Renouncing U.S. citizenship is a major decision, often driven by personal, financial, or lifestyle considerations. However, for certain individuals, giving up U.S. citizenship can also trigger a significant financial consequence: the U.S. Exit Tax. This tax can apply to individuals who are considered “covered expatriates,” and it can result in a tax bill as if certain assets were sold the day before expatriation.
In this blog, we break down who is subject to the exit tax, how it’s calculated, and what steps you can take to prepare.
What Is the Exit Tax?
The exit tax, under Internal Revenue Code section 877A, applies to certain individuals who expatriate and are deemed “covered expatriates.” It functions as a mark-to-market tax, treating your worldwide assets as if they were sold the day before you relinquished citizenship or long-term residency. The goal is to prevent tax avoidance through expatriation.
Who Is a Covered Expatriate?
To determine whether the exit tax applies, you must assess whether you are a “covered expatriate.” You will fall into this category if any one of the following applies:
- Net Worth Test: Your net worth is $2 million or more on the date of expatriation.
- Tax Liability Test: Your average annual net income tax liability exceeds $206,000 (for 2025, adjusted annually for inflation) for the five years before expatriation.
- Certification Test: You fail to certify on IRS Form 8854 that you have complied with all U.S. federal tax obligations for the five preceding years.
Note: Some exceptions apply for dual citizens and certain minors, but these are narrowly defined and subject to conditions.
How Is the Exit Tax Calculated?
Once classified as a covered expatriate, the IRS applies a mark-to-market regime:
- You are treated as having sold all of your worldwide assets at fair market value the day before expatriation.
- Any net gain from this deemed sale is subject to capital gains tax.
- However, there is a gain exclusion amount – for 2025, it is $890,000 (indexed for inflation).
Example: Sarah has worldwide assets with an unrealised gain of $1.2 million. After applying the $890,000 exclusion, the taxable gain is $310,000, which is then taxed at applicable long-term capital gains rates.
What Assets Are Included?
Virtually all property interests are included in the calculation:
- Real estate (worldwide)
- Investment portfolios
- Deferred compensation (subject to special rules)
- Interests in trusts and foreign pensions
Certain assets, such as deferred compensation items, are not subject to the mark-to-market rules, but instead have their own specific tax treatment. Non-qualified pensions would potentially suffer unique tax treatment too.
Filing Requirements and Form 8854
To formally expatriate for tax purposes, you must:
- File Form 8854, Initial and Annual Expatriation Statement
- Attach the form to your final U.S. tax return
- Certify five years of U.S. tax compliance
Failure to file Form 8854 or to certify compliance can automatically classify you as a covered expatriate, even if you don’t meet the net worth or tax liability tests.
Planning Considerations
If you’re considering expatriation, here are a few key planning steps:
- Review your net worth and income tax history against the threshold tests.
- Pre-expatriation gifting may reduce your net worth below the $2 million threshold.
- Consider accelerating income or asset sales before expatriation to take advantage of lower rates or offset losses.
- Work with a tax advisor to ensure Form 8854 is complete and accurate.
Final Thoughts
The exit tax is complex and can result in a hefty tax bill if not carefully planned for. If you’re contemplating renouncing U.S. citizenship or giving up long-term permanent residency, understanding the mechanics of the exit tax is essential to avoid costly surprises.
The information in this blog post is for general informational purposes only and does not constitute professional tax advice. We strongly recommend consulting a qualified tax professional before making any decisions. US Expat Tax Advisor is not liable for any actions taken based on this content.
If you would like more information or want to schedule a one-on-one consultancy call, please get in touch using our contact form.
