The Grass May Not be Greener for Expatriates Leaving the U.S. for Tax Relief

What we know about IRC 877A that may have expatriate hopefuls unpacking their bags.

By Leo Parmegiani, Partner and Yevgeny Antonov, Director

Section 877A was added to the Internal Revenue Code (IRC) in 2008, introducing the current tax regime for expatriates. Since then, a growing number of U.S. citizens have relinquished their citizenships, with many long-term permanent residents also giving up their green cards.

For a multitude of reasons (e.g., business relocations, lifestyle preferences, country family ties, political inclinations), many U.S. citizens are relinquishing their U.S. citizenship and long-term permanent residents are formally giving up their green cards to end the maze of never-ending tax compliance and reporting obligations. This is true even for those who have already permanently moved outside the U.S.

These obligations include reporting income activity and asset holdings on a worldwide basis and could result in tens of thousands of dollars in tax compliance costs even if, in some cases, no taxes are owed. By giving up their ties to the U.S., they hope to be free of federal tax filings and also break tax residency in the state in which they reside to end their state tax responsibilities as well.

But not so fast. We’d like to share what we know about Section 877A that may make soon-to-be expatriates feel the grass won’t be greener by leaving the U.S.

Summarized below is critical information to consider when deciding on relinquishing U.S. citizenship or a green card, including the rules around giving up citizenship, the expatriate exit tax, the mark-to-market rule, exclusion amounts and allocating them across assets, reporting obligations and some of the IRS enforcement actions we’ve seen relating to 877A.

Relinquishing U.S. Citizenship

For the purpose of 877A, an individual relinquishes citizenship on the earliest date in which:

• They renounce U.S. nationality before a diplomatic or consular officer of the United States.
• They furnish to the U.S. Department of State a signed Statement of Voluntary Relinquishment of U.S. Nationality confirming the performance of an act of expatriation.
• The State Department issues a Certificate of Loss of Nationality to the individual.
• A U.S. court “cancels a naturalized citizen’s Certificate of Naturalization.”

A person ceases to be a lawful permanent resident on the occurrence of the earliest of the following:

• Their green card is revoked or administratively or judicially determined to have been abandoned or they:

1. 1. Begin to be treated as a resident of a foreign country under a tax treaty between the United States and the foreign country.
   2. Do not waive treaty benefits available to residents of the foreign country.
   3. Notify the IRS of this treatment.

The 877A Expatriate Exit Tax: Covered Expatriates, Qualifying Conditions, Amounts Taxed

What a significant number of expatriate hopefuls do not know is that there is a potential hefty expatriate exit tax to pay, whereby covered expatriates meeting certain conditions are treated as having sold their worldwide assets at fair market value and are taxed on the deemed gain. Breaking this down for you:

Covered Expatriates applies to certain individuals meeting certain conditions:

• Any U.S. citizen who relinquishes citizenship or
• Any long-term permanent resident who held their green card in at least eight of the last 15 calendar years and ceases to be a permanent resident.

Coupled with any of the following conditions:

• Average annual net-income tax liability over the last three years of $201,000 in 2024.
• Net worth of $2 million on the date of the expatriation.
• Failure to certify or submit evidence of tax compliance for the preceding five years.

If the US person is considered covered and meets any one of the above conditions, an exit tax will be imposed:

• On the deemed gain of the asset (derived via a mark-to-market rule).
• For any amount that exceeds the IRS threshold for that tax year ($866,000 in 2024).

The Mark-to-Market Rule for Deemed Sale of Assets

All property of a covered expatriate under the mark-to-market regime is “treated as sold on the day before the expatriation date for its fair market value.”  For this purpose, covered expatriates are deemed to own:

1. “Any interest in property that would be taxable as part of his or her gross estate” for federal estate tax purposes if he or she had died on the day before the expatriation date.
2. “His or her beneficial interest(s) in each trust (or portion of a trust)” that would not be part of the gross estate.

Fair market values are generally determined “in accordance with the valuation principles” of the federal estate tax, applied as though the covered expatriate had died on the day before the expatriation date. Gift tax principles are used to value interests in trusts not includable in the expatriate’s gross estate and life insurance policies.

The Allowable Exclusion Amount … and Allocating it Across Assets

For each tax year, there is an allowable exclusion amount that would be allocated across all the assets subject to the mark-to-market rule. For 2024, that amount is $866,000.

To calculate the allocation of an exclusion amount across each mark-to-market asset, the expatriating taxpayer would:

1. Determine the built-in gain or loss, G/(L), for each asset deemed sold (Fair Market Value minus Adjusted Tax Basis).
2. Calculate the total G/(L) for all assets.
3. Determine the allocation ratio of each asset by dividing built-in asset G/(L) by total G/(L).
4. Multiply each asset’s ratio by the tax-year exclusion amount to determine its allocation amount.
5. Subtract each asset’s allocation amount from its built-in G/(L) to determine reportable G/(L).

Follow the example below to understand how the built-in gains would be derived and reported on Form 1040 by the taxpayer (in this instance, deemed gains are $1,020,600 and $113,400):

Note: *To calculate the exclusion allocation, multiply the allocation ratio by $866,000.

The exclusion amount allocated to each asset would then be subtracted from the amount of built-in gain deemed realized on each asset as follows:

Asset X $1,800,000 – $779,400 = $1,020,600

Asset Y $200,000 – $86,600 = $113,400

Assets Excluded from the Deemed-Gain Calculation

Certain assets are excluded from this immediate gain calculation — such as tax-deferred accounts, retirement plans and interests in non-grantor trusts — but are subject to their own special tax regime designed to ensure U.S. tax is imposed at a later date.

Other assets also have certain nuances under the mark-to-market regime which should be considered by the taxpayer, such as the deemed sale of a principal residence. Typically, a taxpayer could claim a Section 121 exclusion of up to $250,000 ($500,000 for married taxpayers filing jointly) if they owned and used the property as the taxpayer’s principal residence for periods aggregating two years or more during the five-year period ending on the date of the property sale or exchange.

However, the IRS has taken a position that a “deemed sale” would not qualify the taxpayer for the Section 121 exclusion, whereby the only exclusion amount that can be claimed on the deemed sale would be the allowable exclusion amount ($866,000 in 2024).

Reporting Obligations for Covered Expatriates: Form 1040 or 1040NR + Form 8854

Along with Form 1040 or 1040NR, the covered/qualifying expatriate must file Form 8854 for the expatriation year, reporting information relevant to the application of these provisions. Form 8854 must be signed under penalties of perjury, with a separate copy also being mailed to the IRS.

If the taxpayer fails to file it by the due date, fails to include all required information on the form or includes incorrect information, they are liable for a penalty of $10,000. The IRS may, however, waive the penalty if the taxpayer demonstrates that the failure was due to reasonable cause and not willful neglect.

IRS Enforcement Actions

The IRS has noticed that the compliance rate for those required to file Form 8854 is low and has contacted taxpayers in a number of ways, from “soft reminder letters” to full examinations.

In addition, since 2017, the IRS Large and International Business Division (LB&I) has launched various initiatives, identified problem areas and developed techniques to seek out taxpayers who have not complied and may owe significant tax interest and penalties.

The focus is on incomplete or inaccurate Form 8854 filings and using available government databases, such as social security numbers, to track down non-filers. A recent Treasury Inspector General Report has even suggested that the IRS may work with the U.S. Department of State to add social security numbers to the Certificate of Loss of Nationality to better track expatriating individuals who had failed to file Form 8854.

In any case, the IRS seems committed to improving its processes and pursuing expatriates who they believe did not expatriate properly, including potential criminal actions against individuals who intentionally and significantly underreported their U.S. income and assets in prior years.

Read more about Section 877A here.

PKF O’Connor Davies Has Experience to Help You Before, During or After Expatriation

The PKF O’Connor Davies International Tax team has significant experience in this area and advises clients on the risks, both as expatriation is considered and also before a green card is applied for, so that our clients can make prudent educated tax and financial decisions, especially since they could have lifelong effects.

Similarly, we advise those citizens and long-term residents who are living outside the U.S. to stay current with their U.S. tax obligations. We also advise those who have not kept up, assisting them in getting back into compliance with minimal penalties where possible.

Contact Us

If you require these services or know someone in this situation, please contact your PKF O’Connor Davies International Tax partner or:

Leo Parmegiani, CPA, MST   
Partner
lparmegiani@pkfod.com

Yevgeny Antonov, JD
Director
yantonov@pkfod.com