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US Pre-Expatriation Tax Planning – the Ultimate Tax Guide to Leaving the United States

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Option 1 :

For $1000, we can review your last 5 years of tax returns to ensure that there are no outstanding issues that would jeopardise your expatriation.

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For $3000, we can create a mathematical model to help you calculate your present exit tax exposure and make recommendations on how to reduce it.

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For $500, we offer a 1 hour Zoom call to answer questions you may have on any of the tax aspects of renouncing your US citizenship or surrendering your Lawful Permanent Residence status (Green Card Status).

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Every year, more and more US citizens renounce their citizenship, and green card holders give up their visa status.

These actions could well trigger a tax problem:

The US Expatriation Tax Regimes. The Expatriation Tax Regimes has two significant underlying components; the “Exit Tax” (IRC s.877a) and the “Inheritance Tax” (IRC s. 2801).

Most have heard of the Exit Tax. Few have heard that the Heart Act added a new federal transfer tax, which imposes an “Inheritance Tax” on certain gifts or bequests (testamentary dispositions) made by a “covered expatriate” to U.S. recipients.

The Inheritance Tax is payable by the recipient of the gift or bequest, not the expatriate. There is no expiration of the potential applicability of §2801. Thus, a gift or bequest made by a covered expatriate several years (or longer) after expatriation could trigger the tax.

The Inheritance Tax is imposed in addition to the mark-to-market tax paid by the covered expatriate upon exit. Currently, the tax rate imposed by §2801 is 40% of the value of the gift or bequest.

Now let’s return to the Exit Tax.

The US Expatriation Tax Regime Exit Tax rules impose an income tax on certain people called “Covered Expatriates” who have made their exit from the US tax system.

The defining feature of the Exit Tax is that all worldwide appreciated assets are treated “as if” they are sold on the day before citizenship or resident status is terminated. If applicable, net capital gain (after an exclusion amount of roughly $821,000 in 2023) from the deemed sale is taxed when the expatriate’s final US tax return for the year of expatriation is filed.

There are other rules that accelerate income for a person leaving the United States. These other rules apply to items such as IRAs, pensions, deferred compensation plans, and beneficial interests in trusts.

Long-Term Permanent Resident (Green-Card Holder) —An expatriated green-card holder is subject to §877A as a covered expatriate only if a long-term permanent resident prior to expatriation.

A long-term lawful permanent resident is a person who has been a green-card holder during eight of the previous 15 years prior to expatriation.

If a green-card holder expatriates before this eight-of-15-year test is met, §877A does not apply. A U.S. resident alien (under the U.S. substantial presence income tax test)[9] is not subject to the §§877 or 877A tax if the resident has no green card.

Statutory Tests — Section 877A applies to only covered expatriates who meet any one of the three tests, set out in §877(a)(2)(A)-(C).

1. The Net Worth Test:

Having a net worth of $2 million or more on the date of expatriation. The $2 million threshold considers all assets worldwide. The expat is considered to own any interest in property that would be taxable as a gift under Ch. 12 of the code (i.e., the gift tax provisions) if the individual was a citizen who transferred that interest immediately prior to expatriation.

2. The Average Annual Income Tax Liability Test:

Earning an average annual net income tax for the five years ending before the date of expatriation of more than a specified amount, adjusted for inflation ($171,000 for 2020).[12] An individual who files a joint tax return must take into account the net income tax reflected on the joint return.

3. Failure to Certify Tax Compliance:

Failure to certify satisfaction of federal tax compliance to the Secretary of Treasury for the five preceding taxable years or failure to submit such evidence of compliance as “may be required.” Individuals without considerable assets or income may nonetheless become covered expatriates by failing to certify tax compliance.

Special Deferral Rules of §877A(b) — The exit tax deemed sale or distribution may leave insufficient liquidity to cover the tax, as no actual sales proceeds are available. Under certain circumstances, payment of the tax may be deferred until an actual sale of the property (or death). Section 877A(b) provides detailed rules permitting a covered expatriate to defer payment of the mark-to-market tax (on a property-by-property basis).

Payment is tolled until the property is actually sold or exchanged, death, or the security required to make the deferral election fails to meet statutory requirements (whichever is earlier).

To make the deferral election, the covered expatriate must provide “adequate security” and agree to pay statutory interest on the deferred tax. If the covered expatriate elects deferral, gains deferred are based on the value of property as of the taxing date (i.e., as of the day prior to expatriation).

Under the §877A mark-to-market regime, a covered expatriate with an interest in a nongrantor trust (or certain deferred compensation assets) must annually file Form 8854.

Form 8854 reflects distributions from the trust. The filing requirement appears to have no time limit under IRS Notice 2009-85. The notice also affirms that a covered expatriate must file a Form 1040-NR in the event he or she earned taxable income and U.S. income taxes are not fully withheld at the source. As foreign institutions or persons will likely not withhold at the source (under §1441), this requirement usually creates a mandatory filing obligation for covered expatriates.

Lastly, Notice 2009-85 affirms that a covered expatriate with a beneficial interest in a nongrantor trust (or deferred compensation asset) must file Form W-8CE (which identifies the payor). This filing is required on the earlier of the date of the first distribution from the trust (subsequent to expatriation) or 30 days after the date of expatriation.

Begin with a complete review of your global assets, liabilities, and average U.S. income tax liability over the past five years. Under
IRC §877A, individuals are classified as “covered expatriates” if their net worth exceeds USD 2 million or their average annual income tax liability exceeds USD 201,000 for 2025 (adjusted annually). Early awareness allows time to undertake lawful net-worth reduction and restructuring strategies.

Before expatriation, consider outright gifts to family members, including the use of the §2503(b) annual exclusion or the unified estate and gift tax credit to make larger transfers. Gifts should ideally be made at least three years prior to expatriation to avoid inclusion under §2035. Unlimited tax-free gifts to a U.S. citizen spouse are allowed under §2523(a), provided the spouse does not become a covered expatriate. For long-term green card holders, transfers can sometimes be made after leaving the U.S. but before formal expatriation to avoid U.S. transfer taxes. The proposed expatriate may gift assets sufficient to reduce his or her net worth below the $2 million net worth test (for characterization as a covered expatriate).

For example, before expatriation, an expatriate may use the §2503(b) annual exclusion (currently $15,000 per donee) to make non-taxable gifts or, alternatively, make larger gifts by utilizing his or her unified estate and gift tax credit.

Gifts should be made at least three years prior to expatriation to avoid §2035, which adds the value of gifts made within three years of a decedent’s death (or deemed expatriation death) to the deceased’s taxable estate. Unless an exception applies,all gifts made during the three years prior to expatriation are not only included as assets subject to deemed sale, but are likely included in calculating the inheritance tax. 

A potential expatriate may also make unlimited tax-free gifts to a U.S. citizen spouse (prior to expatriation). Interspousal gifts are generally not subject to the three-year “clawback” rule of §2035. If, however, the recipient spouse is also expatriating, the marital gifting strategy will function only if the recipient spouse avoids covered-expatriate status. Otherwise, the proposed transfers will subject the spouse to §877A.

For potential non-citizen covered expats (long-term green-card holders), another possible strategy (to avoid U.S. transfer taxes on foreign assets) is to make transfers after permanently departing the U.S. (but before actually expatriating).

Although the green-card holder would remain a U.S. resident for U.S. income tax purposes, domicile (for estate and gift tax purposes) may be moved outside the U.S. Transfers made while a non-resident, non-citizen for estate and gift tax purposes are not subject to U.S. transfer taxes, unless the property gifted is tangible and located in the U.S.[ Under such circumstances, the mark-to-market tax regime may arguably be avoided on assets gifted (three years before expatriation) and completely avoided if the gifts sufficiently reduce new worth.

Establishing a domestic irrevocable nongrantor trust before expatriation can be an effective method to reduce net worth while maintaining control through an independent trustee. Properly structured expatriation trusts can lawfully shift ownership without triggering §877A inclusion. The trust should be formed in a U.S. state that permits self-settled discretionary trusts and drafted to ensure that the transfer is complete for gift tax purposes while avoiding grantor trust status under §671–§679. After three years, assets within such a trust fall outside the deemed sale and §2801 inheritance tax rules.

  • As a permanent legal resident (green-card holder), the future covered expatriate (domiciled in the U.S.) may take advantage of a full unified estate and gift tax credit by implementing general U.S. transfer tax avoidance strategies before expatriation (three years before expatriation). These include utilizing valuation discounts for potential transfers, gifts to domestic irrevocable trusts, grantor retained annuity trusts, qualified personal residence trusts, intentionally defective grantor trusts (with the toggle-off switch), charitable lead trusts, charitable remainder trusts, etc.
  • As an alternative to outright gifts or other general estate tax-saving vehicles, a potential expatriate may fund an irrevocable (self-settled) trust for himself, his spouse, and descendants. Gifts to a properly structured “expatriation trust” may likely be used to lower net worth (to avoid the $2 million net worth threshold). One strategy is to establish an expatriation trust, to reduce the potential expatriate’s net worth below the $2 million net worth test.  The expatriation trust should be formed as an irrevocable nongrantor discretionary U.S. domestic trust in a state permitting self-settled discretionary trusts. The expatriation trust should be drafted to complete the transfer for U.S. transfer tax purposes (harvesting the settlor’s unified credit).  The trust must also qualify as nongrantor for U.S. income tax purposes (with trust income taxed to the trust). To avoid potential inclusion under §877A, the potential expatriate should also release any powers over trust assets (i.e., powers of appointment). As this vehicle remains a domestic trust under §7701, §684 (deemed mark-to-market sale) would not apply to the transfer of assets into the trust. The potential expatriate may retain the ability to remove and replace independent trustees. Following the passage of three years from funding, §877A would not apply to the assets held in trust.  Moreover, future distributions from the expatriation trust to U.S. beneficiaries (or the expatriate) would also avoid the §2801 inheritance tax.

Other pre-expatriation structures may include grantor retained annuity trusts (GRATs), qualified personal residence trusts (QPRTs), intentionally defective grantor trusts (IDGTs), charitable lead trusts (CLTs), and charitable remainder trusts (CRTs). These instruments can leverage valuation discounts and use of the lifetime exemption to legally lower exposure to the exit tax and U.S. estate tax.

 

Plan ahead to ensure sufficient liquidity for potential exit tax obligations. Consider selling illiquid assets such as real estate or private business interests in advance. Valuation freezes or recapitalisations, such as converting common shares to preferred shares, can reduce future appreciation exposure. Staggering sales over several years can also optimise capital gains rates.

Research how your new country of residence will treat your assets and income. If it offers a step-up in basis on arrival, deferring major sales until after becoming a tax resident there may minimise double taxation. Conversely, if worldwide income is taxed from the first day of residence, consider realising gains in the U.S. beforehand. Aligning both systems’ timing rules prevents overlap in tax exposure.

A long-term green card holder or non-citizen settlor may shift domicile (for estate and gift tax purposes) outside the U.S. before expatriation, even while remaining a U.S. income tax resident. This can permit gifts of non-U.S.-situs assets without triggering U.S. gift tax. Transfers of certain U.S.-situs intangible assets may also escape U.S. gift tax, provided they occur after the domicile shift and more than three years before expatriation.

Alternatively, as discussed above, the non-citizen settlor may utilize foreign domicile transfer tax planning before expatriating. While maintaining U.S. income tax residency, the proposed expatriate establishes domicile outside the United States. Transfers of non-U.S.-situs assets are then not subject to U.S. transfer tax.

Moreover, the transfer of certain U.S.-situs intangible assets avoids U.S. gift tax (including gifts to U.S. donees). For a resident alien with substantial non-U.S. assets and U.S.-situs intangibles, U.S. transfer tax may be avoided. Following the passage of three years from such transfers, §877A does not apply the deemed sale rule to the assets transferred. This strategy may also permit the potential expatriate to completely avoid the exit tax (if transfer brings his or her net worth below $2 million).

Commission independent appraisals for closely held entities and intellectual property. Ensure valuations comply with Revenue Ruling 59-60 and are defensible under IRS review. Proper documentation substantiates exit tax calculations and supports future audits.

Identify all deferred compensation arrangements, pensions, and stock options. Compensation that qualifies as “eligible” under §877A(d) (where the payor agrees to withhold 30%) avoids immediate taxation. File Form W-8CE within 30 days of expatriation to preserve eligibility. Non-eligible plans are subject to immediate taxation on expatriation.

Ensure all restructurings, trust fundings, and corporate reorganisations are completed before expatriation. Transactions lacking economic substance may be disregarded under the IRS’s “look-through” doctrine. Maintain evidence of timing, purpose, and valuation.

Selling your primary residence before expatriation removes its value from the $2 million net-worth calculation and allows gain recognition under §121 while still eligible. Covered expatriates generally cannot claim the §121 exclusion upon deemed sale under §877A, making pre-expatriation sale preferable. Note that, in the event of a deemed sale of the homestead upon expatriation, the popular §121 income tax exclusion (excluding gain from the sale of a personal residence) is likely not available to a covered expatriate.

Although federal law governs expatriation, state income tax may still apply to income earned before expatriation. Consider relocating to a no-income-tax state before departure to reduce exposure. Ensure all ties to high-tax states are severed, such as voter registration, driver’s licence, and property ownership.

At the Time of Expatriation

File Form 8854 (Initial and Annual Expatriation Statement) to report assets, liabilities, and compliance for the preceding five tax years. Failure to certify full compliance automatically classifies the taxpayer as a covered expatriate under IRC §877(a)(2)(C).

Covered expatriates are deemed to sell all assets the day before expatriation. For 2025, the first USD 866,000 of gain is excluded, with the remainder taxed at applicable capital gains rates. Taxpayers may elect to defer payment under §877A(b) by providing adequate security (such as a bond or letter of credit) and waiving treaty rights to prevent collection. Deferred amounts accrue statutory interest.

After Expatriation

After expatriation, income derived from U.S. sources (interest, dividends, rents) remains subject to withholding under IRC §871(a). File Form W-8BEN and rely on applicable treaty provisions to reduce or eliminate withholding where possible.

Post-expatriation, gifts or bequests to U.S. persons may trigger §2801 tax, payable by the recipient. Advance estate planning, such as using foreign trusts or structured inheritances, may mitigate exposure. Form 708, though not yet released, will eventually formalise this obligation.

Maintain all valuations, transaction records, and compliance filings permanently. The IRS may review expatriation years later, especially where valuations are questioned or Form 8854 is incomplete.

Section 349(a)(5) explains how a United States citizen can give up their U.S. citizenship while living abroad. This section states that a person can lose their nationality by choosing to give it up in a formal way before a diplomatic or consular officer of the United States in a foreign state, in such form as prescribed by the Secretary of State.

To give up U.S. citizenship, a person must choose/want to do so, go in person to see a U.S. consular or diplomatic officer in a foreign country at a U.S. Embassy or Consulate, and sign an oath saying they want to give up their citizenship. A person cannot give up their citizenship in another way, such as by mail, on the Internet, or through someone else. In fact, U.S. courts have said that some attempts to give up U.S. citizenship do not count for various reasons.

A person who wants to give up their U.S. citizenship must also give up all the rights and privileges that come with being a U.S. citizen.

People who want to give up their U.S. citizenship should know that unless they already have citizenship from another country, they might not have any citizenship at all. This means they will not have the protection of any government and might have trouble traveling because they will not have a passport from any country.

Not having any citizenship can cause many problems, such as having difficulty owning or renting a place to live, getting a job, getting married, getting medical help or other benefits, or going to school. Those who renounced their citizenship will need a visa to travel to the United States or show that they can enter the country without a visa under the Visa Waiver Program. If they cannot get a visa, they might never be able to go back to the United States again.

People who want to give up their U.S. citizenship should know that it does not change their liabilities on taxes or military service (they can ask the Internal Revenue Service or U.S. Selective Service for more information).

Also, giving up U.S. citizenship does not mean someone cannot be punished for breaking United States law or that they do not have to pay back the money they owe, including child support payments.

It is common for individuals to have pension accounts arising from a temporary work assignment and they are concerned with the U.S. withholding tax of 30%. They are also concerned about the 10% early withdrawal penalty.

What is deferred compensation?

 

The following items are defined by the IRS as deferred compensation items.
Normal domestic pension-like arrangements
First, there are things that look like normal types of plans. These are defined as “any interest in a plan or arrangement described in section 219(g)(5).”

 This means:

  • a plan described in section 401(a) that includes a trust exempt from tax under section 501(a),
  • an annuity plan described in section 403(a),
  • a plan established for its employees by the United States, by a State or political subdivision thereof, or by an agency or instrumentality of any of the foregoing, but excluding an eligible deferred compensation plan (within the meaning of section 457 (b)),
  • an annuity contract described in section 403(b),
  • a simplified employee pension (within the meaning of section 408(k)),
  • a simplified retirement account (within the meaning of section 408(p)), or
  • a trust described in section 501(c)(18).

 

Foreign pensions

An interest in a foreign pension plan or similar retirement arrangement or program is a “deferred compensation item” for exit tax purposes. Yes, you will have to wrangle with that pension you built up for decades before becoming a US resident.

Special stuff identified in Notice 2009-85

Deferred compensation items also include things that are defined in Section 5.B(4) of Notice 2009-85. This is a “catch-all” provision. If you have the right to get some compensation, the IRS wants to deal with it for the exit tax.

No section 83 election

Sometimes employees are given property (like stock in the employer company) as compensation. They can make an election to treat themselves as having received the full value of that property in the year of receipt. The provision of the Code is section 83. Alternatively, they might not make the election, in which case they wait until some future date to take the item into income.

The exit tax rules say that if you made the section 83 election, the item is not a deferred compensation item. (Makes sense. It is now an asset that is taxed under the mark-to-market rules.) But if you did not make the section 83 election, then it is a deferred compensation item and must be dealt with accordingly for exit tax purposes.

Eligible deferred compensation

Once you know that you have an item of deferred compensation, you must figure out whether it is eligible deferred compensation or ineligible deferred compensation.An eligible deferred compensation item means any deferred compensation item where:

  • The payor is either a US person or a non-US person who elects to be treated as a US person for purposes of the exit tax; and
  • The covered expatriate notifies the payor of his or her status as a covered expatriate and irrevocably waives any right to claim any withholding reduction under any treaty with the United States.

Paperwork and timing requirements

Covered expatriates who have eligible deferred compensation must file Form W-8CE with the plan custodian.Form W-8CE must be filed “on the earlier of (1) the day prior to the first distribution on or after the expatriation date or (2) 30 days after the covered expatriate’s expatriation date as defined in section 877A(g)(3)).”Form W-8CE instructs the payor to withhold tax on payments made to you.
 

Taxation of eligible deferred compensation

Distributions from an eligible deferred compensation plan are taxed at 30 percent as payments are made.The 30 percent tax is withheld from the payments and sent to the IRS by the payor. The remaining amount of the payment is sent to you, the covered expatriate.

Ineligible deferred compensation

Ineligible deferred compensation is any deferred compensation item that is not eligible deferred compensation.

Paperwork and timing requirementsJust like covered expatriates who have items of eligible deferred compensation, owners of ineligible deferred compensation items must file Form W-8CE with the plan custodian, using the same deadlines.For ineligible deferred compensation, Form W-8CE instructs the payor to provide the covered expatriate with the present value of the plan on the day before expatriation:“Within 60 days of the receipt of a properly completed Form W-8CE, the payor of the ineligible deferred compensation item must advise the covered expatriate of the present value of the covered expatriate’s accrued benefit in the deferred compensation item on the day before the expatriation date.”Although there is a requirement for the payor to provide the present value, it is not uncommon for the payor to fail to do so.

In that case, the covered expatriate must calculate the present value himself, using guidance for valuation methods for various types of assets found in Section 5 of IRS Notice 2009-85.

Taxation of ineligible deferred compensation

Ineligible deferred compensation items are taxed as if they were fully distributed to the covered expatriate on the day before expatriation; this is the reason that the payor must provide the present value of the plan to the covered expatriate when presented with Form W-8CE.The covered expatriate must include the present value of his interest in the deferred compensation item in taxable income for the year of expatriation.This can be problematic, because when the expatriate takes distributions from the plan in a later year, he may be subject to tax only in his country of residence, and he will not have the benefit of a foreign tax credit from the exit tax already paid for the year of expatriation. Depending on the country of residence, for some retirement plans this can cause the total tax rate to approach 80 percent.

Pre-planning for distributions from ineligible deferred compensationIt can be helpful to plan ahead to time your distributions carefully to minimize your overall tax rates. It may be impossible to completely eliminate the double tax problem, but it can usually be made less bad with some planning ahead.

 

Exception for services performed outside the US

For someone who accrued deferred compensation benefits outside the US before becoming a resident or citizen, there is a bit of a break. Those deferred compensation items are not subject to the exit tax rules.If you were a US citizen or green card holder working abroad when you accrued the benefits, however, they are not excluded from the exit tax calculations.

Section 877A(h)(2) provides that, solely for purposes of determining the tax imposed by reason of section 877A(a), property that was held by a non-resident alien on the day that individual first became a resident of the United States (within the meaning of section 7701(b)) will be treated as having a basis on such date of not less than the fair market value of such property on such date. A covered expatriate to whom this basis adjustment rule applies may make an irrevocable election, on a property-by-property basis, not to have such rule apply. The election must be made on Form 8854, which must be filed with the covered expatriate’s Federal income tax return for the taxable year that includes the day before the expatriation date. See section 8 of this notice for information concerning Form 8854.

The IRS and Treasury Department intend to exercise their regulatory authority to exclude from this step-up-in-basis rule United States real property interests within the meaning of section 897(c) (“USRPIs”) and property used or held for use in connection with the conduct of a trade or business within the United States.

Thus, if on the date the non-resident alien first became a resident of the United States, the non-resident alien held property that was a USRPI or was property used or held for use in connection with the conduct of a trade or business within the United States, then the basis of such property may not be stepped up to fair market value under 877A(h)(2).

If, however, prior to becoming a resident of the United States, the non-resident alien was a resident of a country with which the United States had an income tax treaty, and the non-resident alien held property used or held for use in connection with the conduct of a U.S. trade or business that was not carried on through a permanent establishment in the United States under the income tax treaty of such country and the United States, then that property is eligible for a step up in basis to fair market value under 877A(h)(2).

Conclusion

If you are not a U.S. citizen with a U.S. IRA or 401(k) and expect to depart the United States or have already departed the United States, contact us to discuss your options.

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Table of Contents: US Pre-Expatriation Tax Planning – the Ultimate Tax Guide to Leaving the United States

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Derren works with International Entrepreneurs, Expats and Investors who are exposed to multiple jurisdictions. Tax optimization. Asset Protection. Compliance Obligations. Strategies include second citizenships, second residencies, trusts, foundations, insurance wrappers and other offshore structures.

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