Who Pays the Expatriation Tax and How Is It Calculated?

The expatriation tax is a U.S. federal tax on the asset growth of citizens and certain long-term residents who relinquish their citizenship or residency. This tax applies to the unrealized gains on an individual’s worldwide assets. The mechanism ensures that individuals who benefited from the U.S. economic system fulfill their tax obligations before ending their U.S. tax relationship.

Determining Covered Expatriate Status

Liability for the expatriation tax depends on being classified as a “covered expatriate.” This status applies to U.S. citizens who renounce their citizenship and long-term residents who abandon their residency. A long-term resident is someone who has held a green card for at least eight of the last fifteen years. An individual is considered a covered expatriate by meeting any one of three tests.

The first measure is the Net Worth Test. An individual meets this test if their net worth is $2 million or more on the date of expatriation. This includes the fair market value of all worldwide assets, such as real estate, stocks, and retirement accounts, minus any outstanding liabilities.

Another financial measure is the Average Annual Net Income Tax Test. This test is met if an individual’s average annual net income tax liability for the five years before expatriation exceeds an inflation-adjusted amount, which is $206,000 for 2025. This figure is the actual tax paid to the IRS, not the person’s gross or taxable income.

The final criterion is the Tax Compliance Test. An individual is deemed 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 prior to expatriation. This certification is made on Form 8854, the Initial and Annual Expatriation Statement.

Calculating the Mark-to-Market Tax

For covered expatriates, the exit tax is based on a mark-to-market calculation. This system treats most of a person’s worldwide assets as if they were sold for their fair market value on the day before expatriation. This “deemed sale” generates a taxable event on the unrealized appreciation of those assets.

A key part of this calculation is a lifetime capital gains exclusion, which is indexed for inflation. For individuals expatriating in 2025, this exclusion is $890,000. This amount reduces the total calculated gain, meaning only gains above this threshold are subject to tax.

The calculation begins by determining the unrealized gain for each asset, which is its fair market value minus its original cost basis. The total of these individual gains is the gross unrealized gain. The lifetime exclusion amount is then subtracted from this total to determine the net taxable gain.

This net taxable gain is taxed using standard U.S. capital gains rates. The character of the gain depends on the asset’s holding period. Assets held for one year or less are taxed as short-term gains at ordinary income rates, while those held longer are taxed at preferential long-term rates.

Tax Treatment of Special Assets

While the mark-to-market regime applies to most assets, certain types of accounts and compensation arrangements receive special treatment and are excluded from the deemed sale calculation.

Specified tax-deferred accounts, such as traditional Individual Retirement Arrangements (IRAs) and 529 plans, are not subject to the mark-to-market rules. Instead, the entire value of these accounts is treated as if it were distributed to the owner on the day before expatriation. This deemed distribution is fully taxable as ordinary income.

Deferred compensation items are categorized as either eligible or ineligible. For eligible items, like 401(k)s where the payer is a U.S. entity, tax is not due at expatriation. Instead, the plan administrator withholds a 30% tax on any future distributions made to the covered expatriate, who must provide Form W-8CE to the payer.

Ineligible deferred compensation items are treated as a lump-sum distribution on the day before expatriation, with the entire present value taxed as ordinary income. Interests in trusts are also handled differently. Assets in a grantor trust are subject to the mark-to-market rules, while distributions from a non-grantor trust to a covered expatriate may be subject to a 30% withholding tax.

Filing and Payment Procedures

Filing Form 8854, the Initial and Annual Expatriation Statement, is a mandatory part of the process for every citizen relinquishing citizenship and every long-term resident abandoning a green card. This applies regardless of net worth or whether any tax is owed. Failure to file this form can result in being automatically classified as a covered expatriate.

Completing Form 8854 requires a detailed disclosure of financial information. The filer must present a balance sheet listing all worldwide assets and liabilities at fair market value as of the expatriation date. The form also requires an income statement for the tax year of expatriation.

The filing deadline for Form 8854 is the same as the individual’s final income tax return. A person who expatriates must file a dual-status return for that year, covering the periods they were a U.S. resident and a nonresident. Form 8854 must be attached to this return.

Any expatriation tax owed is reported on the dual-status return and is due at the same time as the final income tax payment. This payment is made to the IRS along with any other income tax owed for the year.