The Price of Freedom: The US Exit Tax (Section 877A)
The Price of Freedom: The US Exit Tax (Section 877A)
You have your second passport. You are ready to renounce US citizenship to escape global taxation. But first, you must pass the IRS “Covered Expatriate” test, or face a massive phantom tax bill.
Executive Summary
- The Global Tax Trap: The US is one of two countries (with Eritrea) that taxes based on Citizenship, not residency. Even if you live in Dubai or Singapore, you owe US taxes. The only way out is Renunciation.
- The Exit Tax (Section 877A): If you are a “Covered Expatriate” (Net Worth > $2M or High Taxpayer), the IRS treats you as if you sold all your worldwide assets on the day before you leave. You must pay Capital Gains Tax on the unrealized gains (Phantom Income).
- The “Forever Taint” (Section 2801): If you leave as a Covered Expatriate, you become toxic to your US heirs. Any gift or inheritance you send back to a US citizen (e.g., your children) is taxed at **40%**, regardless of the lifetime exemption limits.
The “Covered Expatriate” Tests
You are “Covered” (and taxed) if you fail ANY of these three:
1. Net Worth Test: Your global net worth is > $2,000,000.
2. Tax Liability Test: Your average annual US income tax bill (last 5 years) is > ~$201,000 (indexed).
3. Compliance Test: You certify that you have filed taxes correctly for the last 5 years. (Failing to check this box is automatic failure).
👉 Strategy: You must “Slim Down” your net worth below $2M before you renounce.
Mechanic: The “Slim Down” Gift Strategy
Simulation: Expatriation of a Founder ($10M Net Worth)
| Status | Exit Tax (877A) | Gift Tax to US Heirs (2801) |
|---|---|---|
| Covered Expatriate | Yes (Mark-to-Market) | Yes (40% Penalty Tax) |
| Non-Covered Expatriate | None ($0) | None (Standard Rules Apply) |
| Green Card Holder | Yes (If held 8 of 15 yrs) | Depends on status |
“Renunciation is the ultimate divorce from Uncle Sam. But like any divorce, if you don’t separate your assets correctly before you sign the papers, the settlement will bankrupt you. The goal is not just to leave, but to leave ‘Non-Covered’.”