Who this is for
- US self-employed people, partnerships and corporations paid in, or paying in, a foreign currency
- US businesses that keep a balance in a foreign currency
Not covered here
- Business or travel expenses paid in a foreign currency
- A business abroad whose functional currency is not the dollar
- Foreign-currency loans, forward contracts and options
- Whether an account abroad needs an FBAR
- What accounting standards require in financial statements
- An individual's personal, non-business currency transactions
What currency do my US books use, and at what rate do I record foreign amounts?
Keep the ledger in US dollars, and record each foreign amount at the spot rate on the day you receive it, pay it or accrue it. The IRS requires return amounts in dollars and says the dollar is the functional currency (the currency a business measures its results in) for every taxpayer except some qualified business units (QBUs): separate, clearly identified units of a business that keep their own books and records.
Keep the currency, the foreign amount, the date and the rate on every foreign line. Records must be sufficient to establish income and deductions.
On the cash method you book income when you actually or constructively receive it, at that day's rate. Money that an agent you authorize receives for you, or that is available to you without substantial restriction, counts then, so a later bank payout may not be the receipt date (IRS Publication 538). An invoice paid later therefore creates no exchange gain or loss; one appears when you later convert or spend foreign currency. On accrual books, an invoice paid later creates one too.
A foreign amount is simple only when it is paid the day it is booked. It is not simple when an invoice is paid weeks later, when you keep a balance in a foreign currency, when payouts in several currencies pile up unreconciled, when the exchange differences are large, or when earlier months were booked at one rate. Those cases create exchange gains and losses, covered below, and they are the ones where the rate, the method and the earlier months have to be settled together.
Gather: invoices showing currency and date, statements showing the rate and the dollars received, platform payout reports, and a note of where your rates come from.
Should I use the spot rate on the day or a yearly average?
Use the spot rate on the day. The IRS says to use the rate prevailing when you receive, pay or accrue the item. It has no official exchange rate and generally accepts any posted rate that is used consistently. Its rate sources include Treasury and Federal Reserve rates. If more than one rate applies, such as an official and a parallel rate, use the one that most properly reflects your income.
| Situation | Rate to use |
|---|---|
| Money arrives, is paid or is booked on a given day | The spot rate that day |
| A bank or platform converted the money | The dollars you actually received (26 CFR 1.988-2) |
| Invoices and bills for goods or services in the ordinary course | The spot rate that day, or a spot-rate convention set at intervals of one quarter or less, such as the month-end rate or a monthly average, if it is consistent with your financial accounting. Use the same convention for the dollars you treat as received or paid and for the basis of currency you receive. You cannot change it without IRS consent (26 CFR 1.988-1) |
| A yearly average from the IRS table | Generally not for anything settled later: an exchange gain or loss compares the rates on two dates, which one yearly figure cannot show |
What is Section 988, and does it apply to my business?
Section 988 of the Internal Revenue Code sets the tax rules for exchange gain or loss on foreign-currency transactions. It applies to a business with a dollar functional currency, which is every taxpayer except some QBUs, when the business does any of the following under 26 CFR 1.988-1:
- Sells, converts or spends foreign currency. The regulation calls it "nonfunctional currency" because it is not the dollar.
- Books income or an expense that will be paid or received later, in an amount stated in a foreign currency.
- Borrows or lends in a foreign currency, or enters a currency forward, futures or option contract.
What matters is the currency the amount owed is stated in. A sale priced and paid in dollars has no exchange gain or loss, even if the customer is abroad. For a marketplace sale, the platform's payout terms show whether you are owed the foreign amount or a fixed dollar amount.
This page covers selling, converting or spending foreign currency, and amounts paid or received later. Loans and currency contracts follow separate timing rules (26 CFR 1.988-2).
When do I have an exchange gain or loss: when I convert, spend or get paid later?
You have one when a foreign-currency invoice or bill is settled, or when foreign currency leaves your hands by conversion or payment. A rate that moves while you wait creates nothing yet. 26 CFR 1.988-2 sets the timing:
| Event | Exchange gain or loss? | Measured as |
|---|---|---|
| A foreign-currency invoice you issued is paid | Yes, on the payment date | Dollars at the payment-date rate minus dollars booked |
| A foreign-currency bill you owe is paid | Yes, on the payment date | Dollars booked minus dollars at the payment-date rate |
| You convert foreign currency to dollars | Yes, on the conversion | Dollars received minus the dollar basis of the currency (its dollar cost, or its value when you were paid, under your convention if you use one) |
| You swap one foreign currency for another | Yes, on the swap | Dollar value of what you receive at that day's rate minus the dollar basis of the currency you give up; that value generally becomes the basis of the new currency |
| You spend foreign currency on a purchase | Yes, on the purchase | Dollar value of the purchase at that day's rate minus the dollar basis of the currency used |
| You deposit foreign currency in a bank account, withdraw it, or move it between bank accounts in the same currency | No | Nothing is recognized |
| The rate moves while an invoice is open or a balance is held | Not yet | Nothing until it is settled or disposed of |
If you booked a bill earlier and pay it from a foreign balance, you have both: a gain or loss on the bill (booking-date rate against payment-date rate) and a gain or loss on the currency (its dollar basis against its value that day). Record each on its own line.
A business on the cash method does not recognize an unpaid invoice as tax income just because it was issued: it generally reports income when it actually or constructively receives it, at that day's spot rate. For the method itself, see cash or accrual for a small business.
What is the journal entry for a euro invoice or bill that is paid weeks later?
Record the invoice in dollars at the invoice-date rate, then book the difference on the payment date to a realized exchange gain or loss account, set up under other income and expenses, not sales. The journal entries are below; they are a bookkeeping method, not an IRS-prescribed entry. They assume accrual books and an accrual-method return, with the invoice or bill date also the date the item is taken into account for tax. If the tax date differs, use it; if your books and return use different methods, a preparer reconciles the two.
| Step | Debit | Credit |
|---|---|---|
| Invoice date | Accounts receivable, at the invoice-date rate | Sales, same dollars |
| Payment date, dollars received are less than dollars booked | Bank (dollars received) and exchange loss | Accounts receivable (dollars booked) |
| Payment date, dollars received are more than dollars booked | Bank (dollars received) | Accounts receivable (dollars booked) and exchange gain |
| Bill date | Expense or inventory, at the bill-date rate | Accounts payable, same dollars |
| Payment date, dollars paid are more than dollars booked | Accounts payable (dollars booked) and exchange loss | Bank (dollars paid) |
| Payment date, dollars paid are less than dollars booked | Accounts payable (dollars booked) | Bank (dollars paid) and exchange gain |
The regulation computes an invoice as the euros received times the payment-date rate, minus the euros received times the booking-date rate, and reverses the two rates for a bill. If the payment lands in a euro account instead of being converted, book the deposit at that day's spot rate, or at your convention rate if you use one. That dollar amount generally becomes your basis in those euros; a taxpayer with a convention sets that basis consistently with it, so a preparer should confirm the figure.
How do I record a foreign currency account where I keep a balance?
Track two numbers for each foreign-currency account: the foreign balance and its dollar basis, which is the dollars you paid for the currency or, for currency you were paid, generally its dollar value on the day you received it. Depositing foreign currency in a bank account in that currency, or moving it to another such account, creates no gain or loss. Paying someone with it, or converting it, does.
When currency leaves the account, the gain or loss is the dollar value received or spent minus the basis of the units used. The regulation allows any reasonable basis method applied consistently to all such accounts: first in first out, last in first out or pro rata. It rejects a method that consistently uses the highest-basis units first.
26 CFR 1.988-2 speaks of accounts with a bank or other financial institution. Whether a payment company's balance fits is a question for a preparer. To set up and reconcile those balances, see multi-currency payment balances in the books.
A balance held at a bank abroad may also need an FBAR once your foreign accounts together exceed $10,000 at any time in the year (FinCEN). See FBAR for company accounts abroad.
How do I record a currency conversion and its fees?
Measure the exchange gain or loss on the dollars before any fee the provider withheld, and record each fee as its own expense. Do not net a fee into sales or into the exchange gain or loss, so gross income stays visible and the fee line matches the provider's statement. Measuring on the net deposit and then also deducting the fee would count the fee twice.
| What the statement shows | How to record it |
|---|---|
| Converting a foreign balance you hold | Debit bank for the dollars received, debit fees for any fee withheld, and credit the foreign account at its dollar basis; the difference is the exchange gain or loss |
| Dollars deposited after the provider converted money owed to you | Bank for the net deposit, plus fees for any amount withheld; compare the total (the dollars before the fee) with the dollars booked to find the exchange gain or loss |
| A conversion, transfer or payout fee charged separately | Expense, such as bank or payment fees |
| A fee taken out of the payout before it reached you | The same expense; show the gross amount, the fee and the net deposit as three lines, and measure the exchange gain or loss on the gross amount |
| A markup built into the provider's rate | Nothing extra to book: it is already in the dollars you received |
To match payouts to sales, see reconciling sales and payouts.
Do I book unrealized gains or losses at year end for tax?
Not for the transactions on this page. For tax, 26 CFR 1.988-2 realizes an exchange gain or loss when a payable or receivable is paid or received, or when the currency is disposed of, not at the year-end rate.
An unpaid foreign invoice stays at the amount booked when it was issued. An unconverted balance stays at its dollar basis. A December invoice paid in January puts the gain or loss in the year of payment.
One narrow exception: an interest-bearing bank deposit in a hyperinflationary currency has an exchange gain or loss each year, and a depositor's loss on it first reduces that deposit's interest income; any excess stays an ordinary exchange loss (26 CFR 1.988-2). A currency is hyperinflationary when its country's cumulative inflation over the 36 months ending with the tax year is at least 100% (26 CFR 1.988-1). Ask a preparer if you hold one.
If your software posts a year-end revaluation entry, the tax figure comes from the realized amounts above, so a preparer should confirm how that entry is treated. What accounting standards require for financial statements is a different question and is not covered here.
Is the exchange gain or loss ordinary income, and where does it go on the return?
For the transactions on this page it is ordinary gain or loss, not capital (26 CFR 1.988-3). Some currency contracts can elect capital treatment; they are not covered here. The return instructions do not name exchange gain or loss, so a net gain generally goes on the other-income line and a net loss on the other-deductions line, with a statement listing the type and amount.
| Return | Net gain | Net loss |
|---|---|---|
| Schedule C | Line 6, other business income | Part V, other expenses (line 48) |
| Form 1065 | Line 7, other income (loss) | Line 21, other deductions |
| Form 1120-S | Line 5, other income (loss) | Line 20, other deductions |
| Form 1120 | Line 10, other income | Line 26, other deductions |
The line numbers come from the latest published return instructions and can change.
A large loss can trigger a disclosure. For an individual or trust, a Section 988 loss of at least $50,000 in one year, including a share passed through from a partnership or S corporation, may require Form 8886. Test the loss before offsetting gains or other income, and check the exclusions in Revenue Procedure 2013-11. If it is required, attach the form to the return and send an exact copy to the IRS Office of Tax Shelter Analysis (26 CFR 1.6011-4). A corporation, partnership or S corporation tests its own loss against much higher thresholds.
What if my business abroad uses a currency other than the dollar?
The dollar is the functional currency for every taxpayer except some QBUs, and even a unit that keeps its own books uses the dollar in several cases (IRS; 26 CFR 1.985-1). A foreign branch that qualifies for a local functional currency is outside this page: its functional currency, rates and Section 987 rules are in books for a business abroad.
Example
These examples are illustrative. Amounts are in US dollars (US$); euro (€) and pound (£) rates are per unit.
A euro invoice paid six weeks later
An Oregon LLC on the accrual method bills a German client €10,000 on March 1, when €1 = US$1.10. It books US$11,000 of sales and a US$11,000 receivable. The client pays on April 15, when €1 = US$1.06, and the bank converts the euros on arrival: US$10,600 is deposited.
The receivable closes at US$11,000, and the US$400 shortfall is an ordinary exchange loss. Net income from the job is US$10,600 either way. An LLC on the cash method books US$10,600 of income on April 15 and has no exchange loss.
Spending from a euro balance
A Delaware corporation holds €20,000 bought at €1 = US$1.10, so its dollar basis is US$22,000. It buys from a supplier and pays €5,000 at once, with no earlier bill, when €1 = US$1.04.
The purchase is booked at US$5,200 (€5,000 × 1.04). The basis of the euros used is US$5,500 (€5,000 × 1.10), so the corporation has a US$300 exchange loss, recorded apart from the purchase cost. The entry: debit the purchase US$5,200 and exchange loss US$300; credit the euro account US$5,500. The remaining €15,000 keeps a basis of US$16,500.
A marketplace sale in pounds
A Florida seller on the accrual method sells goods to a UK buyer through a marketplace for £8,000, and the marketplace owes her that pound amount. On the sale date £1 = US$1.25, so she books US$10,000. The marketplace later converts the pounds and pays out US$10,200 before its fees.
The receivable closes at US$10,000, and the extra US$200 is an ordinary exchange gain. The marketplace's fees are recorded separately as an expense.
Different for you?
- Payouts or invoices in several currencies pile up unreconciled, the exchange differences are large (a Section 988 loss near the Form 8886 line, for example), or earlier months were booked at one rate: the rate, the method and the restated months are bookkeeping work. Bring the invoices, statements showing conversion rates, and payout reports. For months or years that are behind, see catching up on overdue books.
- You paid business or travel expenses in a foreign currency: see expenses paid in a foreign currency.
- Your money sits in a multi-currency payment balance: see multi-currency payment balances in the books.
- Foreign clients pay you and send no tax form: see income from foreign clients without a tax form.
- Payouts do not match sales reports: see reconciling sales and payouts.
- The account is at a bank abroad: see FBAR for company accounts abroad.
- Your business abroad keeps books in the local currency: see books for a business abroad.
- You borrow or lend in a foreign currency, including with an owner or parent abroad, or hold a currency contract: the timing and character rules differ from the ones here. Have a tax professional read the agreement and the transfer records before it is booked (corporate tax for a company, individual tax for a sole proprietor); the entries are bookkeeping work.
- Your business is in Canada and holds a US-dollar account: see foreign exchange gain or loss on a USD account.
Figures on this page
| Figure | Value | Source |
|---|---|---|
| FBAR filing threshold Total maximum value of all foreign financial accounts at any time in the calendar year; an FBAR is required when the total is more than this | $10,000 | FinCEN: Report Foreign Bank and Financial Accounts Checked |
| Cumulative inflation at which a currency is hyperinflationary for Section 988 Cumulative inflation of at least this share over the 36 calendar months ending on the last day of the taxpayer's current taxable year | 100% | eCFR: 26 CFR 1.988-1, Certain definitions and special rules (paragraph (f), referring to 26 CFR 1.985-1(b)(2)(ii)(D)) Checked |
| Form 8886 loss threshold for an individual or trust's Section 988 foreign currency loss in one tax year Loss from a Section 988 transaction in a single tax year, including a loss passed through from a partnership or S corporation; larger thresholds apply to other loss transactions | $50,000 | IRS: Instructions for Form 8886 (Loss Transactions) Checked |
Primary sources
- IRS: Foreign currency and currency exchange rates
- IRS: Yearly average currency exchange rates
- eCFR: 26 CFR 1.988-1, Certain definitions and special rules
- eCFR: 26 CFR 1.988-2, Recognition and computation of exchange gain or loss
- eCFR: 26 CFR 1.988-3, Character of exchange gain or loss
- eCFR: 26 CFR 1.985-1, Functional currency
- eCFR: 26 CFR 1.6001-1, Records
- IRS: Publication 538, Accounting Periods and Methods
- IRS: Instructions for Schedule C (Form 1040)
- IRS: Instructions for Form 1065
- IRS: Instructions for Form 1120-S
- IRS: Instructions for Form 1120
- IRS: Instructions for Form 8886
- eCFR: 26 CFR 1.6011-4, Requirement of a statement disclosing participation in certain transactions
- FinCEN: Report Foreign Bank and Financial Accounts
About this guide
Published by Cloud Accounting under standing professional approval. This version has no separately recorded personal review. It explains general rules for the tax year shown. It is not advice for your situation.
Changes
- : First published.