Thinking of Leaving the U.S.? Beware of Taxes!

Many Americans have recently considered the possibility of leaving the U.S. Their motivations vary, but often revolve around family ties, culture, political concerns, and the U.S. tax regime. But individuals considering leaving the U.S. often overlook the U.S. income, gift, and estate tax implications. 

The U.S. is the only modern, industrialized country in the world that taxes its citizens on their worldwide income, gifts, and estates, regardless of their country of residence. That means individuals would continue to have to report their worldwide income on Form 1040 every year, even if they move all their affairs to another country. Permanent residents, also known as “green card holders,” likewise will be taxed on their worldwide income, regardless of country of residence. To prevent the application of this rule, the U.S. citizen would have to surrender their citizenship, and the green card holder would be required to formally relinquish their green card. Many individuals, upon discovering that they would have to renounce their U.S. citizenship or their green card to avoid being taxed on their worldwide income, decide to remain in the U.S.  

Exit and Inheritance Taxes

For those individuals who proceed with their plans to leave the U.S. and give up citizenship or their green card, a special set of laws may apply if the individual satisfies the definition of a “covered expatriate.” If someone is a covered expatriate, the U.S. imposes an exit tax on that person and, perhaps even more significant, an inheritance tax on U.S. citizens or certain residents who receive gifts or bequests from the person at what would be in effect a 40% tax on wealth received.  

The term “covered expatriate” includes any U.S. citizen who relinquishes citizenship and any “long-term resident” who terminates U.S. residency, if that individual: 

• Has an average annual net income tax liability for the five preceding years ending before the date of the loss of U.S. citizenship or residency termination that exceeds $206,000 for 2025 filings (the “tax liability test”);
• Has a net worth of $2 million or more on that date (the “net worth test”); or 
• Fails to prove, under penalties of perjury, that they have complied with all U.S. federal tax obligations for the preceding five years or fails to submit such evidence of compliance as the U.S. Secretary of the Treasury may require (the “certification test”). 

An individual needs to meet only one of the three tests to be treated as a covered expatriate. 

An individual can avoid being treated as a covered expatriate under the certification test by filing a completed Form 8854.  A long-term resident is an individual who is a lawful permanent U.S. resident in at least eight out of the prior 15 years, ending with the year of expatriation. Holding a green card for any portion of a tax year is counted as a full year when determining long-term residence.

Under the exit tax rules, covered expatriates are deemed to sell their worldwide assets the day before departure and are taxed on the gain. For calendar year 2025, the first $890,000 (adjusted for inflation each year) of gain will be excluded from taxation. Certain assets are excluded from the deemed sale rules and the $890,000 exclusion amount does not apply to those assets. Examples of such assets include individual retirement accounts (IRA), other retirement accounts, and beneficial interests in non-grantor trusts. The entire IRA is deemed distributed the day before departure, with tax applying to the deemed distribution. By default, other retirement accounts, such as 401(k) plans, are taxed on a deemed distribution of the entire account the day before departure, but an election may be available to opt for a 30% ongoing U.S. withholding tax on payments as they occur. Distributions from non-grantor trusts to the covered expatriate may be subject to the 30% ongoing withholding tax. 

U.S. citizens and green card holders should thoroughly review the tax cost of departure and determine if that cost outweighs the desire to exit and surrender their citizenship or green card.

Beware of U.S.-Source Income

Even if a taxpayer departs from the U.S. to another country and successfully surrenders their citizenship or green card, they will continue to be subject to U.S. income taxation on U.S.-source income. For example, if the U.S. expatriate earns most of their income from a trade or business located in the U.S., that income will continue to be subject to tax in the U.S. as effectively connected income. Dividends on U.S. stocks and gains from the sale of U.S. real estate are other examples of U.S.-source income.

State Income Tax Issues

In addition to federal taxes, taxpayers currently resident in a U.S. state that imposes its own state income tax should carefully consider that state’s rules concerning terminating residency from the state. Many states have a subjective definition of residency that revolves around the taxpayer’s domicile. If the taxpayer does not change that domicile, the state will consider the expatriate to be a resident of that state. As a resident, the taxpayer typically will be subject to taxation on their worldwide income in that state. As with the federal tax, even if the taxpayer successfully terminates residency, the state will continue to tax income sourced to that state. Examples of such income include rental income on real estate located in the state, trade or business income from businesses operating in the state, and gains from the sale of real estate located in the state.

Trusts Subject to Separate Exit Tax

In general, if a U.S. non-grantor trust becomes a foreign trust, the trust will be deemed to have sold all its assets at fair market value on the date of conversion and pay federal tax on any resulting gain. For example, a U.S. non-grantor trust becomes a foreign trust if a U.S. citizen or resident with substantial decision-making authority over the trust becomes a nonresident. In addition, if a foreign grantor trust with a U.S. grantor becomes a non-grantor trust upon the grantor’s loss of U.S. citizenship or residency, this too will trigger a deemed sale of all the trust’s assets, with the grantor being taxed on any gain. Unlike the exit tax for individuals, there is no exclusion amount from the deemed gain.

For more insights on managing foreign trusts from a U.S. perspective, refer to BDO's article on taxpayer nightmares and how to prevent them.

Taxation in the Destination Country

Any taxpayer arriving in another country should retain professional tax advisors in that country to provide consultative advice regarding the consequences of their arrival. Tax regimes around the world can differ significantly from the U.S. tax regime. U.S. investment funds may be taxed heavily in the destination country. Trusts and distributions from trusts could be subject not only to income tax but also to an inheritance tax. Business structures in the U.S. may be considered different taxable entities in the destination country. The destination country may also have favorable regimes available to immigrants. An income tax treaty between the U.S. and the destination country can help alleviate double taxation by the two countries on certain types of U.S.-source income.

Conclusion

Tax planning for your departure from the U.S. and arrival in the destination country is essential. Many taxpayers have been shocked by what might be considered excessive taxes upon departure from the U.S. and arrival in the destination country. Prudence dictates that the taxpayer hire an international firm with experience dealing with individuals departing from the U.S. and settling in another country.