July 11, 2022 - Douglas Myser

1256 Foreign currency contracts defined. The proposed regulations by the IRS and Treasury Department defined the mark to market rules that would be defined as only including forward contracts. The new definition, which would be added at Regulations Section 1.1256(g)-2, would define a foreign currency contract within the meaning of Section 1256 as one that requires the delivery of, or the settlement of which depends on the value of, a foreign currency that is traded in the interbank market. The contract must also be entered into at arm's length at a price determined by references to the price in the interbank market. 1256 Foreign currency contracts defined.

The past 38 years of developments in foreign currency trading and Section 1256, which provides mark to market tax treatment of specified contracts, indicated that need for the more specific definition, the preamble to the proposed regulations states. In addition, the proposed regulations would overrule a Sixth Circuit Decision in 2016 that in effect included foreign currency options as Section 1256 contracts. Congress intended, in amending Section 1256 in the Deficit Reduction Act of 1984, P.L. 98-369, to include cash settled foreign currency forward contracts within that section's definition of a foreign currency contract, in addition to the section's original (1981) requirement of delivery of the currency, thus adding contracts settled by reference to the currency's value, the preamble explains.

However, the legislative history of Section 1256 does not indicate Congress intended to include over the counter foreign currency options regardless of whether they may be cash settled. Therefore, "it would be inconsistent with this purpose to construe the term foreign currency contract as including options or other derivatives," the preamble states.

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