The exit tax for covered expatriates

The U.S. exit tax under IRC §877A applies only to covered expatriates — but for those who qualify, it's substantial: a single-year deemed-sale event that pulls forward potentially decades of unrealized gain, plus separate rules for retirement accounts, deferred compensation, and trust interests. This article walks through the actual mechanics, with the 2025 numbers and statutory cross-references.

For the question of who's a covered expatriate in the first place, see Giving up U.S. citizenship: the tax side. This article assumes you've already determined that covered-expatriate status applies.

What §877A does at the highest level

§877A divides the covered expatriate's worldwide assets into four buckets, each with different treatment:

1. Most property (stocks, real estate, business interests, art, crypto, etc.) — mark-to-market deemed sale under §877A(a)
2. Specified tax-deferred accounts (IRAs, 529s, HSAs, etc.) — deemed full distribution under §877A(e)
3. Deferred compensation (employer pensions, 401(k)s, non-qualified deferred comp) — either 30% withholding at future payout or present-value inclusion now, depending on classification, under §877A(d)
4. Non-grantor trust interests — 30% withholding on future distributions under §877A(f)

Each bucket has its own mechanics. Let's walk through them.

Bucket 1: Mark-to-market deemed sale (§877A(a))

The default rule for most property:

• All your worldwide property is treated as sold at fair market value on the day before the expatriation date.
• Gain or loss is recognized as if you actually sold each asset on that day.
• Wash sale rules of §1091 do not apply (per the IRS expatriation page).
• Net gain is reduced by an inflation-indexed exclusion. For 2025, the exclusion is $890,000 (per the 2025 Form 8854 instructions). Above that, the net gain is taxable on your expatriation-year return.

The character of the gain — capital vs. ordinary, long-term vs. short-term — is determined as if the property were actually sold. A long-held stock position generates long-term capital gain; a recent crypto trade in your portfolio might be short-term. Different assets in the deemed sale produce different tax characters in the same year.

What's not in this bucket

Per §877A(c), the mark-to-market rule excludes:

• Deferred compensation items (treated under §877A(d) — see Bucket 3)
• Specified tax-deferred accounts (treated under §877A(e) — Bucket 2)
• Interests in non-grantor trusts (treated under §877A(f) — Bucket 4)

So when you read "mark-to-market deemed sale," it means: everything except those three carve-outs.

The basis question

For property you held before becoming a U.S. citizen or resident, §877A(h)(2) provides a step-up election: property held when you became a U.S. person gets a basis of "not less than the fair market value" of the property on the date you became a U.S. person. The election is irrevocable and made on Form 8854. This protects naturalized citizens and long-term residents from being taxed on pre-immigration gain.

For property acquired after you became a U.S. person, normal basis rules apply.

The deferral election (§877A(b))

If the up-front exit tax is painful, you can elect to defer payment until the property is actually sold. Requirements per §877A(b):

• Adequate security: a bond meeting §6325 or a letter of credit acceptable to the IRS
• Irrevocable waiver of any treaty benefits that would prevent the U.S. from later assessing the tax
• Interest accrues under §6601 — the federal underpayment rate (set quarterly, recently around 7–8%)
• The election is irrevocable once made

The deferred tax becomes due on the earlier of:

• The actual sale or disposition of the property, or
• The due date of the return for the year of the covered expatriate's death

For high-value, illiquid assets (a closely held business, a foreign property you'd lose money selling quickly), the deferral can be the difference between a manageable exit and a forced fire sale. For liquid stock you intended to sell anyway, deferral usually isn't worth the bond cost and interest accrual.

Bucket 2: Specified tax-deferred accounts (§877A(e))

Per the 2025 Form 8854 instructions, these accounts are:

• IRAs (other than SEP and SIMPLE IRAs)
• 529 plans
• ABLE accounts
• Coverdell education savings accounts (ESAs)
• Health savings accounts (HSAs)
• Archer MSAs

The rule: the entire interest in each of these accounts is treated as distributed on the day before the expatriation date. The full balance becomes ordinary income on the expatriation-year return.

Important softener: per §877A(e), the 10% early-withdrawal penalty does not apply to this deemed distribution. You pay ordinary income tax on the balance but no penalty.

Still — for someone with $500K in a Traditional IRA, the deemed distribution generates $500K of ordinary income on top of whatever exit tax applies to their other assets. The combined tax bill can easily exceed half of the IRA balance.

The deemed distribution is not a basis step-up for future tax purposes in the country where you retire. If you actually withdraw funds years later, the foreign country may tax the distribution again — with no U.S. tax to credit against.

Bucket 3: Deferred compensation (§877A(d))

Deferred comp gets split into two categories.

Eligible deferred compensation items

A deferred comp item is eligible if:

• The payor is a U.S. person (or a non-U.S. person electing to be treated as one), and
• The expatriate notifies the payor of covered-expatriate status (via Form W-8CE) and irrevocably waives any treaty right to a reduced withholding rate

Treatment: when payments are eventually made, the payor withholds 30% of each taxable distribution at source. No immediate inclusion in income on the expatriation-year return.

This is the cleaner outcome — your accrued benefit stays in the plan, grows tax-deferred, and the U.S. extracts its tax at distribution via withholding.

Form W-8CE timing: file with the payor on the earlier of:

• The day before the first distribution on or after the expatriation date, or
• 30 days after the expatriation date

Missing the W-8CE deadline can convert eligible items into ineligible — bad outcome.

Ineligible deferred compensation items

Anything that doesn't qualify as eligible: payor is foreign and won't comply, or you fail to file the W-8CE timely.

Treatment: the present value of the accrued benefit is included in income on the expatriation-year return as if you'd received it that day. You pay tax now on a benefit you may not actually receive for decades, with no future credit if the benefit doesn't materialize.

The early-withdrawal penalty does not apply (parallel to §877A(e)).

Bucket 4: Non-grantor trust interests (§877A(f))

A non-grantor trust is one where the covered expatriate was not considered the owner under the grantor-trust rules (§§671–679) on the day before expatriation. The §877A treatment:

• Trustee withholds 30% of the taxable portion of any future distribution to the covered expatriate
• The trust recognizes gain as if the distributed property were sold to a third party for FMV (if the property's FMV exceeds basis)

The 30% withholding applies regardless of the recipient's country of residence or any otherwise-applicable treaty.

For grantor trusts (where the expatriate was the deemed owner before expatriation), the underlying assets are included in the §877A(a) mark-to-market regime instead — no special trust treatment.

Worked example

Assume a covered expatriate, 2025 expatriation, with these assets:

• U.S. brokerage: $1.5M FMV, $500K basis → $1M gain (long-term capital)
• Foreign brokerage: $400K FMV, $300K basis → $100K gain (long-term)
• Foreign rental property: $800K FMV, $400K basis → $400K gain (Section 1250 rules apply for depreciation recapture)
• Traditional IRA: $300K balance → entire $300K is ordinary income under §877A(e)
• Vested 401(k): $200K balance; covered by W-8CE → no current inclusion, 30% withheld on future distributions
• Total mark-to-market gain (Bucket 1): $1,000,000 + $100,000 + $400,000 = $1,500,000
• §877A(a)(3) exclusion: $890,000 (2025)
• Net mark-to-market gain taxable: $1,500,000 − $890,000 = $610,000
• §877A(e) deemed IRA distribution: $300,000 of ordinary income
• §877A(d) deferred comp: $0 current inclusion (eligible, W-8CE filed)

The expatriation-year return reports:

• $610K of net capital gain (mostly long-term, taxed at 20% + 3.8% NIIT)
• $300K of ordinary income from the IRA
• Full year of other income normally reported

Approximate U.S. tax bill on the expatriation items alone:

• $610K capital gain × ~23.8% = ~$145K
• $300K IRA distribution at high marginal rates (top bracket on much of it) ≈ ~$100K
• Combined exit-related tax: ~$245K

That's the price of the exit. Plus continuing 30% withholding on every future 401(k) distribution forever.

The §2801 tail: gifts to U.S. recipients

Even after the exit tax is paid and the expatriate has left the U.S. tax system, §2801 creates a permanent reporting and tax obligation on U.S. citizens and residents who receive gifts or bequests from a covered expatriate.

Key mechanics (per the §2801 implementing regulations, finalized January 2025):

• The U.S. recipient pays the tax, not the expatriate
• Rate: the highest gift-tax rate, currently 40%
• No statute of limitations — applies indefinitely after expatriation
• Annual exclusion for small gifts (parallels the gift-tax annual exclusion — $18K in 2024, adjusts annually)
• Reporting on the §2801 reporting form for the recipient

For an expat planning to gift assets to U.S.-citizen family members after renunciation, this rule converts what would have been tax-free family transfers into a 40% bill for the recipients. Estate-planning around §2801 is a specialty discipline; the rule is one of the major reasons high-net-worth covered expatriates often do significant gifting before the expatriation date (when normal U.S. gift-tax rules apply, with the unified lifetime exemption).

When the exit tax is avoidable

A few categories of property are not subject to mark-to-market at all:

• U.S. real property held directly — not in the mark-to-market regime; remains subject to normal U.S. tax at actual sale (FIRPTA may apply to the future sale)
• Property already taxed by another regime (very narrow)
• Property held in grantor trusts with foreign grantors after expatriation — the trust rules govern, not §877A(a)

For most covered expatriates, the vast majority of net worth is in the mark-to-market regime. Selectively realizing losses in the year before expatriation (to reduce the deemed-gain base), gifting assets to non-expatriating family members in advance, and timing the expatriation date to a low-income year are the standard planning moves.

The dual-status return and ongoing filings

The expatriation year requires:

• Form 1040 covering January 1 through the expatriation date (full citizen / resident period)
• Form 1040-NR covering the expatriation date through December 31 (non-resident period — U.S.-source income only)
• Form 8854 filed with the 1040, computing the exit tax
• Form W-8CE filed with eligible-deferred-compensation payors

Subsequent years:

• Form 8854 annually if you elected deferral on any exit-tax property, have eligible deferred comp in progress, or hold non-grantor trust interests with ongoing §877A(f) withholding
• Form 1040-NR for any year you have U.S.-source income
• Continuing FBAR if you have signature authority over U.S.-person accounts (rare post-expatriation)

Missing the annual Form 8854 carries a $10,000 penalty per year.

Common mistakes covered expatriates make

• Renouncing without modeling the exit tax first. The mark-to-market date is the day before expatriation — you can't time it after the fact.
• Not making the §877A(h)(2) basis step-up election when applicable. Naturalized citizens with pre-immigration property pay tax on gain they wouldn't have owed under any other regime.
• Missing the W-8CE deadline and converting eligible deferred comp into ineligible (immediate present-value inclusion).
• Forgetting §2801 when planning gifts. Post-expatriation transfers to U.S. relatives cost 40%.
• Not maintaining the deferral-election bond. If the security lapses, the IRS can accelerate the tax.
• Treating the U.S. real-property exclusion as a free pass. It just defers the tax; FIRPTA still applies at actual sale.
• Filing Form 8854 once and stopping. Annual reporting is required if deferred items remain.

Next steps

• Giving up U.S. citizenship: the tax side — the parent article
• Green-card holder living abroad — the 8-year long-term-resident clock that brings green-card holders into §877A
• Streamlined Filing Procedures — the cleanup path before expatriation
• The exit-tax decision involves tax, immigration, citizenship law, and estate planning. Run your specific facts past a credentialed cross-border attorney and EA before any embassy appointment.

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Sources used

• IRC §877A statutory text — subsections (a) through (h), particularly the mark-to-market regime, deferral election, treatment of deferred compensation and tax-deferred accounts, non-grantor trust withholding, and basis step-up election
• IRS, "Expatriation tax" — wash-sale carve-out, four expatriating acts
• IRS, "Instructions for Form 8854 (2025)" — $890K exclusion amount for 2025, list of specified tax-deferred accounts, W-8CE timing, $10K penalty, no early-withdrawal penalty on deemed distributions
• IRC §6601 — interest on tax not timely paid, referenced by §877A(b) for the deferral interest
• §2801 — implementing regulations finalized January 2025; 40% rate via reference to highest gift-tax rate under §2502