Introduction: Section 987 and the UK Company You Thought Was Simple
Section 987 taxes the movement in sterling against the dollar inside your UK business, and it does so even though HMRC taxes none of that movement at all. Consequently, an American running a profitable London company can face a US tax bill on a gain that exists nowhere in the company's accounts, nowhere on its corporation tax return and nowhere in its bank statements.
The rule has been law since 1986. However, it only became genuinely unavoidable in the last two years, because the final regulations published in December 2024 apply to tax years beginning after 31 December 2024. Therefore, 2026 is the second live year, and it is the first in which most affected filers will actually notice.
At TaxYork we see the same pattern repeatedly. A founder incorporates a UK limited company, files a check-the-box election to keep the American side simple, and inadvertently creates a qualified business unit with a sterling functional currency. As a result, Section 987 switches on. This guide explains what it taxes, how to compute it, which elections cut the work, and why the answer for most Americans in Britain is far better than it first appears.
What Section 987 Actually Taxes
Section 987 taxes the currency gain or loss that arises because your business keeps its books in one currency while you are taxed in another. Specifically, it applies where you own a qualified business unit, commonly called a QBU, whose functional currency differs from your own.
Your functional currency as a US individual is the dollar. Meanwhile, a genuine trading business in London has a sterling functional currency. Therefore, the gap between the two must be measured, and Section 987 is the provision that measures it.
The statutory text sits at 26 US Code section 987. Notably, the section is short. The complexity lives entirely in the regulations underneath it.
Why Americans in Britain Get Caught
Most guidance on this topic addresses tax directors at multinational groups. Accordingly, it assumes a corporate structure, a treasury function and a dedicated compliance team. Individual Americans running UK companies receive almost no attention, yet they are squarely within the rules.
The IRS confirms the point in its own training material. Indeed, its practice unit on branch operations in a foreign currency works through the case of a disregarded entity owned directly by a US taxpayer, not by a corporation. Therefore, sole founders are not an edge case.
Which UK Structures Create a Section 987 QBU
Not every UK business triggers Section 987. The trigger is a QBU with a functional currency other than the dollar, so the structure you chose years ago determines the answer today.
The Check-the-Box Election That Starts It
The most common trigger among our clients is a single-member UK limited company that has filed Form 8832 to be treated as a disregarded entity. That election is usually made for good reasons. Specifically, it avoids the controlled foreign corporation regime, removes Form 5471, and pushes the UK corporation tax onto your personal return where it can generate a foreign tax credit.
However, the election has a consequence that rarely gets mentioned at the time. Once the company is disregarded, its sterling-denominated trade becomes your sterling-denominated trade. Consequently, you own a QBU, and Section 987 applies from that moment.
Foreign Branches and Unincorporated Trades
A US person carrying on a UK trade without any company at all can also hold a QBU. For instance, an American consultant operating as a sole trader in London, keeping sterling books and a sterling business account, meets the definition.
The regulations require a separate set of books and records and a trade or business. Therefore, casual freelancing invoiced in sterling from a personal account will usually fall short. Nevertheless, the boundary is fact-sensitive, and we test it rather than assume it.
What Does Not Trigger Section 987
A UK company that has not checked the box remains a corporation for US purposes. Accordingly, it is a controlled foreign corporation, and Section 987 does not reach you personally. Instead, the company's own currency position is dealt with inside the corporate rules.
Personal foreign currency holdings sit outside this regime too. Specifically, gains on a personal sterling bank account fall under section 988, which is a separate provision with separate consequences. Confusing the two produces the wrong answer on both.
How Section 987 Gain Is Calculated Under the 2024 Regulations
The final regulations on currency gain or loss with respect to a qualified business unit impose a method practitioners call the foreign exchange exposure pool, or FEEP. Broadly, it measures your currency exposure annually and then recognises a slice of it when money actually comes out of the business.
Marked Items Versus Historic Items
The method begins by splitting the QBU's balance sheet in two. Firstly, marked items are financial assets and liabilities such as cash, receivables and payables, translated at the year-end spot rate. Secondly, historic items are non-financial assets such as equipment and intangibles, translated at the rate on the date they were acquired.
Currency exposure attaches to the marked items. Therefore, a consultancy holding most of its value in a sterling bank balance carries far more Section 987 exposure than a business whose value sits in fixed assets. This distinction alone explains why service businesses in London generate the largest numbers.
The Annual Pool and the Remittance Trigger
Each year you compute a net unrecognised Section 987 gain or loss and add it to a running pool. Importantly, nothing is taxed at that stage. The pool simply accumulates.
Recognition happens on a remittance, which means a transfer of money or property from the QBU back to you, or on termination of the QBU. Consequently, drawing profits out of your UK business is the taxable event. The IRS practice unit states the position plainly, confirming that a remittance triggers recognition and that termination can do the same.
The Transition Computation Nobody Can Skip
Every taxpayer within the rules had to perform a pre-transition computation under Treasury Regulation section 1.987-10, translating the QBU balance sheet at the spot rate on the day before the transition date. For calendar-year filers that date was 1 January 2025.
This step is mandatory. Furthermore, it applies regardless of which simplifying election you later choose, and regardless of what method you used before. Therefore, a 2026 return prepared without a 2025 transition computation behind it is built on sand.
The Elections That Cut the Work Under Section 987
Three elections reduce the burden substantially, and choosing correctly matters more than the underlying computation for most individual filers.
The Current Rate Election
The current rate election translates all of the QBU's income, deductions, gains and losses at the yearly average exchange rate, with the balance sheet translated at year-end spot rates. Consequently, it removes the need to track historic acquisition rates item by item.
For a founder-run consultancy this election is usually the right answer. Additionally, it aligns the US computation closely with the sterling figures already prepared for Companies House and HMRC, which reduces both cost and error.
The Annual Recognition Election
The annual recognition election lets you recognise the whole net unrecognised Section 987 gain or loss each year, whether or not any remittance occurs. At first glance that sounds worse, because it accelerates tax. However, it can be decisively better.
The reason is the foreign tax credit limitation, explained in the next section. Moreover, annual recognition removes the pool entirely, so you never face a single large catch-up charge when you eventually sell the business or leave Britain.
Notice 2026-17 and the Equity and Basis Pool Method
Treasury previewed further simplification on 25 February 2026. Specifically, Notice 2026-17 announces proposed regulations offering an equity and basis pool method, which computes a single annual net remittance rather than tracking daily conventions.
The notice also relaxes the loss suspension rules. Under the previewed approach, suspension bites only where the remittance proportion exceeds five per cent annually or the potential suspended losses exceed five million dollars, tested per QBU rather than in aggregate. Therefore, the overwhelming majority of individual founders escape loss suspension entirely.
Taxpayers may rely on the notice for tax years beginning after 31 December 2024. Nevertheless, the FEEP method remains the default, so the simplification only applies if you elect into it.
The Trap Nobody Writes About: No UK Tax Means No Credit
Here is the point that every competing article misses, because every competing article is written for corporations rather than for Americans living in Britain.
HMRC Computes Everything in Sterling
British corporation tax is a sterling tax. HMRC's guidance is unambiguous on this, stating in CFM64100 that profits are computed in sterling, with the underlying rules sitting in the currency provisions of the Corporation Tax Act 2010.
Consequently, a UK company with a sterling functional currency records no currency gain whatsoever on its own equity. There is nothing for HMRC to tax. Therefore, the Section 987 gain is a purely American artefact, and no UK tax exists to credit against it.
Why the Limitation Rescues Most Filers Anyway
Fortunately, the analysis does not end there, and the conclusion is genuinely favourable. Under Treasury Regulation section 1.987-6, Section 987 gain is ordinary income, and its source and separate category follow the assets of the QBU using an asset method.
For a UK trading business, those assets are overwhelmingly foreign-source and general category. Accordingly, the gain increases your foreign-source general basket income without carrying any foreign tax with it. That raises your section 904 limitation, which lets you absorb excess UK credits that would otherwise expire unused.
In practice, therefore, a highly taxed American in Britain frequently pays no incremental cash tax on a Section 987 gain at all. Instead, the gain quietly rescues credits that were heading for waste.
Losses Cut the Other Way
The mirror image is unwelcome. A Section 987 loss reduces foreign-source general basket income, shrinks the section 904 limitation and can strand UK credits you were relying on.
Consequently, the direction of sterling matters to your credit position even in years when your business performance is unchanged. Furthermore, this asymmetry is precisely why the annual recognition election deserves a deliberate decision rather than a default.
Structure, Reporting and Penalties
Getting Section 987 right is inseparable from getting the surrounding structure and forms right, because the same election that creates the exposure drives the reporting.
Check the Box, or Do Not
The structural choice is a genuine trade-off rather than an obvious win. Leaving the UK company as a corporation keeps Section 987 away from your personal return, but exposes you to the net CFC tested income rules and Form 5471. Our guide to the Section 962 election for US owners of UK companies covers that route in detail.
Checking the box removes those problems and delivers a clean foreign tax credit on UK corporation tax, charged at 25% above £250,000 of profits with marginal relief between £50,000 and that threshold. However, it creates a QBU. Therefore, we model both routes together rather than treating the currency question as an afterthought.
Form 8858 and the Cost of Missing It
A US person owning a foreign disregarded entity or a foreign branch files Form 8858 annually, and Schedule C-1 of that form reports Section 987 gain or loss. Our detailed guide to Form 8858 for Americans running a UK business walks through completion.
The penalty for failure is $10,000 per form per year. Additionally, a further reduction of foreign tax credits can apply, which for high earners paying substantial UK tax is frequently the more expensive consequence.
Exchange Rates and Evidence
Rate selection is a common audit point, so use published sources rather than a bank app. The IRS publishes yearly average currency exchange rates, and its 2025 average for sterling is 0.759 pounds to the dollar, equivalent to roughly $1.32 per pound.
Spot rates matter too, because marked items and remittances translate at spot. The US Treasury publishes its own reporting rates of exchange, which is a defensible quarter-end source. Therefore, we document the rate source contemporaneously for every remittance rather than reconstructing it later.
A Worked Case Study: A London Consultancy and a £400,000 Draw
Consider Ben, a US citizen resident in London who owns a UK limited company running an advisory practice. Ben filed Form 8832 in 2021, so the company is disregarded and constitutes a QBU with a sterling functional currency.
The Position Before the Remittance
At 1 January 2026 the QBU holds net marked items of £1,000,000, largely cash and receivables, and the spot rate is $1.25 to the pound. By 31 December 2026 the spot rate has moved to $1.35. Consequently, the year's net unrecognised Section 987 gain is approximately $100,000, being the £1,000,000 exposure multiplied by the ten cent movement.
Nothing is taxable yet. The gain sits in the pool, and Ben's UK corporation tax return shows no such figure, because HMRC computed everything in sterling from the outset.
The Remittance and the Recognised Gain
During 2026 Ben draws £400,000 out of the company. On these facts the remittance represents roughly forty per cent of the QBU's value, so approximately $40,000 of the pooled gain becomes recognised. The precise figure follows the regulatory steps rather than this simplification, but the order of magnitude holds.
That $40,000 is ordinary income, foreign-source, and general category. At a 37% marginal rate it carries $14,800 of US tax. Meanwhile, the UK charge on the same amount is precisely nil.
Why Ben Pays No Extra Cash Tax
Ben also draws a £150,000 salary from the business and pays substantial UK tax on it, leaving him with excess general basket foreign tax credits each year. Because the Section 987 gain adds $40,000 of foreign-source general basket income carrying no foreign tax, it lifts his section 904 limitation by $14,800.
Consequently, $14,800 of previously unusable UK credits now absorb the charge, and Ben's cash tax does not move. Had sterling fallen instead, the resulting loss would have shrunk his limitation and stranded roughly the same amount of credit. Therefore, the planning point is the election, not the exchange rate.
Fixing Missed Section 987 Years
Many owners discover this regime late, typically when a US accountant reviews the structure during a sale or a mortgage application.
The Usual Pattern
The typical file we inherit shows a check-the-box election filed years ago, no Form 8858 in any year, and no transition computation. Consequently, three separate problems need fixing at once, and the currency computation is rarely the hardest of them.
Furthermore, the reporting failure is generally the larger exposure. Penalties attach to the missing form rather than to the tax, which is often nil once credits are applied.
The Routes Back Into Compliance
Where the failures were non-wilful, the IRS Streamlined Filing Compliance Procedures remain the principal route, and our IRS Streamlined Filing service prepares the returns, the information forms and the certification together. Additionally, our FBAR and FATCA reporting service covers the account reporting that a UK company invariably triggers alongside.
Professional standards guidance from the ICAEW, the Chartered Institute of Taxation and AICPA and CIMA informs how we document every position taken on a late filing.
How TaxYork Can Help With Section 987
We prepare both sides of the return for Americans who own UK businesses, which means the currency computation and the corporation tax computation are done by the same team.
What We Do
Firstly, we determine whether you hold a QBU at all, because a meaningful minority of referrals turn out not to. Secondly, we run the transition computation and rebuild the pool from the correct starting point. Thirdly, we model the current rate and annual recognition elections against your actual credit position rather than against a generic assumption.
What We Watch For
We test the interaction with your foreign tax credit limitation every year, since that is where the real money sits. Furthermore, we review the check-the-box position periodically, because a structure that suited a £200,000 business rarely suits a £2,000,000 one. Our tax treaty optimisation service and US tax return preparation for expats run alongside this work.
Conclusion
Section 987 is unavoidable if you own a UK business through a disregarded entity, and the 2024 regulations removed any remaining ambiguity about that. Therefore, the question is no longer whether it applies but how you elect.
The reassuring news is that the outcome is usually benign. Because the gain is foreign-source, general category and unaccompanied by any UK tax, it typically expands your foreign tax credit limitation and absorbs credits that would otherwise expire. Consequently, the taxpayers who suffer are those with currency losses and those with little UK tax to credit.
Ultimately, treat this as an elections exercise rather than an arithmetic one. Get the transition computation right, choose the elections deliberately, file the Form 8858, and the rest follows.
Contact Us
To review whether your UK company creates a QBU, to run the transition computation, or to fix missed years, contact us or book a consultation with our cross-border team.
Email hello@taxyork.com or call 020 3488 8606. We act for American founders, investors and company owners in Britain, and we handle the US and UK filings together.
Disclaimer
This article provides general information about Section 987 and the taxation of currency gains for US owners of UK businesses. It does not constitute tax advice and should not be relied upon in place of professional guidance tailored to your circumstances. The figures in the case study are illustrative, and the regulatory computation must be performed in full. Tax rules change, and the positions described reflect published guidance at the date of writing. Always obtain specific advice before acting.
Written by the TaxYork Expert Team — US-UK tax specialists.