Who Pays US Exit Tax? Rules Expats & HNWIs Should Know

The US exit tax is a federal tax imposed on certain individuals who renounce their US citizenship or give up long-term permanent residency.

Unlike state-level exit taxes, which apply when someone changes residency within the US, the federal exit tax is triggered by expatriation and is based on a deemed sale of worldwide assets.

This article breaks down the key aspects of the exit tax by answering the most common questions, including:

• Is there an exit tax to leave the US?
• Does California have a tax for moving out of state?
• What is the exit tax charge?
• What is the dual citizen exception for expatriation?
• How do you avoid US exit tax?

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Who Has to Pay US Exit Tax?

The US exit tax applies to individuals classified as covered expatriates under Section 877A of the Internal Revenue Code.

This category includes certain US citizens who renounce their citizenship and long-term green card holders who give up their residency status.

To determine who qualifies as a covered expatriate, the IRS uses several tests:

• Citizenship vs. Long-Term Green Card Test:
  US citizens are automatically subject to the test upon renunciation. Green card holders, however, are only considered long-term residents if they held lawful permanent resident status in at least 8 out of the last 15 years before expatriation.
• Net Worth Test:
  If your net worth is $2 million or more on the date of expatriation, you may be considered a covered expatriate.
• Tax Liability Test:
  If your average annual net income tax for the five years before expatriation exceeds a specific threshold ($206,000 for 2025, adjusted annually), you meet this criterion.
• Certification Test:
  Even if you don’t meet the income or net worth thresholds, failure to certify compliance with US tax obligations for the past five years using Form 8854 will also categorize you as a covered expatriate.

How does the US exit tax work?

Covered expats must calculate the fair market value of all their assets including real estate, investments, retirement accounts, and personal property, and recognize any unrealized gains as if they had sold those assets.

The key aspect is that the tax applies to unrealized gains, meaning profits that have accrued but have not yet been realized through an actual sale.

This can result in a significant tax liability even if the individual hasn’t liquidated any assets.

A certain exclusion amount applies (adjusted annually), allowing some gains to be exempt from tax, but any gains above that exclusion are subject to capital gains tax rates.

This mechanism is designed to prevent taxpayers from avoiding US taxes by expatriating before selling appreciated assets.

What States Have an Exit Tax?

It’s important to clarify that the US exit tax is a federal tax, and no states currently impose an official exit tax on individuals who renounce citizenship or give up their green cards.

However, some states have residency-based tax rules that can feel like an exit tax when you move out.

States such as California and New York are particularly aggressive in auditing former residents.

These states may attempt to tax individuals on income earned after they leave, especially if they determine that the person still qualifies as a resident for part of the year or changed residency primarily to avoid taxes.

As of now, there is no officially enacted California exit tax.

However, a proposed assembly bill in California’s legislature seeks to impose an exit tax on high-net-worth individuals with significant unrealized capital gains who choose to relocate out of the state.

If passed, this would mark a shift toward state-level exit taxation for certain taxpayers.

These state-level taxes differ from the federal exit tax in that they do not involve a deemed sale of worldwide assets or a one-time expatriation-triggered tax.

Instead, they focus on ongoing income earned within the state or during periods where an individual is still deemed a resident.

In summary, while some states may create significant tax consequences when relocating, the true exit tax is currently imposed only at the federal level.

Nonetheless, moving out of high-tax states still requires careful planning to avoid surprise liabilities.

US Exit Tax Rate

US Exit Tax on Cash

The US exit tax is not specifically levied on cash holdings, but rather on the total fair market value of all worldwide assets.

This includes cash, but the tax is triggered by the unrealized gains on assets, so simply holding cash does not generate a taxable event.

However, liquid assets such as bank accounts, retirement funds, and other cash equivalents are included in the calculation of your total net worth and asset value at expatriation.

While cash itself typically has no unrealized gain, its value contributes to the overall picture that determines whether you meet the net worth threshold for being a covered expatriate.

Additionally, US expatriates are required to comply with extensive reporting requirements for both foreign and domestic financial accounts.

This includes filing FBARs (Foreign Bank Account Reports) and FATCA (Foreign Account Tax Compliance Act) disclosures, which help the IRS track offshore assets and cash holdings.

Failing to report these accounts properly can lead to significant penalties and increase scrutiny during the exit tax process.

US Exit Tax for Dual Citizens

Dual citizens are treated under the same exit tax rules as other US citizens when they choose to relinquish their US citizenship.

The key factor is whether they meet the criteria of a covered expatriate based on net worth, tax liability, and compliance with tax filings.

Dual citizenship does not exempt someone from the exit tax; if a dual citizen renounces their US citizenship and meets the covered expatriate tests, they will be subject to the exit tax regardless of their other nationality.

However, some scenarios may affect the application of the tax:

• If the dual citizen has never been a long-term green card holder or doesn’t meet the net worth or tax liability thresholds, they may avoid being classified as a covered expatriate.
• Dual citizens who retain their US citizenship are not subject to the exit tax, even if they live abroad indefinitely.
• Some dual citizens may plan their expatriation carefully to avoid triggering the tax, such as by managing their assets or tax compliance years in advance.

In summary, dual citizenship itself doesn’t provide an exemption from the US exit tax; it depends on individual circumstances and compliance with IRS rules.

Can You Avoid Exit Tax in the US?

Yes. While the US exit tax can be significant, there are legal strategies to minimize or avoid it altogether:

• Reducing Net Worth or Tax Liability: Individuals may lower their net worth below the $2 million threshold by gifting assets to family members or charitable organizations well before expatriation. Similarly, managing income and tax liabilities in the years leading up to renunciation can help stay under the average annual tax threshold.
• Timing Expatriation Carefully: Planning the exact timing of renunciation can affect tax consequences. For example, expatriating early in the year may allow you to limit taxable income for that year.
• Filing IRS Form 8854: This form is crucial for certifying that you have met all tax obligations for the five years preceding expatriation. Failure to file or inaccurate reporting can cause you to be treated as a covered expatriate regardless of your net worth or tax liability, triggering the exit tax.

Conclusion

The US exit tax affects covered expatriates.

Understanding who pays the US exit tax is crucial, particularly for high-net-worth individuals.

With careful pre-expatriation planning, including gifting, asset structuring, and timely filing of IRS Form 8854, it’s possible to reduce or avoid this tax.

Ultimately, proper planning and compliance are essential to mitigate the financial and legal risks of exiting the US tax system.