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Renouncing U.S. citizenship is a major life decision that carries both personal and financial consequences. A key financial consideration when giving up a U.S. passport or residency is the possibility of U.S. exit tax, which applies depending on an individual’s income and net worth.
In this guide, we explain who is affected by exit tax, how to calculate it, strategies to reduce its impact, and the essential paperwork you’ll need throughout the process.
What is the US exit tax?
The U.S. exit tax applies to individuals renouncing their U.S. citizenship or Green Card holders relinquishing their long-term resident status. It’s a method for the U.S. government to tax the increase in asset value (unrealized gains) at the time of expatriation, significantly impacting high-net-worth individuals.
The exit tax treats renouncing citizenship as a taxable event. As such, individuals may owe taxes not only on worldwide income earned up to the renunciation date, but also on the previously untaxed increase in the value of their assets. In other words, the U.S. exit tax applies as if the individual sold all their property at fair market value on the day before expatriation. Understanding the United States exit tax is essential in preparing for the financial aspects of renouncing citizenship.
Who is affected by the exit tax?
The exit tax affects only individuals who the IRS considers to be a “covered expatriate.” For exit tax purposes, a covered expatriate is a taxpayer who meets the criteria of any of the following three tests at the time they expatriate (i.e., renounce U.S. citizenship or terminate long-term permanent residency).
Net worth
An individual satisfies the net worth test if they have a net worth of $2 million or more on the date of expatriation. Net worth is calculated as the total value of an individual’s worldwide assets minus their liabilities or debts. This means that if an individual owns high-value assets, such as real estate or investments, but also carries significant debts (e.g., mortgages, loans, or credit card balances), these liabilities are subtracted from the total asset value when determining net worth.
Tax liability
If an individual’s average annual net income tax liability over the five tax years preceding the date of expatriation exceeds a threshold amount (which is indexed annually for inflation) they are considered a covered expatriate. The threshold in 2024 is $201,0001. It is important to note that this amount refers to the total U.S. income tax owed, not taxable income.
Certification
A final test is met if the taxpayer fails to certify on Form 8854 (Initial and Annual Expatriation Statement) that they have complied with all federal tax obligations for the 5 tax years preceding the date of expatriation. With this criteria in mind, it’s essential to ensure all federal tax obligations are fully met before expatriating, to avoid unnecessarily having to pay an exit tax.
Exit tax for Green Card holders
The definition of a covered expatriate applies to Green Card holders and U.S. citizens alike, but Green Card holders are subject to an additional test when relinquishing their status. Only long-term permanent residents, defined as those who held lawful permanent resident status (a Green Card) for at least eight of the last 15 years, are subject to pay an exit tax.
With the definition of long-term permanent residency in mind, the timing of Green Card relinquishment can be critical to minimize an exit tax bill. It is important to note that the exit tax is only triggered once an individual is deemed to have expatriated, which can only occur when they file Form I-407 , formally abandoning their Green Card.
Other exceptions to the exit tax
Even as a covered expatriate, there are two additional potential exemptions to paying the exit tax for those renouncing U.S. citizenship. These are particularly relevant to individuals who have had little or no connections to the U.S. for a significant period of time, such as Accidental Americans.
Dual citizenship at birth
Dual citizens at birth may avoid the exit tax if they remained a citizen of the other country at the time of expatriation and have been a U.S. resident (as defined for tax purposes) for no more than 10 of the last 15 years.
Minors
Similarly, minors who relinquish their U.S. citizenship before the age of 18½ are exempt, provided they have not been a U.S. resident for more than 10 years.
These exceptions acknowledge unique circumstances and provide some relief for individuals navigating the complexities of expatriation and exit tax obligations.
How to calculate the exit tax
Once you’ve determined that you are a covered expatriate, calculating the exit tax involves several steps, starting with determining your net worth and ending with the filing of Form 8854. They include:
- Calculate your net worth
- Calculate unrealized gains on assets
- Subtract the exclusion amount. The exclusion for 2024 is $821,000. Subtract this amount from your total unrealized gains to determine your taxable gains:
Taxable gains = Fair market value – Adjusted basis
Note: Liabilities reduce your net worth for the $2 million threshold test, but they do not reduce your unrealized gains for the purposes of the exit tax.
For example: If you own a property worth $1,000,000 with a $700,000 mortgage, your net worth reflects $300,000 equity for the net worth test. However, for the exit tax, the full FMV ($1,000,000) is used when calculating unrealized gains, and the mortgage is not subtracted.
Strategies for minimizing the exit tax
Although the exit tax can seem overwhelming, with proactive planning you can reduce its impact with these strategies:
- Asset Management: Restructure your portfolio before renouncing to reduce unrealized gains. This might include selling highly appreciated assets or transferring ownership to reduce your taxable net worth.
- Gifting strategies: Consider gifting assets to family members or trusts, keeping in mind U.S. gift tax rules and thresholds.
- Primary Residence Sale: Review how the sale of a primary residence qualifies for a capital gains exclusion (up to $250,000 for single filers or $500,000 for married filers).
- Tax Loss Harvesting: Realize losses on underperforming investments to offset gains and reduce the overall taxable amount when calculating the exit tax.
- Charitable Contributions: Donate highly appreciated assets to qualified charities. This can reduce your net worth while also avoiding capital gains tax on those assets.
- Strategic timing: Plan the timing of your renunciation to align with favorable tax conditions, such as after selling high-gain assets or before significant asset appreciation occurs to minimize taxable gains.
Engaging with a tax or financial advisor who specializes in expatriation can provide insights into tailoring these strategies to your specific situation, ensuring compliance and efficiency.
Filing Form 8854: The final step
Form 8854, the Initial and Annual Expatriation Statement, is the final step in the renunciation process. This form must be filed with the IRS to report your expatriation and confirm your compliance with the exit tax obligations. Completing this form accurately is crucial, as any discrepancies may lead to penalties.
Form 8854 collects detailed information about your net worth, income tax liability, and asset documentation. It is advisable to work with a professional who understands the form’s complexity. Submitting this form is not just a legal obligation; it also serves to protect you against possible future tax liabilities as an expatriate.
You must file Form 8854 by the same deadline as your U.S. individual income tax return. This is typically April 15th, unless you are eligible for an automatic extension (e.g., June 15th for expats living abroad). If you request a filing extension for your income tax return (Form 4868), the Form 8854 deadline will also extend to October 15th.
Failing to file Form 8854 on time can result in severe penalties, including being automatically classified as a covered expatriate regardless of whether you meet the other criteria.
What happens after renunciation?
After renouncing U.S. citizenship, many individuals wonder about their ongoing tax obligations and financial status. While renunciation is irrevocable and reinstating citizenship is virtually impossible, certain tax responsibilities may persist, especially for U.S.-sourced income.
After renouncing citizenship, you are no longer subject to U.S. taxes on worldwide income, which can provide significant financial relief. However, any income derived from U.S. assets, such as rental property or dividends from U.S.-based investments, will still be subject to taxation.
By understanding these obligations and consulting with a tax professional, you can ensure smooth financial planning and compliance both before and after renouncing U.S. citizenship.
