U.S. Exit Tax: How It Works and How To Avoid It

According to the IRS, nearly 5,000 Americans renounced their U.S. citizenship in 2024. If you’re thinking about making a similar move, you’ll want to be aware of the exit tax and its implications before you schedule your embassy appointment.

This tax applies only to “covered expatriates” who meet at least one of three tests: 

• Net worth of $2 million or more;
• Average annual tax liability exceeding $211,000 for 2026 or; 
• Failure to certify five years of tax compliance

While many people who renounce their citizenship owe nothing because they don’t meet these thresholds, others may have to pay a significant amount of money. In this guide, we’ll go into more detail about who pays the exit tax, how the IRS calculates it, and what planning techniques can save you hundreds of thousands in taxes.

What Is the U.S. Exit Tax?

The U.S. exit tax came into law through the Heroes Earnings Assistance and Relief Tax (HEART) Act of 2008. Congress created this tax to prevent wealthy Americans from renouncing their citizenship to dodge future U.S. tax obligations on assets they accumulated while living under the U.S. tax system. The law replaced an earlier, less effective version from the American Jobs Creation Act of 2004, which the IRS admitted it couldn’t enforce because it lacked the resources to track former citizens living abroad.

The exit tax works as a one-time settlement of your U.S. tax obligations when you give up citizenship or terminate long-term green card status. The IRS treats you as if you sold all your worldwide assets at their current market value the day before you expatriate. This “deemed sale” triggers capital gains tax on the appreciation that occurred while you were resident in the United States, even though you haven’t actually sold anything. You pay tax on paper gains above the $910,000 exclusion amount for 2026.

Who Qualifies for Expatriation?

U.S. citizens who formally renounce their citizenship at an American embassy or consulate abroad qualify as expatriates for tax purposes. Long-term green card holders also qualify as expatriates when they terminate their lawful permanent resident status. You’re considered a long-term resident if you held your green card for at least 8 of the 15 years ending with the year you give it up.  

Exceptions to Covered Expatriate Status

Two narrow exceptions let certain people avoid covered expatriate status even if they meet the net worth or tax liability tests. These exceptions don’t waive the compliance certification requirement – you still must file Form 8854 and certify five years of tax compliance to use them.

• Dual Citizenship: The dual citizen exception applies if you became a U.S. citizen and a citizen of another country at birth. You must continue to be a citizen and tax resident of that other country on your expatriation date, and you can’t have been a U.S. resident under the substantial presence test for more than 10 of the 15 tax years ending with your expatriation year. 
• The Minor Exception: The minor exception applies if you expatriated before turning 18½ years old and weren’t a U.S. resident for more than 10 years before expatriation. The 18½ age cutoff gives people who renounced as minors a six-month window to reconsider their decision, though this reconsideration option only exists for those who renounced before age 18.

Note: Both exceptions require active use – you must claim them on Form 8854 and provide documentation. The IRS won’t automatically apply these exceptions just because you meet the criteria.

Who Must Pay the Exit Tax?

As we indicated at the beginning, the IRS uses three tests to determine covered expatriate status. Meeting all three isn’t necessary – just one test triggers the classification.

Test #1: Net Worth of $2 Million or More

Your worldwide net worth on the day you expatriate determines if you meet this test. The IRS counts everything you own anywhere in the world: your primary residence, vacation properties, foreign real estate, investment accounts, retirement accounts like IRAs and 401(k)s, business interests, partnerships, vehicles, art collections, jewelry, and all cash and bank accounts. You subtract your liabilities – mortgages, personal loans, credit card balances, and business debts – from your total assets to calculate net worth.

Expert Tip:  Only your individual assets count toward the threshold. If you’re married to a non-U.S. citizen, their assets don’t get added unless community property rules attribute them to you.

Test #2: Average Annual Tax Liability Exceeding the Threshold

This test looks at your actual U.S. income tax paid, not your gross income or taxable income. You calculate the average of your net U.S. income tax liability for the five years ending before your expatriation date. For 2025, the threshold was $206,000, and for 2026, it’s $211,000. This amount adjusts annually for inflation.

Net income tax liability means the tax you actually owed to the IRS after applying foreign tax credits. If you earned $300,000 per year while living abroad but used the Foreign Earned Income Exclusion to exclude $120,000 and claimed foreign tax credits for taxes paid to your host country, your U.S. tax liability might be zero or close to it. Many high-earning expats never cross this threshold because these credits reduce what they owe to the U.S. government.

Test #3: Tax Compliance Certification Failure

You must certify on Form 8854 that you filed all required U.S. tax returns and met all federal tax obligations for the five years before your expatriation date. Failing to make this certification automatically makes you a covered expatriate, regardless of your net worth or tax liability. You could have $500,000 in assets and $20,000 in annual tax liability, but if you can’t certify compliance, you’re a covered expatriate.

This test catches the most people because many Americans living abroad didn’t know they had to file U.S. tax returns. Someone born in the U.S. who moved to Canada at age five and never returned might have a modest net worth and low tax liability, but 30 years of unfiled returns means they can’t certify compliance. 

How the Exit Tax Is Calculated

Now that you understand who has to pay the exit tax, here’s an overview of how it’s calculated:

• The Mark-to-Market Regime: The mark-to-market regime treats your expatriation as a taxable sale of everything you own. The IRS assigns a deemed sale date of the day before your expatriation and calculates your gain or loss as if you actually sold each asset for its fair market value on that date.
• The Exclusion Amount: The IRS lets you exclude net gains from the exit tax – $890,000 for 2025 and $910,000 for 2026. You apply this exclusion once against your total net gains from all assets subject to the mark-to-market regime.
• Tax Rates on Marked Gains: Net gains above the exclusion amount get taxed at long-term capital gains rates. The federal rate is either 15% or 20%, depending on your total income level for the year.
• Specified Tax-Deferred Accounts: The IRS treats retirement accounts as if you took a complete distribution on the day before expatriation. Traditional IRAs, Roth IRAs, inherited IRAs, 401(k) plans, 403(b) plans, SEP IRAs, SIMPLE IRAs, 529 college savings plans, ABLE accounts, Health Savings Accounts, and Coverdell Education Savings Accounts all fall under this category.
• Deferred Compensation Items:  These items include 401(k) accounts, 403(b) accounts, qualified pension plans, profit-sharing plans, and certain stock option plans provided by U.S. employers. You can choose between two options for these accounts: elect a 30% withholding tax on future payments when you actually receive them, or include the present value as a lump sum in your income at expatriation.
• Foreign Pensions: Foreign pension treatment depends on the tax treaty between the U.S. and the country where the pension exists, the type of pension plan under local law, and whether the plan qualifies as a specified tax-deferred account under U.S. rules. Some tax treaties explicitly address how pensions get taxed at expatriation, while others remain silent and force you to apply the default exit tax rules.
• Non-Grantor Trusts: If you hold a beneficial interest in a non-grantor trust as of the day before expatriation, the trust faces special taxation rules. Distributions of income from the trust to you as a covered expatriate get hit with 30% withholding tax when the trustee makes payments. The trust must withhold this amount and send it to the IRS, reducing what you actually receive.
• Cash: Cash and bank accounts can’t generate gains or losses because they have no cost basis separate from their face value. Cash still counts toward the $2 million net worth test even though it doesn’t create exit tax liability under the mark-to-market rules.
• Real Estate: Real estate anywhere in the world gets treated as sold at fair market value on the day before expatriation. Mortgages reduce your net worth for the $2 million test, but don’t reduce the fair market value used to calculate gains.
• Business Interests: Business interests in partnerships, LLCs, S corporations, and C corporations all face the deemed sale treatment. The IRS scrutinizes business valuations closely because taxpayers have an incentive to understate values and reduce their exit tax.

Strategies to Reduce or Avoid the Exit Tax

Starting your exit tax planning 18 to 24 months before your intended expatriation date gives you the most options. This timeframe lets you restructure assets across multiple tax years, smooth out income spikes, complete Roth IRA conversions, and make charitable contributions that reduce your net worth below the $2 million threshold. You can time asset sales to use available exclusions and credits while you’re still a U.S. person.

Strategy #1: Stay Below the Net Worth Threshold

Gifting assets to family members reduces your net worth dollar-for-dollar. The annual gift tax exclusion for 2026 is $19,000 per recipient. You can give this amount to as many people as you want without using any of your lifetime gift and estate tax exemption or filing a gift tax return. A parent with three adult children can gift $57,000 per year ($19,000 to each child) without tax consequences. Married couples can combine their exclusions to gift $38,000 per recipient.

Expert Tip: Gifts to U.S. citizens or residents from covered expatriates after expatriation face a 40% tax under IRC Section 2801, paid by the recipient. This tax applies to gifts exceeding $100,000 in 2025, indexed for inflation. You must complete your gifting before expatriation to avoid hitting your family members with this burden. 

Other strategies include:

• Charitable Contributions: Donating appreciated assets to qualified charities reduces your net worth and avoids capital gains tax on the appreciation. 
• Strategic Debt Structuring: Legitimate debt reduces your net worth for the $2 million test. A mortgage on investment property, a business loan, a home equity line of credit, or personal loans all count as liabilities that lower your net worth calculation. 
• Timing Asset Valuations: Stock portfolios worth $2.8 million in January might drop to $2.4 million by March during a market correction. Choosing your expatriation date during a market downturn reduces both your net worth test and your mark-to-market gains.

Strategy #2: Manage Average Tax Liability

Income smoothing spreads large income events across multiple years to keep your five-year average below the threshold. Someone planning to sell their business for $5 million can structure the sale as an installment sale over three years instead of taking the full payment in year one. This reduces the tax spike in any single year and lowers the average when you calculate it for expatriation purposes.

Other strategies include:

• Capital Loss Harvesting: If you own stock that’s declined $150,000 in value and other stock that’s appreciated $200,000, selling both in the same year gives you $200,000 in gains offset by $150,000 in losses, leaving $50,000 in net capital gains. This reduces your tax liability for that year and brings down your five-year average.
• Roth Conversions: Converting traditional IRA funds to a Roth IRA before expatriation lets you pay tax now at potentially lower rates and avoid the deemed distribution rules for traditional IRAs. 
• Strategic Timing of Expatriation Date: Choosing when to expatriate affects which five years count for your average tax liability calculation. If 2021 was a high-income year and 2026 will be low, delaying expatriation by one year could drop your average below the threshold.

Strategy #3: Ensure Tax Compliance

Filing all required tax returns for the five years before expatriation is the only way to certify compliance on Form 8854. You need your Form 1040 or 1040-NR for each year, plus any state returns required by your circumstances. Missing even one year prevents certification and automatically makes you a covered expatriate regardless of your net worth or tax liability.

Expert Tip: The IRS Streamlined Filing Compliance Procedures let you catch up on unfiled returns if your failure to file wasn’t willful. You file the last three years of tax returns, the last six years of FBARs, and certify that your noncompliance was non-willful. 

Strategy #4: Optimize Asset Structure

Selling appreciated assets before expatriation lets you use exclusions and deductions available only to U.S. residents. If you sell your primary residence for a $600,000 gain after the exclusion and sell underperforming stocks for a $150,000 loss in the same year, the loss reduces your taxable gain to $450,000, lowering your current-year tax liability and helping your five-year average stay below the threshold.

You can also restructure your business entity. C corporations, S corporations, partnerships, and LLCs each face different tax treatment at expatriation. Converting from one entity type to another before expatriation can reduce exit tax in some situations: for example, an S corporation with $2 million in retained earnings and a $500,000 fair market value creates a $500,000 deemed sale gain at expatriation.

Strategy #5: Strategic Timing

Market conditions affect both your net worth test and your mark-to-market gains calculation. Stock market corrections can reduce portfolio values by 10-20% or more within weeks. Real estate markets move more slowly but still fluctuate based on interest rates, local economic conditions, and seasonal factors. Monitoring your asset values quarterly helps you identify favorable timing windows. 

Life events create natural timing opportunities for lower asset values or lower income years. For example:

• Retirement reduces your income and may require you to spend down assets for living expenses, lowering your net worth. 
• Divorce splits assets between spouses, potentially bringing each person’s individual net worth below $2 million. 
• Business sales followed by charitable giving or major purchases can temporarily reduce net worth. 

You need flexibility in your expatriation timeline to take advantage of these windows when they appear.

Strategy #6: Tax Deferral Election

The tax deferral election lets you postpone paying exit tax until you actually sell the assets that generated the deemed gains. You remain liable for the tax, but you don’t need immediate cash to pay it. The IRS requires you to post adequate security – usually a bond or letter of credit – to guarantee payment when the deferred tax comes due.

You must appoint a U.S. agent to receive IRS communications about the deferred tax, and interest accrues from your expatriation date until you pay. The IRS uses the applicable federal rate, which changes quarterly. The deferral makes sense for illiquid assets you can’t easily sell, but the interest cost adds up quickly for assets you could liquidate.

Strategy #7: Treaty Planning for Green Card Holders

Tax treaties between the U.S. and other countries contain tie-breaker provisions that determine your tax residency when both countries claim you as a resident. Many long-term green card holders maintain closer ties to their home country than to the U.S., even while holding the green card. The treaty lets you claim residence in your home country and break the tie with the U.S. for tax purposes.

You must establish tax residency in the treaty country according to that country’s domestic law. This typically requires a permanent home in that country, physical presence for a minimum number of days, and ties like family, employment, or business activities. Filing tax returns in the treaty country and paying taxes there strengthens your claim to treaty residence. The U.S.-India treaty, U.S.-UK treaty, and most other U.S. tax treaties include similar tie-breaker rules based on permanent home, center of vital interests, and habitual abode.

Filing Form 1040-NR and claiming treaty benefits prevents you from becoming a long-term resident for exit tax purposes. You complete Form 8833 to disclose your treaty position, explaining which treaty article you’re using and why you qualify as a resident of the treaty country. You file this in the year you abandon your green card using Form I-407. The treaty claim means you aren’t subject to the eight-year test for long-term resident status.

Get Your Exit Tax Questions Answered By A Tax Professional

The decision to renounce US citizenship or give up a green card is usually driven by life circumstances, family considerations, or career opportunities abroad. Fortunately, with proper planning and professional guidance, most people can significantly reduce or completely avoid the exit tax. The strategies outlined in this guide have helped thousands of expats navigate the expatriation process successfully.

At USA Tax Gurus, we provide tax planning and compliance services for U.S. citizens and long-term green card holders considering expatriation. We can help with tax compliance catch-up for clients with unfiled returns, Form 8854 preparation, exit tax computation with strategies to minimize liability, and coordination of all tax filings with your expatriation timeline. To book a free consultation, please fill out a contact form or call 213-212-8737 today.