What Is the IRS Expatriation Tax and How Does It Work?

The U.S. expatriation tax applies to individuals who renounce their U.S. citizenship or terminate their long-term residency. Governed by Section 877A of the Internal Revenue Code, this tax applies to the worldwide assets of certain individuals to ensure the government can collect taxes on unrealized gains. This framework prevents high-net-worth individuals from avoiding U.S. taxes by changing their citizenship or residency status. The law treats expatriation as a constructive sale of the individual’s assets, which triggers a potential tax liability.

Who is a Covered Expatriate?

The expatriation tax does not apply to everyone who gives up U.S. citizenship or long-term residency, but is limited to individuals defined as “covered expatriates.” This determination is based on meeting any one of three specific tests on the date of expatriation. An individual who has been a lawful permanent resident (green card holder) in at least eight of the last 15 tax years is considered a long-term resident and is subject to these same rules.

The first test is the Net Worth Test. An individual is classified as a covered expatriate if their net worth is $2 million or more on the date they expatriate. This calculation includes all of their assets worldwide, valued at their fair market value. The $2 million threshold is not indexed for inflation.

A second path is the Average Annual Net Income Tax Liability Test. This test is met if an individual’s average annual net income tax liability for the five years preceding the expatriation date exceeds a specific, inflation-adjusted amount. For 2025, this threshold is $206,000.

The final criterion is the Tax Compliance Certification Test. An individual becomes a covered expatriate if they fail to certify on Form 8854 that they have complied with all U.S. federal tax obligations for the five years before their expatriation. A failure to make this certification automatically results in covered expatriate status.

There are limited exceptions to these rules. An individual who was a dual citizen from birth may be exempt if they continue to be a citizen of and are taxed as a resident in the other country, provided they were a U.S. resident for not more than 10 of the last 15 years. Another exception applies to certain minors who expatriate before reaching age 18 ½ and have not been a U.S. resident for more than 10 tax years.

Calculating the Mark-to-Market Exit Tax

For covered expatriates, the exit tax is based on the mark-to-market calculation. This system treats most of an individual’s worldwide property as if it were sold for its fair market value on the day before the expatriation date. This “deemed sale” generates a capital gain or loss on each asset, which is reported on the final U.S. tax return.

A statutory exclusion amount, which is adjusted annually for inflation, is part of this calculation. For 2025, a covered expatriate can exclude the first $890,000 of net capital gains from the deemed sale. Any net gain above this exclusion amount is taxed at the prevailing capital gains rates.

Not all assets are subject to the mark-to-market rules, as certain assets receive special treatment. Eligible deferred compensation items, like some pension plans, are generally subject to a 30% withholding tax on payments made to the expatriate. For ineligible deferred compensation plans, the present value of the accrued benefit is treated as received the day before expatriation and taxed as ordinary income.

Specified tax-deferred accounts, including traditional and Roth IRAs, are also handled differently. The entire value is treated as distributed the day before expatriation, making the full amount subject to income tax. Interests in non-grantor trusts are not marked to market; instead, future distributions to the covered expatriate are typically subject to a 30% withholding tax.

Expatriation Filing Requirements

The process of expatriating involves specific and timely tax filings. A requirement for the year of expatriation is the filing of a dual-status tax return. This return consists of a Form 1040 covering the portion of the year the person was a U.S. citizen or resident, attached to a Form 1040-NR for the portion of the year they were a nonresident alien.

Accompanying this final return is Form 8854, the Initial and Annual Expatriation Statement. This form is used to certify tax compliance for the preceding five years and to report the balance sheet of worldwide assets and liabilities. It is on this form that the individual determines if they are a covered expatriate and calculates the exit tax liability.

The deadline for filing Form 8854 is the same as the due date for the dual-status tax return, including any extensions. Failing to file this form can have consequences, as the IRS may automatically classify the individual as a covered expatriate, even if they do not meet the financial tests. Furthermore, penalties for failing to file Form 8854 can be substantial.

The Inheritance Tax on Gifts from Covered Expatriates

The tax consequences of being a covered expatriate can extend beyond the individual’s own liability. A separate tax applies to U.S. citizens or residents who receive large gifts or bequests from a covered expatriate. This provision ensures that wealth that has escaped the U.S. transfer tax system is taxed when transferred to a U.S. person.

This tax is paid by the U.S. recipient of the gift or inheritance, not the covered expatriate. The tax is imposed at the highest federal gift or estate tax rate, currently 40%, on the value of the gift or bequest that exceeds the annual gift tax exclusion amount.

The U.S. recipient is responsible for reporting these transfers and paying the tax by filing Form 708, the U.S. Return of Tax for Gifts and Bequests from Covered Expatriates. Under final regulations, the tax applies to covered gifts and bequests received on or after January 1, 2025. This provision serves as a backstop, capturing assets for tax purposes years after an individual has renounced their U.S. ties.