The U.S. income tax system generally imposes federal income taxes on U.S. citizens’ and U.S. permanent residents’ (green card holders) worldwide income whether or not the individual is residing in the U.S. or in a foreign country. Although there are some exceptions in tax treaties for worldwide taxation of green card holders, those exceptions create various complexities that minimize their use. The only “escape” from worldwide federal taxation is the relinquishment of U.S. citizenship or permanent residence. But there is a catch - U.S. citizens and long-term residents may be subject to an “exit tax” under Internal Revenue Code Sec. 877A when relinquishing their U.S. citizenship or ceasing to be U.S. long-term residents1, if they are “covered expatriates.”  

GHJ NOTE: State tax implications should also be considered, which depend on the person’s state of residence and are beyond the scope of this discussion. 

Many other countries impose their version of an exit tax. The purposes of the exit tax are to:  

  1. Make sure that all unpaid taxes are settled before a U.S. citizen or resident exits the U.S. tax system  
  2. Tax unrealized appreciation in the assets the individual holds at the time of exit 

The exit tax is assessed on individuals as if they had sold all their assets the day before the exit event, which is also called a “deemed distribution.” 

WHO QUALIFIES AS A COVERED EXPATRIATE? 

Understanding who is subject to the exit tax requires a closer examination of the term “covered expatriate” as defined in IRC Sec. 877A(g)(1). An individual is classified as a covered expatriate if they meet one of the three tests outlined in IRC Sec. 877(a)(2): 

  1. Net worth test: The individual has a net worth of $2 million or more on the date of expatriation. 
  2. Tax liability test: The individual has an average annual net income tax liability for the five tax years ending before the date of expatriation of more than $206,000.  
  3. Tax-compliance test: The individual fails to certify on Form 8854, Initial and Annual Expatriation Statement, that they have complied with all federal tax obligations for the five tax years preceding the date of expatriation. 

There are exceptions to the status as covered expatriates for certain dual-citizens and certain minors: 

  • Certain dual-citizens qualify for an exception if both of the following requirements are met: 
  • The individual is a U.S. citizen and a citizen of another country at birth and continues to be a citizen and is taxed as a resident of the other country on the expatriation date 
  • The individual was not considered a resident of the U.S. for more than 10 years during a 15-year period which ends with the tax year the individual expatriated 
  • Certain minors qualify for an exception if they expatriated before the age of 18.5 years old and the minor was not considered a resident of the U.S. for more than 10 years before expatriating 

If an individual is a covered expatriate and no exception applies, the individual will have to determine how much tax will be due on the deemed sale of the worldwide assets. 

TAX IMPLICATIONS OF EXPATRIATION AND ASSET VALUATION 

For most assets, the mark-to-market regime applies. This means that worldwide assets are valued at fair market value (FMV) on the day before the expatriation. Any gains above the exclusion amount, which was $890,000 for tax year 2025, are subject to capital gains tax rates. 

In addition to the exit tax, net investment income tax of 3.8 percent will also apply to certain types of investments such as interest, dividends and capital gains. 

For investments in tax deferred accounts such as IRAs, HSAs or 529 plans, a special valuation regime applies, and they are treated as fully distributed on the day of the expatriation and are subject to ordinary tax rates. 

In any case, the assets and investments have to be evaluated, and the taxable income has to be calculated depending on the nature of the investment. 

Deferring Exit Tax Through Election 

One planning tool is an irrevocable election to defer the payment of mark-to-market tax imposed on the deemed sale of property until either the property is actually sold or the taxpayer dies, according to the following rules: 

  • The election is made on a property-by-property basis 
  • The deferred tax is due on the tax return for the tax year in which the property is actually disposed of 
  • Interest charges apply for the period in which the tax is deferred 
  • The election is made on Form 8854 Part II, Section D 
  • There is adequate security provided (such as a bond) 
  • There are limitations to the due date of the payment of the deferred tax, which is the earlier of the below dates 
  • The due date of the tax return required for the year of death 
  • The time that the security provided for the property fails to be adequate 
  • The individual must provide an irrevocable waiver of any right under any double tax treaty that would preclude assessment or collection of the exit tax 

Covered expatriates are required to file an initial Form 8854 with their last U.S. tax return. 

POST-EXPATRIATION TAX OBLIGATIONS AND PLANNING CONSIDERATIONS 

Even after expatriation, covered expatriates are not completely relieved of any filing obligations in the U.S. in certain cases: 

  • Reporting and taxation of U.S. source income 
  • Retirement account distributions 

If covered expatriates make gifts or bequests to U.S. persons, special rules apply. In general, gifts and bequests from foreign persons are non-taxable to the U.S. recipient but may have to be reported on Form 3520 depending on the amount of the gift. If a gift or bequest is received from a covered expatriate, the recipient may be subject to tax under Section 2801, which imposes a transfer tax on such gifts and bequests. 

Carefully planning the expatriation can make a significant difference on the tax burden that comes with the exit tax. For example, reducing net worth by gifting assets prior to expatriation and using the lifetime exemption amount for such gifts can be advisable and should be planned well in advance of an expatriation to avoid the anti-abuse rules.  

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Expatriation comes with complex tax implications, from the exit tax itself to ongoing U.S. filing obligations. Proper planning can help mitigate financial burdens and ensure compliance with IRS requirements. Evaluating net worth, understanding potential tax liabilities and structuring assets strategically are critical steps in the process. GHJ’s International Tax Services Practice provides tailored guidance to navigate the challenges of expatriation, optimize tax outcomes and develop a comprehensive tax strategy. Contact GHJ to discuss how proactive planning can support a smooth and tax-efficient transition.