In this blog, we discuss how green card holders who are considering abandoning their green cards can utilize the provisions of an income tax treaty to avoid the imposition of the potentially onerous exit tax.
IRC 877A and the Exit Tax
The so-called “exit tax” is a tax imposed under IRC Section 877A of the Internal Revenue Code on “expatriates” who are classified as “covered expatriates.”
The exit tax is a tax on the built-in appreciation in the expatriate’s property (such as a house), as if the property had been sold for its fair market value on the day before expatriation. The current maximum capital gains rate is 23.8%, which includes the 20% capital gains tax and the 3.8% net investment income tax. Gain is recognized only to the extent that the deemed gain exceeds in aggregate $600,000, as indexed for inflation. For 2025, the indexed amount is $890,000.
In addition to the tax on the built-in appreciation in one's property, special rules apply with respect to pensions and deferred compensation that are maintained at the time of expatriation. As a general rule, a pension will be deemed to have been withdrawn (and deferred compensation paid) on the day before expatriation, resulting in ordinary income tax (up to 37%) on the taxable portion of the pension. This creates a potential risk of double taxation when the pension is actually withdrawn in a later year (as it may be taxed again locally). Certain exceptions apply to this tax (for instance with respect to foreign pensions that grew prior to becoming a U.S. person).
Being an “Expatriate”
Under IRC Section 877A(g)(3), an “expatriate” is defined as either: (1) a U.S. citizen who renounces (or otherwise loses) his or her U.S. citizenship, or (2) a “long-term resident” who abandons (or otherwise has revoked) his or her green card (or takes a treaty position that he is no longer a U.S. tax resident and notifies the IRS of the commencement of such treatment).
Green card abandonment is accomplished by filing the Form I-407 with the U.S. Citizenship and Immigration Services (USCIS).
A “long-term resident” is defined in IRC Section 877 to mean an individual (other than a citizen of the United States) who is a lawful permanent resident of the United States (i.e., a green card holder) in at least 8 taxable years during the period of 15 taxable years ending with the taxable year during which the expatriation occurs (the “8-ouf-of-15-year rule”).
The Treaty Residency Exception
IRC Section 877A specifies that for purposes of the 8-out-of-15-year rule, a treaty residency exception applies, as follows: “an individual shall not be treated as a lawful permanent resident for any taxable year if such individual is treated as a resident of a foreign country for the taxable year under the provisions of a tax treaty between the United States and the foreign country and does not waive the benefits of such treaty applicable to residents of the foreign country.”
This offers green card abandoners living in treaty countries an important opportunity to avoid the exit tax by subtracting treaty non-residence years from the 8-out-of-15-year count.
While the treaty residency exception seems straightforward at first blush, some have argued that there is a certain ambiguity as to its practical application; namely, it is unclear whether a treaty residency position must be actively claimed on a tax return in order to utilize the exception.
Such argument is buoyed by another section of the Code, Section 7701(b)(6), which defines the term “lawful permanent resident.” Section 7701(b)(6) states: “An individual shall cease to be treated as a lawful permanent resident of the United States if such individual commences to be treated as a resident of a foreign country under the provisions of a tax treaty between the United States and the foreign country, does not waive the benefits of such treaty applicable to residents of the foreign country, and notifies the Secretary of the commencement of such treatment.” We note that such provision is generally not interpreted to mean that taking a treaty position permanently ends lawful permanent residence status upon the first year it is claimed (unless the individual is a long-term resident). Rather, the treaty residency exception must be claimed each year until the green card is abandoned.
Tax Residence under Treaty Law
As discussed above, in order to utilize the treaty residency exception, a green card holder must be able to claim that he should be considered a tax resident of a foreign country (rather than the United States) in accordance with an applicable U.S. income tax treaty.
Most U.S. tax treaties have a set of “tie-breaker” tests to determine tax residence for treaty purposes if, under local law, both countries can tax the individual. A tax and treaty expert should be consulted to determine whether a strong treaty position can be claimed.
In terms of reporting, a treaty residence claim is made on an IRS Form 8833. A late-filed form can trigger a $1,000 penalty (in the case of an individual), however not filing the form does not preclude the applicability of the treaty position to the taxpayer.
It should be noted that according to the IRS, a green card holder who can claim U.S. non-residence under the treaty is still obligated to file certain tax forms on an annual basis, including, for instance, the FBAR (to report foreign bank accounts surpassing an aggregate balance of $10,000) and the Form 5471 (to report ownership in a non-U.S. corporation). However, we note that in a recent case, a District Court ruled that treaty non-residents are in fact not required to file FBARs. It remains to be seen if this decision will be appealed.
Being a “Covered Expatriate”
We note that even if an individual falls within the definition of an “expatriate” (because, for example, he or she does not live in a treaty country and therefore can’t use the treaty residency exception), then such individual does not necessarily become subject to the exit tax. Rather, an expatriate will be classified as a “covered expatriate,” subject to the exit tax rules of IRC Section 877A, if at least one of three threshold tests is satisfied:
- the individual’s average annual net income tax for the five taxable years ending before the date of expatriation exceeds a specified, inflation-adjusted amount ($206,000 in 2025);
- the individual’s net worth is $2 million or more;
- the individual fails to certify that he has been in compliance with the tax and reporting requirements of the Internal Revenue Code for the five preceding taxable years.
An expatriate’s certification of tax compliance is made on an IRS Form 8854, which must be filed with his final personal income tax return for U.S. tax residents (Form 1040). A late-filed form can trigger a $10,000 penalty.
For the majority who pass the first two covered-expatriate criteria, avoiding the exit tax comes down to proving a history of tax compliance. A delinquent taxpayer should consider entering into an IRS tax amnesty program to clean up the past and keep IRS penalties at bay, prior to renouncing.
The Streamlined Filing Compliance Procedures are available for U.S. expats whose failure to file was due to non-willful conduct. Under this popular tax amnesty program, the taxpayer is required to file the prior 3 years of tax returns, including required information returns, and 6 years of FBARs. A delinquent U.S. expat who complies with these procedures will have to pay previously unpaid taxes with interest, but will not be subject to any penalties.
