and loss are present in code section 988. Following transactions are included in code section 988.
- Disposition of nonfunctional currency.
- Transactions where the taxpayer lends or borrows funds through the use of a bond, debenture, note, certificate or other evidence of indebtedness.
- Transactions where the taxpayer accrues an item of income or expense that will be received or paid at a future date, including a payable or receivable relating to a capital expenditure.
- Transactions where the taxpayer enters into a forward contract, futures contract, currency options or similar financial instrument.
- Code section transactions do not include any transactions entered into by an individual unless the transaction is related to a business or investment activity.
- The entire amount of gain or loss arising from a foreign currency transaction involving a debt instrument, receivables or payables is treated as a foreign currency gain or loss only to the extent it is attributable to a change in exchange rates that occurs between the transaction’s booking date and the payment date.
- If an average exchange rate is consistent with the taxpayer’s financial accounting, the taxpayer can elect to use that average exchange rate, based on intervals of one quarter year or less, to both accrue and record the receipt and payment of amounts in satisfaction of trade receivables and payables that are denominated in a nonfunctional currency.
Tax Consequences:
- If a domestic corporation with the U.S dollar as its functional currency makes a sale on account that is denominated in a foreign currency, the gross profit from the sale is recognized separately from any foreign currency gain or loss arising from an account receivable that is denominated in the foreign currency.
- Foreign currency gains and losses attributable to a code section 988 transactions are treated as ordinary income or loss, and are sourced by reference to the residence of the taxpayer or the QBU of the taxpayer on whose books the underlying asset, liability, or item of income or expense is properly reflected. For purposes of this source rule, a U.S resident is any corporation, partnership, trust, or estate that is a U.S person, as well as any individual who has a tax home in the United States.
Hedging Transactions:
A hedge and hedged transaction qualify for integration treatment only if they meet the definitional requirements of code section 988 hedging transactions. Code section 988 includes following 3 categories of hedging transactions:
Hedged Debt Instruments
These include hedges associated with transactions in which the taxpayer lends or borrows funds through the use of a bond, debenture, note, certificate, or other evidence of indebtedness.
Hedged executory contracts for goods and services
These include hedges involving executory contracts to pay or receive nonfunctional currency in the future with respect to the sale or purchase of property or services in the ordinary course of the taxpayer’s business.
Hedge for the period between the trade and settlement dates on the purchase or sale of a publicly traded stock or security.
Foreign currency transactions for personal use:
Foreign currency gains realized by an individual from the disposition of foreign currency in a personal transaction are not taxable, provided that the gain does not exceed $200. Note that the threshold is $200 per transaction, as opposed to cumulative gains of $200 per year.
References:
Practical Guide to US Taxation of International transactions 9th Edition
Robert J. Misey Jr.
Michael S. Schadewald
Publishers: Wolter Kluwer, CCH Incorporated.