Understanding the US Exit Tax for Expats: How It Works and Impacts You
Are you a US expat planning on renouncing your citizenship? Or perhaps you are intending to give up a long-term Green Card after US residency. These are huge decisions, the financial consequences of which should not be underestimated.
There are many reasons why a US expat may want to give up their citizenship, but a few considerations need to be taken into account before doing so. One of the most important is the US exit tax, also known as the expatriation or departure tax.
Our guide will highlight how this tax works, how it is calculated, who may be affected, and tips on how to minimise its impact.
Definition: US Exit Tax
This is a special tax the US charges certain individuals who renounce their US citizenship or long-term Green Card. The IRS treats this moment as if you have sold your worldwide assets at their current market value the day before expatriation, and taxes you on the gains, even if you have not actually sold anything.
What is the US Exit Tax?
This tax was introduced in 2008 as part of the Heroes Earnings Assistance and Relief Tax Act (HEART Act), and section 877A of the IRS tax code imposes this as a final tax for certain individuals who plan to sever their financial ties to the US.
In essence, this involves the IRS treating an individual's departure from the US as if they sold all their worldwide assets at fair market value the day before they officially expatriate. This is referred to as a ‘deemed sale’, and even if you did not sell anything, you may owe taxes on unrealised gains.
This is to ensure that all US tax liabilities are settled before an exit, especially for individuals who have accumulated significant wealth whilst under the US tax system.
Who Must Pay the Exit Tax - Covered Expatriates
Not everyone leaving the US will need to pay this tax. Only individuals deemed as ‘covered expatriates’ will be targeted. You will be classified as a covered expatriate if any of the following apply:
- Your worldwide net worth at the time of exit is $2 million or more
- Your average annual US income tax liability for the five years before expatriation exceeds the threshold of $206,000
- You cannot certify full US tax compliance for the five years preceding your expatriation on Form 8854
These tests apply to both US citizens and long-term Green Card holders (those who held a Green Card for 8 of the last 15 years).
It's important to note that to formally give up your Green Card, you must file form I-407. Simply letting it lapse will not end your US tax residency.
How is the Exit Tax Calculated?
If you are deemed a covered expatriate, you will be subject to the exit tax, which works under the ‘mark-to-market’ regime. The IRS views your assets as if you sold them the day before you give up your citizenship or long-term residency and capital gains tax will then be due on gains which exceed the ‘exclusion amount’, which is $890,000 for 2025.
Here is a simplified way to calculate how much you may owe:
Calculate the unrealised gain from each asset by subtracting your cost basis from its fair market value.
Net all gains and losses.
Subtract the $890,000 exclusion amount.
Apply relevant capital gains tax rates- typically 15-20%, with a possible additional 3.8% net investment income tax
Special Treatments: Retirement Accounts & Deferred Compensation
Not all assets are subject to the mark-to-market regime. Some tax-deferred accounts, like IRAs (traditional, Roth or inherited), 529 education plans and HSAs, are instead treated as though they were entirely cashed out the day before expatriation. The balance is taxed as ordinary income, although there is no early withdrawal penalty.
Some retirement and employment plans and specified tax deferred accounts receive special treatment under the exit tax:
- Eligible Deferred Compensation, such as a 401(k) from a US employer, may qualify for deferred taxation, but the IRS may require 30% to be withheld upon future withdrawals.
- Ineligible Deferred Compensation schemes will be taxed right away, based on their current value at the time of expatriation.
- Trust interests, especially from non-grantor trusts, and other income may trigger specific tax implications, and these often require case-by-case analysis.
US Exit Tax Exemptions
Some individuals may be exempt from the US exit tax, including:
- Accidental American citizens - those who held US nationality at birth but have never lived in the United States or had substantial ties.
- Dual citizens at birth, who have remained citizens of another jurisdiction and have been US tax residents for less than 10 of the last 15 years.
- Minors renouncing before age 18.5, provided they have not been US residents for more than 10 years.
How to Minimise or Avoid the US Exit Tax
Whilst the IRS imposes strict rules for the exit tax, with the correct panning, there may be ways to mitigate your exposure.
Timing and Net Worth Management
One way to avoid the exit tax is to strategically manage your net worth to fall below the $2 million threshold before expatriation. This may involve gifting assets to family, restructuring of assets or even incurring and documenting legitimate debt.
For Green Card holders, leaving the US before gaining long-term residency (before 8 years) can help to avoid exit tax altogether.
Realise Gains Early
For individuals who have accumulated assets, selling them before expatriation may leverage lower capital gains or exemptions (e.g., the primary residence exclusion). Selling underperforming assets at a loss may offset gains before the deemed sale.
Charitable Giving
Other than the personal and philanthropic benefits of charitable giving, donating appreciated assets to qualified charities may be an effective way of reducing your net worth and gain exposure.
Ensure Compliance
It's important to remain on top of your filing obligations and tax returns, and ensure that you file form 8854 to certify five years of compliance, and failure to do so will automatically classify you as a covered expatriate, regardless of your wealth or net worth.
Seek Expert Advice
Due to the complexity of deferred accounts, trusts, treaties and other nuances, expert financial advice is invaluable. The right guidance from professional advisers can mean the difference between a tax saving strategy and a costly oversight.
Top Tip
Plan ahead. Once you officially expatriate, it may be too late for taxation strategies. By working with an adviser in advance, you may be able to reduce your exit tax exposure.
Final Thoughts
Giving up your US citizenship or long-term Green Card status may have repercussions. The exit tax is one of the biggest obstacles that US expats may face, but with the right knowledge and proper planning, it can be manageable.
By understanding whether you are deemed a covered expatriate, the exit tax rules and calculations, the special treatments for certain deferred accounts, the available exemptions and certain strategies to reduce exposure, you can work towards a plan which secures your financial future abroad.
At The Wealth Genesis, we can help you navigate the exit tax and apply strategies which may be available to you. To learn more, book a free discovery call with one of our advisers today.
