What Is the U.S. Exit Tax and Who Needs to Pay It?

The U.S. exit tax applies to certain individuals who relinquish U.S. citizenship or terminate long-term U.S. residency. This tax ensures individuals settle their accumulated tax obligations before fully departing the U.S. tax system. It treats expatriation as a taxable event.

Defining Expatriation and Exit Tax

Expatriation refers to the formal act of relinquishing U.S. citizenship or terminating long-term U.S. residency. This involves legally severing tax ties with the United States. For tax purposes, an expatriate is a U.S. citizen who gives up citizenship or a long-term resident who ceases to be a lawful permanent resident.

The core concept of the U.S. exit tax is the “deemed sale” rule, also known as the mark-to-market regime. Under this rule, individuals are treated as if they sold all their worldwide assets at fair market value on the day before their expatriation date. Any unrealized gains on these assets become subject to tax, even without an actual sale. This mechanism ensures the U.S. taxes wealth accumulated while an individual was subject to its tax jurisdiction, preventing tax avoidance on appreciated assets.

Individuals Subject to Exit Tax

The exit tax applies to individuals classified as “covered expatriates.” Not every person who renounces U.S. citizenship or ends long-term residency is subject to this tax. An individual is a covered expatriate if they meet one or more of three specific tests at the time of expatriation.

The first is the net worth test. An individual is a covered expatriate if their worldwide net worth is $2 million or more on the expatriation date. This includes assets like real estate, investments, retirement accounts, and personal property, valued at fair market value, minus liabilities.

The second is the tax liability test. An individual meets this test if their average annual net income tax liability for the five tax years preceding expatriation exceeds $206,000 for individuals expatriating in 2025. This amount refers to the total U.S. tax owed, not the individual’s taxable income.

The third is the certification test, which focuses on tax compliance. An individual is a covered expatriate if they fail to certify under penalty of perjury that they have complied with all U.S. federal tax obligations for the five years preceding their expatriation. This certification is typically made on IRS Form 8854. Failing this requirement automatically classifies an individual as a covered expatriate.

Long-term residents are also subject to these rules if they terminate their residency. A long-term resident is a green card holder who has been a lawful permanent resident for at least 8 of the last 15 tax years ending with the year of expatriation.

Calculating the Exit Tax

Once an individual is determined to be a covered expatriate, the exit tax liability is calculated using the mark-to-market regime. This treats all worldwide assets, such as stocks, bonds, real estate, and other personal property, as if they were sold at fair market value on the day before expatriation. Taxable gain is determined by subtracting the adjusted cost basis of each asset from its fair market value. Any resulting gains are then recognized.

A statutory exclusion amount reduces the deemed gain subject to tax. For 2025, this exclusion is $890,000. For example, if total unrealized gains are $1.5 million, the first $890,000 is excluded, leaving $610,000 subject to capital gains tax.

Certain assets, like deferred compensation and specified tax-deferred accounts, have special rules. These may be treated as fully distributed on expatriation and subject to ordinary income tax rates. Additionally, gifts or bequests from a covered expatriate to U.S. persons after expatriation can be subject to a separate tax on the U.S.-based recipient.

Reporting Obligations

Covered expatriates have specific reporting obligations to U.S. tax authorities. The primary form required is Form 8854, “Initial and Annual Expatriation Statement.” This form notifies the IRS of the status change and provides financial information.

Form 8854 certifies compliance with U.S. federal tax obligations for the five years prior to expatriation. It is generally filed with the individual’s final U.S. income tax return for the year of expatriation, by the tax return’s due date. If no income tax return is required, Form 8854 must still be submitted separately by the same deadline.

Other forms may be necessary based on financial situation. For example, capital gains from deemed sales are reported on Schedule D of Form 1040. Individuals with interests in specified foreign financial assets may also need to file Form 8938, Statement of Specified Foreign Financial Assets, under FATCA. Failure to comply with these reporting requirements can lead to penalties, and may even prevent the individual’s expatriation from being recognized for U.S. tax purposes.