One common concern that US taxpayers overseas have, is that the IRS may tax cash in bank accounts. Fortunately, cash in the bank is usually considered to be “post tax”, meaning it assumed that the cash was taxed when the income was earned, as opposed to tax on bank balances.

But, in what circumstances may US tax exist on bank balances, and when does the IRS consider income to be earned and US tax to apply?

Section 988 of the US Tax Code

As with all US tax rules, the origin exists in the US tax code.

Section 988 covers Foreign Currency Gains, which occur when a US taxpayer transacts or holds one currency, which appreciates or depreciates against the US dollar.

Generally speaking, all US citizens are deemed to have the US dollar as their “functional currency”. This means that the IRS looks at a taxpayers financial circumstances in USD, even if they live abroad, and are earning and saving in a different currency (ie NZD).

This means that fluctuations in the exchange rate between the USD and other currencies, can result in taxable foreign currency gains (FX gains).

Section 988 of the US tax code governs what types of transactions may be considered for foreign currency gains. We’ll go further into when a transaction is considered for Section 988 further into the article, but first let’s establish what a foreign currency gain actually is.

Here’s a basic example:

1st January - US citizen holds $1000NZD - worth $600USD using USD/NZD exchange rate on 1st January

31 December - This $1000NZD is now worth $650USD using USD/NZD exchange rate on 31st December

In this case; we have an unrealised foreign currency gain of $50USD.

As you can see above, the NZD amount has remained the same, but because the IRS only looks at the taxpayers functional currency (USD), then we now have more USD than we did at the beginning of the year.

What types of Personal Transactions Does Section 988 Cover For Foreign Currency Gains

From this point onwards, we’ll refer to foreign currency gains by their shortened term, FX gain.

Fortunately, under Section 988 of the US Tax Code, many forms of personal transactions are excluded from US taxation on FX gains.

However, certain types of transactions can result in US taxation of the FX gain. These include:

• Loans and other debt instruments

This can include transactions such as foreign denominated mortgages (ie an NZD mortgage).

This calculation can be complex, but in basic terms an FX gain on a mortgage can look like this:

• $700,000 NZD mortgage - $450,000USD on the date the mortgage was entered into

• One year later, mortgage paid off in full - USD/NZD exchange rate on date it was paid off means the mortgage was $400,000USD

In the above situation, the IRS views that the USD value of the mortgage dropped by $50,000, and as a result we have taxable income.

We do have an article expanding on this issue here.

• Futures Contracts and similar fixed term investments

Similar to a debt instrument, a financial instrument that results in money being invested and repaid at a later date, can result in FX gains for US tax purposes.

An example of this is when a US citizen purchases bonds:

• Bond Purchased - $1000NZD, $650 USD

• Bond Matures - $1000NZD, $700 USD

Again, here we have $50 of US taxable income. This has come entirely from the fluctuation between NZD/USD during the period the bond was held.

Obtaining good US tax advice from an NZ based US tax consultant is important to ensure that FX gains are planned for effectively.

Will I pay US Tax on Buying and Selling Foreign Currencies?

Most likely, no. However, there are some caveats to this.

Whilst ordinarily, buying, holding or selling foreign currencies can result in FX gain or loss, there is an exception for personal transactions.

Although personally held debt instruments and futures investments are subject to US taxation on FX gains or losses, there is a carve out for personal transactions involving buying, selling and holding foreign currencies.

This means that for your average individual who holds come foreign currency ready for an upcoming holiday, or has savings overseas, we don’t need to worry about Sec. 988 and US tax.

Whilst FX gains on personal disposal of a foreign currency are excluded from US tax, this also means that losses are not claimable.

For example, if a US person were to purchase

• £5000 GBP ready for a holiday to the UK, which cost them $7,000USD

• The holiday didn’t go ahead, and they sold the £5000 GBP back; but only got $6,000USD

Just as FX gains on personal disposal transactions are not taxable in the US, neither is the $1000 USD loss in the transaction above.

Do Currency Traders Pay US Tax on FX Gains or Losses

Whilst personal currency disposal transactions are excluded from FX gain or loss taxation under Sec 988 of the US tax code, there are similar rules to New Zealand for those who professionally buy and sell currencies.

For those who purchase foreign currencies with the intention of selling for a profit, will generally be caught under the “trader rules” of the US tax system. These individuals do pay tax on their earnings, however also have the benefit that losses are deductible.

It is crucially important to obtain expert US tax advice in this area, which is particularly complex.

Foreign Currencies Held By NZ Companies Or Self-Employed Individuals

Where things change is when business is involved.

For US persons in New Zealand, who operate a New Zealand Ltd company, we no longer have the personal “carve out” mentioned above.

In this case, the New Zealand business is reported on the US tax return of the US person owner, through Form 5471. This form tracks the income, expenses, balance sheet, P+L along with much more information for the NZ company.

But, we introduce here some new concepts.

Firstly, as mentioned above, ordinarily the IRS always treats the USD as the functional currency of a US person. But for a foreign business (even if it is 100% owned by the US person), may have a different functional currency.

This means that the IRS can accept that the business is trading and exists in NZD, as opposed to USD.

It’s important to note at this stage, there are many complexities to how the functional currency is arrived at, and it is important to obtain professional US tax advice if further insight is needed into this subject.

But anyway, moving on…

For your average New Zealand Ltd company which is 100% owned by a US citizen, we may have no FX gains or losses at all.

If for example, all of their clients are in New Zealand and all of their bank accounts are in NZD, then we have no interaction with foreign currencies and no need for 988 to apply.

But, where there is interaction, we’re now looking at a few additional concepts. If we have an NZ business which has clients in Australia, we have multiple different moments where a Sec 988 transaction may exist:

A) Invoices - The currency fluctuation between the invoice issue date and payment date, does create taxable FX gain or losses. Here’s an example:

1. Invoice issue date - $5000 AUD - NZD functional currency amount $5500 NZD using spot exchange rate on the day

2. Invoice paid date - $5000 AUD - NZD Functional currency amount $5700 NZD using spot exchange rate on date of payment

In this example above, we have $200 NZD of FX gain, due to the difference between invoice issue and payment.

B) Cash in the bank - Going back to the origins of this article, we can now have FX gains or losses on cash held in the bank. Here’s an example:

1. $5000 AUD held in a Wise Business account - Was worth $5500 NZD on the date it went into the account

2. Later that year, the $5000 AUD is withdrawn, and converted to $5900 NZD

Here, as you can see, we have $400 NZD in FX gains due to “housing” the foreign currency.

Are FX Gains for NZ Ltd Companies subject to US Tax Twice?

Fortunately no, but we do have two different tax events.

The first is the difference between the invoice issue date and payment date. The second is the difference between the exchange rate on the date the foreign currency arrives in the bank account and the date it is eventually withdrawn to NZD (or otherwise disposed of).

Are Self-Employed US Citizens Subject to US Tax on FX Gains?

Yes, although this happens through a different section of the US tax code - Section 987.

This is a much more complex system, with the US regulation only finalised by the IRS in December 2025. We have written an article on the subject here.

Most forms of New Zealand self-employment for US citizens, are treated as a QBU - Qualified Business Unit. A QBU is treated as a separate entity from its owner.

So, for those who are self-employed, even though no entity exists (ie an NZ company), their self-employment business is considered to be an entity separate to the individual.

It is important to note again, that QBU treatment and rules are especially complicated, and not all self-employment businesses fall under these rules. Obtaining US tax advice from a qualified US tax consultant is essential when attempting to plan for NZ based self-employment.

But anyway, back to 987.

The basic difference with Sec. 987 for a self-employed US citizen in New Zealand, is that FX gains or losses are captured on transactions between the QBU (ie the business) and the owner (the US citizen who is self employed).

Confused? We’ll try to explain further.

US Citizen - Functional Currency is USD

NZ QBU - Functional Currency is likely NZD

So, 987 captures transfers between the owner and the QBU, and also the unrealised gains on any bank accounts held by the QBU as at the beginning and the end of the year.

In short, FX gains do exist for self-employed individuals, but in a very complex calculation.

Here’s an example of an FX gain under section 987, for a self-employed US individual living in New Zealand:

1st January - NZD in bank account - $10,000 - Worth $7000 USD using the exchange rate on the day

31 December - NZD in bank account - still $10,000 NZD, worth $8000 USD using the exchange rate on the day

Unrealised gain - $1000USD - this is unrealised as it hasn’t been withdrawn.

But let’s say the US person also paid $20,000 of income to themselves throughout the year.

In this case, we work out a complex calculation, which recognises a small portion of the unrealised gain ($1,000), but not all of it. In this example, let’s assume the ratio fell to 0.055 (this is calculated based on many factors).

We now take the $1,000USD unrealised gain, multiply it by 0.055, which gives us $55 of realised FX gain for the year.

The unrealised again is included in income only gradually, and it is directly proportionate to the amount of income the self-employed person pays to themselves through the year.

Summary

If you’ve made it this far in the article, you’ll by now have seen that Section 988 is a complex area, and it can indeed create income where it wasn’t deemed to exist previously.

When planning for future investments, it is important to obtain expert US tax advice to ensure that all tax considerations are properly planned for and expected.

At the US Tax Team, we offer US tax consulting to assist US citizens with issues such as 988 and other complex areas of the US tax code – reach out to us  at info@usatax.nz