What Is the Exit Tax and Who Has to Pay It?

The US Exit Tax is a federal levy applied to certain individuals who relinquish United States citizenship or terminate long-term residency. This tax aims to ensure individuals settle their tax obligations on accumulated wealth before departing the US tax system. It functions by treating most assets as if they were sold at their fair market value on the day before expatriation, thereby taxing any unrealized gains.

Determining if You are Subject to the Exit Tax

Not every individual who relinquishes US citizenship or a green card is subject to the exit tax. The tax applies specifically to those categorized as “covered expatriates.” An individual becomes a covered expatriate if they meet any one of three distinct tests on their date of expatriation.

One test involves a net worth threshold. An individual is a covered expatriate if their worldwide net worth is $2 million or more on the date of expatriation. This specific amount is not adjusted for inflation. Another test considers an individual’s past tax liability; if their average annual net income tax liability for the five taxable years ending before expatriation exceeds an inflation-adjusted amount, they are deemed a covered expatriate. For 2025, this threshold is $206,000.

The third test relates to tax compliance. An individual is considered a covered expatriate if they fail to certify under penalty of perjury that they have complied with all US federal tax obligations for the five taxable years preceding expatriation. This certification is made on Form 8854, the Initial and Annual Expatriation Statement. All expatriates are required to file Form 8854.

Understanding the Deemed Sale and Mark-to-Market Regime

When an individual is classified as a covered expatriate, most of their assets are subject to a “deemed sale” rule. This means that, for tax purposes, these assets are treated as if they were sold for their fair market value on the day before the individual’s expatriation. This process is known as the “mark-to-market” regime.

Any gain resulting from this hypothetical sale is recognized for tax purposes. A standard exclusion amount is available to reduce the recognized gain. For 2025, this exclusion amount is $890,000. After applying this exclusion, any remaining gain is subject to standard capital gains tax rates, which can also include a Net Investment Income Tax of 3.8%.

Specific Assets and Their Treatment

While most assets fall under the general mark-to-market rule, certain types of property have specific provisions. Appreciated property, such as real estate, stocks, and artwork, is generally subject to the mark-to-market regime, where unrealized gains are taxed as if sold. This ensures that the appreciation in value is captured as part of the exit tax calculation.

Eligible deferred compensation plans, including IRAs, 401(k)s, and certain foreign pension plans, are treated differently. Instead of an immediate mark-to-market taxation, these accounts are generally subject to a 30% withholding tax on future distributions. To qualify for this treatment, the individual must provide appropriate notice, such as Form W-8CE, to the payor within 30 days of expatriation.

Conversely, ineligible deferred compensation plans, such as non-qualified deferred compensation or some foreign pension plans that do not meet eligibility criteria, are taxed immediately. Their present value is recognized as income on the date of expatriation. Interests in non-grantor trusts also have unique rules; they are not subject to the immediate mark-to-market tax, but distributions received by the expatriate from such trusts are generally subject to a 30% withholding tax.

Available Exemptions and Relief

Specific situations and provisions can exempt certain individuals from being classified as covered expatriates or can reduce their potential tax liability. One notable exception applies to certain individuals who were born with both US and another country’s citizenship. To qualify, they must continue to be taxed as a resident of the other country on their expatriation date and must not have been a US resident for more than 10 out of the last 15 taxable years prior to expatriation.

Another exception exists for certain minors who expatriate before reaching 18½ years of age, provided they meet specific residency requirements. They must not have been a US resident for more than 10 years before expatriating. Even if these exceptions apply, individuals are still required to file Form 8854 to formally declare their expatriation and certify compliance.

The standard exclusion amount, which is $890,000 for 2025, serves as a general form of relief by directly reducing the taxable gain from the deemed sale of assets. While some tax treaties may contain provisions that could affect the application of the exit tax for residents of treaty countries, individuals should consult a tax professional for guidance on specific treaty details due to their complexity.