IRC 877A: Deemed Sale Rules for Departing Americans

Filing a late Form 8854 can trigger a $10,000 penalty even when you owe zero exit tax. For Americans with $2 million or more in worldwide assets, skipping this form is worse still — the IRS automatically classifies you as a covered expatriate, piling the full mark-to-market exit tax on top of the fine. The US exit tax is one of the few tax events where the trigger is your status, not your transaction, and where a paperwork failure alone can cost more than a competent CPA would have charged to prevent it.

Who qualifies as a covered expatriate?

A covered expatriate is anyone who leaves US tax residency and meets any one of three tests on their expatriation date. You do not need to meet all three — one is enough to trigger the exit tax.

The rules apply under IRC Section 877A to US citizens who formally renounce and to long-term permanent residents who abandon their green card. "Long-term" means you held lawful permanent resident status for at least 8 of the last 15 tax years ending with the year of abandonment. Someone who got a green card in 2015 and files Form I-407 in 2026 crosses the 8-year threshold and must evaluate all three covered-expatriate tests.

The three tests for 2026

Test	2026 Threshold	Notes
Net worth	$2,000,000+	Worldwide assets minus liabilities on expatriation date; not inflation-adjusted
Average annual income tax	$211,000+	Average US federal income tax liability over the 5 years before expatriation; adjusted annually
Certification failure	Any amount	Failure to certify on Form 8854 that you complied with all US tax obligations for the prior 5 years makes you a covered expatriate automatically

The certification test catches people who assume they are below the financial thresholds. A remote worker who earned $80,000 per year and filed correctly every year is not a covered expatriate — provided they certify compliance on Form 8854. If they skip the form or miss a filing year, that protection disappears.

How the mark-to-market exit tax works

On the day before your expatriation date, the IRS treats every asset you own worldwide as if you sold it at fair market value. Any net gain above the 2026 exclusion amount of $910,000 is taxable in that final US tax year.

Gains are taxed at the applicable long-term or short-term capital gains rate depending on holding period. Assets held over a year face long-term rates (0%, 15%, or 20% depending on income bracket) plus the 3.8% Net Investment Income Tax for higher earners. The exclusion is allocated proportionally across all gain assets — you cannot apply the full $910,000 to one holding and ignore the rest.

Losses are taken into account to the extent the tax code otherwise allows, so an unrealized loss on a foreign property can offset gain on appreciated stock. The wash-sale rules under IRC 1091 do not apply to the deemed sale, which is one of the few technical breaks the exit tax gives taxpayers.

The exclusion amount adjusts annually for inflation. It was $877,000 in 2024, $890,000 in 2025, and $910,000 in 2026. You can find the current-year amount in the IRS Instructions for Form 8854.

Data note: 2026 exclusion amount sourced from IRS guidance and tax professional reporting as of June 2026. The $211,000 average income tax threshold for 2026 reflects annual inflation adjustment. Always confirm current figures on irs.gov before filing.

What happens to your IRA and 401(k)?

IRAs and 401(k)s are treated completely differently from each other under exit tax rules — and getting this wrong is one of the most expensive mistakes a departing American can make.

Traditional IRAs fall under "specified tax-deferred accounts" in IRC Section 877A(e)(2). The IRS treats the entire balance as distributed to you on the day before expatriation. You owe ordinary income tax on the full amount in your final US tax year — no 10% early-withdrawal penalty applies to this deemed distribution, but the income can push your marginal rate to 37% and generate a large additional tax bill even before the mark-to-market gains are counted.

401(k) plans and pension arrangements that qualify as "eligible deferred compensation" under Section 877A(c) are handled differently. They are not deemed distributed at expatriation. Instead, they remain deferred until you actually take distributions. The cost comes later: once you become a nonresident alien, any future 401(k) distribution is subject to 30% withholding with no treaty reduction available. Most tax treaties include a "saving clause" that lets the US keep taxing its citizens and former residents — but once you are a covered expatriate you have already waived treaty benefits, so the 30% rate is permanent.

For more background on how 401(k)s and IRAs interact with expat status before expatriation, see the expat 401(k) and IRA retirement guide.

Green card holders: the 8-of-15 rule and timing

Green card holders who have not held their card for 8 of the last 15 years are not long-term permanent residents and are not subject to the exit tax — which means timing your abandonment before reaching that threshold can save a significant amount.

The expatriation date for a green card holder is the date you file or mail Form I-407 (Record of Abandonment of Lawful Permanent Resident Status) to US Citizenship and Immigration Services. Simply letting a green card expire does not constitute expatriation for tax purposes — you must take affirmative action. An individual who got their green card on January 5, 2018, reaches the 8-year mark on January 5, 2026. Filing Form I-407 in December 2025 means only 7 complete years of LPR status were held, keeping you outside the long-term resident definition.

US citizens have no similar threshold option. Expatriation occurs on the date you formally renounce before a US diplomatic or consular officer. The State Department charges a $2,350 nonwaivable consular fee for processing a Certificate of Loss of Nationality. You must appear in person at a US Embassy or Consulate abroad — renunciation cannot be done inside the United States.

The covered gift and bequest tax: a permanent obligation

Becoming a covered expatriate does not just affect your own tax bill — it creates a permanent 40% transfer tax on future gifts and bequests you make to US persons.

Under IRC Section 2801, enacted as part of the HEART Act in 2008, US citizens and residents who receive gifts or bequests from a covered expatriate owe a 40% tax on transfers above the annual gift exclusion ($19,000 per recipient for 2026). The tax is imposed on the recipient, not the giver. Final regulations under Section 2801 took effect January 1, 2025, and recipients must file Form 708 annually to report and pay the tax.

There is no sunset on this obligation. A covered expatriate who renounced in 2015 continues to generate Section 2801 liability on every gift to a US person indefinitely. Estate planning around this often involves structuring assets into non-US trusts or entities before making transfers, which requires careful legal advice in both the US and the destination country.

What about California's proposed exit tax?

As of June 2026, California has no enacted exit tax, departure tax, or wealth tax. Multiple proposals have failed, and the most recent ballot measure has not passed.

AB 2088 (2020) and AB 259 (2023) both died before becoming law. A potential 2026 Billionaire Tax Act would impose a 5% excise tax on net worth of $1 billion or more measured as of January 1, 2026, but it has not been enacted. California can still enforce worldwide income taxation on residents who move mid-year and can audit whether a move was genuine — particularly where someone claims to have changed domicile but maintains property, business ties, or family connections in the state. For practical guidance on how your income was split between the state and abroad, the broader US expat banking and tax guide covers state-level issues alongside federal rules.

Pre-expatriation planning checklist

None of the following steps replace formal legal and tax counsel, but they represent the structural moves that most exit-tax planners evaluate in the 2-5 years before expatriation.

1. Assess the three covered-expatriate tests early. Get a formal net worth calculation at least two years before your target date. Know where you stand against all three thresholds.
2. File all US tax returns and FBARs. Certification failure on Form 8854 is one of the most common avoidable triggers. Every prior year must be filed and compliant before you can certify.
3. Consider accelerating IRA withdrawals before expatriation. If you have a large IRA balance, phased withdrawals in years before expatriation can reduce the deemed-distribution hit — especially if your income in those years is lower than it will be in the departure year.
4. Evaluate irrevocable trust structures. Assets transferred to an irrevocable trust prior to expatriation are no longer part of your estate for mark-to-market purposes. Annual exclusion gifting ($19,000 per recipient) can also reduce net worth below the $2M threshold if started early enough.
5. Review the 8-of-15 year count for green card holders. If you are approaching year 8, evaluate whether abandoning the card before that date is practical and consistent with your other plans.
6. Understand the 401(k) permanent 30% withholding trap. If your 401(k) balance is substantial, consider rolling it to an IRA and taking distributions — while still a US person — at a lower effective rate rather than facing 30% flat withholding as a nonresident alien forever.
7. File Form 8854 on time. It is due with your final US income tax return (April 15 of the year following expatriation, with extensions to October 15). Missing it triggers the $10,000 penalty and automatic covered-expatriate status.

FEIE users: the exit tax still applies

The Foreign Earned Income Exclusion reduces annual US income tax while you are abroad, but it has no effect on exit-tax liability when you eventually leave US tax residency.

A common misunderstanding is that claiming FEIE for many years keeps your average income tax low enough to avoid the covered-expatriate income tax threshold. This is partially true — FEIE can reduce your annual tax liability and lower your 5-year average. But it does nothing about the net worth test, and it does not make Form 8854 optional. The two regimes address different questions: FEIE is about reducing ongoing US tax while abroad; the exit tax is about your final reckoning when you leave the US tax system entirely. See the FEIE vs. Foreign Tax Credit comparison for how those two tools interact with your ongoing situation.

Relief for those who left without knowing

The IRS offers specific relief procedures for certain former citizens who expatriated without realizing they needed to file — but eligibility is narrow.

To qualify under the IRS Relief Procedures for Certain Former Citizens, you must have net worth under $2 million, total US tax liability of $25,000 or less for the year of expatriation and the prior 5 years, and a non-willful reason for failing to file. The procedures allow eligible individuals to file late returns, complete Form 8854, and avoid covered-expatriate classification without penalty. They do not cover willful non-filing or deliberate tax avoidance.

Putting it together

The US exit tax is not a punishment for leaving — it is the final collection event on decades of deferred gains and contributions that were built up under US tax protection. What makes it expensive is timing: everything happens on a single deemed sale date, with limited ability to spread the income or defer payment.

For most people, the decision to expatriate is made for reasons that have nothing to do with tax — family, retirement location, business, or lifestyle. The exit tax is a planning problem to solve, not a reason to stay. The variables that matter most are net worth relative to $2M, average annual tax relative to $211K, the size of your IRA balance, your 401(k) distribution strategy, and whether you have 2-5 years to restructure before your target date.

Anyone approaching covered-expatriate territory should work with a US international tax attorney or CPA who specializes in expatriation — not a general practitioner. The consequences of getting it wrong are large and largely irreversible.

Sources checked (June 2026): IRS Expatriation Tax overview; IRS Form 8854 and Instructions; Final Section 2801 Regulations, Federal Register, January 14, 2025; IRS Relief Procedures for Certain Former Citizens (IRS.gov). All thresholds are as of 2026 and subject to annual adjustment.

Disclaimer: This article is for informational purposes only and does not constitute tax, legal, or financial advice. Tax rules change and individual situations vary. Consult a qualified US international tax professional before making any expatriation decision.