US Expatriation Tax: Covered Expatriate Status and the Section 877A Exit Tax

The US Exit Tax Framework

The United States imposes an exit tax on "covered expatriates" — individuals who renounce US citizenship or abandon long-term permanent resident (green card) status. The exit tax provisions are contained in Section 877A of the Internal Revenue Code, as amended by the Heroes Earnings Assistance and Relief Tax Act of 2008 (HEART Act).

Unlike the UK system (which has no mark-to-market exit tax) or the German system (which taxes unrealised gains on corporate shareholdings), the US system is a comprehensive mark-to-market regime: all property owned by a covered expatriate on the expatriation date is treated as sold at fair market value on the day before expatriation, with the resulting gain (or loss) included in income for the expatriation year.

This is the most aggressive exit tax regime among OECD countries. It reflects the US's unique position of taxing citizens on worldwide income — the exit tax is designed to prevent Americans from accumulating US-taxable gains and then renouncing citizenship to avoid the realisation event.

Covered Expatriate Status: The Three Tests

An individual is a "covered expatriate" if they meet any one of three tests on the expatriation date:

Test 1: Net Worth Test

The individual's net worth is $2 million or more on the date of expatriation. Net worth includes all assets worldwide, regardless of type or location — real estate, financial assets, business interests, pension rights, trust interests, and personal property.

The $2 million threshold has not been adjusted for inflation since the HEART Act was enacted. In real terms, the threshold captures a much wider group of individuals today than it did in 2008. A person who has accumulated $2 million through homeownership and retirement savings over a lifetime of work is potentially a covered expatriate under this test.

Test 2: Average Annual Net Tax Liability Test

The individual's average annual net income tax liability for the five tax years ending before the expatriation date is $206,000 or more (for 2024 — this figure is indexed for inflation). For 2025, the threshold is approximately $210,000.

The five-year average is calculated from the individual's actual US tax liability (after foreign tax credits), not from gross income. An individual who paid an average of $210,000 in US income tax per year for the five years before expatriation is a covered expatriate under this test.

Test 3: Certification Test (Failure to Certify Compliance)

The individual fails to certify, under penalty of perjury, that they have complied with all US federal tax obligations for the five preceding tax years (and has not established that compliance). The certification is made on Form 8854 (Initial and Annual Expatriation Statement).

An individual who has unfiled US returns for any of the five preceding years, or who has unpaid US taxes, automatically fails the certification test and is therefore a covered expatriate even if they are below the net worth and tax liability thresholds.

Test	2025 Threshold	Fails If...
Net worth	$2,000,000	Net worth ≥ $2M on expatriation date
Average net tax liability	~$210,000 (2025)	5-year average annual US tax ≥ threshold
Certification	N/A	Cannot certify 5-year US tax compliance

The Mark-to-Market Exit Tax: Section 877A

If an individual is a covered expatriate, Section 877A deems them to have sold all property at fair market value on the day before the expatriation date. The gain or loss from the deemed sale is recognised in the tax year of expatriation.

The 2024 Exclusion Amount

An exclusion amount is available to reduce the gain subject to the mark-to-market tax. For 2024, the exclusion amount is $866,000 (indexed annually for inflation). For 2025, it is approximately $885,000. This exclusion applies once to the aggregate deemed gain — it is not applied to each asset individually.

For a covered expatriate with $2 million of unrealised gains in their investment portfolio, the taxable gain after the exclusion is approximately $1.13 million (using 2024 figures). At the current long-term capital gains rate of 20% plus the 3.8% Net Investment Income Tax (NIIT), the exit tax on this gain would be approximately $271,000.

Special Rules for Specific Asset Types

Deferred compensation: Defined benefit pensions and deferred compensation plans owned by covered expatriates are subject to a separate 30% withholding tax on the eligible deferred compensation item, rather than the mark-to-market regime.

Specified tax-deferred accounts (IRAs, 401(k)s): These are treated as if distributed in full on the day before expatriation, with the gross amount (not just the gain) subject to US income tax at ordinary rates (not capital gains rates).

Non-grantor trusts: Distributions from non-grantor trusts to covered expatriates after expatriation are subject to a flat 30% tax (not offset by foreign tax credits or income tax treaties). The trust itself must withhold this amount before making a distribution.

Planning to Reduce Covered Expatriate Status

Reducing Net Worth Below $2 Million

Gifts to a US spouse or to a US charity reduce the donor's net worth. Gifts to a spouse, if the spouse is a US citizen, are unlimited for US gift tax purposes. Gifts to a non-citizen spouse are limited to the annual exclusion amount ($185,000 for 2024).

Accelerating deductible expenditure — prepaying business expenses, making charitable contributions — reduces net worth but has limited utility against the scale of a $2 million threshold.

Reducing Average Tax Liability

The five-year average tax liability test looks back at the five years before expatriation. Implementing legitimate tax reduction strategies for the five years before a planned expatriation can reduce the average. Foreign tax credits, business deductions, retirement account contributions, and loss harvesting all reduce the US tax liability.

The timing of expatriation relative to the five-year average can be managed. A year in which tax liability was exceptionally high (due to a business sale or a large capital gain) falls out of the five-year window one year later.

Curing the Certification Failure

If the only reason for covered expatriate status is the certification failure (unfiled returns or unpaid taxes for any of the five preceding years), the most effective planning is to cure the compliance failure before expatriating. Filing all outstanding returns, paying all outstanding taxes, and then expatriating after the compliance period is current avoids covered status on the certification test.

The IRS's Streamlined Filing Compliance Procedures (discussed in the FBAR article) provide a route to bringing compliance current without necessarily incurring the full statutory penalties for late filing.

HPT Group advises US citizens and long-term green card holders considering renunciation or abandonment on the full scope of the US exit tax analysis, including covered expatriate determination, mark-to-market modelling, and pre-expatriation planning strategies. The US exit tax is one of the most complex and high-stakes areas of international personal tax — early engagement, ideally 3-5 years before the planned expatriation date, provides the most planning flexibility. Contact our US tax advisory team or apply for an exit tax analysis.