IRS issues proposed regs under Section 1256


The IRS recently issued proposed regulations (REG-130675-17) providing that only a forward contract on certain foreign currency is a “foreign currency contract” for purposes of Section 1256.


Section 1256 governs the timing of income with respect to certain specified “Section 1256 contracts.” Specifically, Section 1256(a)(1) requires that each Section 1256 contract held by the taxpayer at the close of a taxable year is subject to mark-to-market with gain or loss taken into account for such taxable year.


The term “Section 1256 contract” includes any “foreign currency contract” as defined in Section 1256(g)(2). A “foreign currency contract” is defined in the statute as a contract that:

  • requires the delivery of, or the settlement of which depends on the value of, a foreign currency which is a currency in which positions are also traded through a regulated futures contract,
  • is traded on the interbank market, and
  • must further be entered into at arm's length at a price determined by reference to the price in the interbank market.


Some taxpayers entered into tax avoidance transactions that relied upon treating foreign currency options as foreign currency contracts under Section 1256. The IRS published Notices 2003-81 and 2007-71 in response. Notice 2003-81 initially described the transactions and identified them as listed transactions. Notice 2007-71 modified and supplemented the prior notice. The IRS also stated in Notice 2007-71 that foreign currency options could not be foreign currency contracts under Section 1256.


The IRS successfully challenged the merits of the listed transactions in three cases in the Tax Court: Summitt v. Commissioner (134 T.C. 248 (2010)), Garcia v. Commissioner (T.C. Memo 2011-85), and Wright v. Commissioner (T.C. Memo 2011-292). The Tax Court held in each case that a foreign currency option was not a foreign currency contract under Section 1256.


The taxpayer in Wright, however, appealed the Tax Court’s ruling, and the Sixth Circuit subsequently reversed the Tax Court’s holding that a foreign currency option could be a foreign currency contract under Section 1256 (809 F. 3d 877 (6th Cir. 2016)). The Sixth Circuit noted, however, that Treasury and the IRS had the authority to prescribe regulations to exclude any type of contract from the definition of foreign currency contract if the inclusion was inconsistent with the purposes of Section 1256.


The preamble of the recently issued proposed regulations discusses the legislative history of Section 1256 and states that it would be inconsistent with the purpose of Section 1256 to include options in the definition of foreign currency contract.


The proposed regulations are effective for contracts entered into on or after the date that is 30 days after they are adopted as final regulations. A taxpayer may relay on the proposed regulations for taxable years ending on or after July 6, 2022, provided the taxpayer and its related parties consistently follow the proposed regulations.



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