FATCA: US-person designation and the exit-tax trigger under section 877A

The decision to renounce United States citizenship or terminate long-term residency has shifted from a question of lifestyle to one of balance-sheet liability, driven by the interaction between the Foreign Account Tax Compliance Act (FATCA) and the exit-tax regime codified in Internal Revenue Code Section 877A. For a principal with USD 10 million in unrealised appreciation across a global portfolio, the difference between a properly timed exit and a rushed one can exceed USD 2.3 million in immediate tax due, before considering the 30 per cent withholding penalty on future US-source income that FATCA imposes on non-compliant former citizens. The trigger is not the act of renunciation itself but the determination of "covered expatriate" status, a classification that turns on net-worth thresholds, average tax liability over the preceding five years, and the existence of a compliance failure with US federal tax obligations. This essay examines the statutory mechanics of Section 877A, the interplay with FATCA’s information-reporting architecture, and the planning levers available to advisors whose clients hold multi-jurisdictional wealth. ## The covered-expatriate determination under section 877A Section 877A of the Internal Revenue Code applies to any individual whose loss of US citizenship or termination of long-term residency occurs on or after 17 June 2008. The statute defines three independent tests, any one of which triggers covered-expatriate status: a net worth of USD 2 million or more on the date of expatriation, an average annual net income tax liability for the five years ending before expatriation that exceeds a threshold indexed for inflation (USD 201,000 for 2025, as estimated by the IRS’s annual inflation adjustments), or a failure to certify compliance with all US federal tax obligations for the five preceding years. The third test is the most frequently overlooked by high-net-worth individuals who maintain multiple residences and assume that non-filing of a Form 5471 or a Report of Foreign Bank and Financial Accounts (FBAR) is a technicality. It is not. A single omitted FBAR for a year in which the client held USD 1.5 million in a Singapore account can render the entire expatriation a covered one, regardless of net worth or tax liability. ### Net-worth test and valuation methodology The USD 2 million net-worth test applies to the fair market value of all assets worldwide, reduced by liabilities, on the date of expatriation. The Internal Revenue Service (IRS) has not issued formal regulations defining valuation methodology for this test, but the legislative history of the Heroes Earnings Assistance and Relief Tax Act of 2008, which enacted Section 877A, indicates that the standard is the same as for estate-tax purposes under Section 2031. For closely held business interests, minority discounts and lack-of-marketability discounts are permissible, but the burden of proof falls on the taxpayer to substantiate the discount with a qualified appraisal. A principal holding 40 per cent of a family office with a gross asset value of USD 25 million and USD 8 million in debt should calculate net worth at USD 10.2 million before any discount, then apply a marketability discount of 25 per cent to arrive at USD 7.65 million — still above the threshold. The only way to fall below USD 2 million is to reduce asset holdings before the expatriation date, which requires a multi-year gifting strategy or a transfer of assets to a non-grantor trust that is not treated as owned by the expatriate. ### Tax-liability test and the five-year lookback The average net income tax liability test uses the amount shown on the taxpayer’s returns for the five taxable years ending before the expatriation date, as reduced by any credits for foreign taxes paid (Form 1116). For a client who realised a large capital gain in year three of the lookback period — for example, the sale of a New York cooperative apartment for USD 4 million — the average can spike above the indexed threshold even if the other four years show modest liability. The threshold for 2025 is USD 201,000, but the IRS has not yet published the official figure for 2026 as of the publication of this article; advisors should use the most recent published figure and adjust for inflation expectations. A common planning error is to assume that foreign tax credits reduce the liability used for this test. They do not. The statute refers to "net income tax liability," which is defined in Section 877A(g)(2) as the sum of the taxes imposed by Subtitle A (income taxes) less the sum of the credits allowable under Subchapter A of Chapter 1. Foreign tax credits are allowable credits, so they reduce the net liability, but the reduction is often smaller than clients expect because the credits are limited to the US tax on foreign-source income. ## The mark-to-market exit tax and its exceptions Once an individual is classified as a covered expatriate, Section 877A(a)(1) imposes a tax on the net unrealised gain in all property as if the property had been sold for its fair market value on the day before the expatriation date. The tax is computed at the rates applicable to long-term capital gains for assets held more than one year, and at ordinary income rates for assets held one year or less. The exclusion amount — the first USD 866,000 of gain (as indexed for 2025) — is available to all covered expatriates, but it is not a deduction against the tax base; it is an exclusion of gain. A client with USD 10 million in unrealised appreciation and no losses to offset would owe approximately USD 1.83 million in federal tax (23.8 per cent on USD 9.134 million after the exclusion), plus any applicable state or local tax, which can add another 3 to 13 per cent depending on the taxpayer’s state of residence at the time of expatriation. ### Deferral elections for non-US situs assets Section 877A(d)(1) permits a covered expatriate to elect to defer payment of the exit tax on assets that are not readily tradable on an established securities market, provided the taxpayer posts a bond or other security acceptable to the IRS and agrees to pay interest on the deferred amount at the rate set under Section 6621 (the federal short-term rate plus 3 per cent). The election is available for interests in closely held corporations, partnerships, real estate, and certain trust interests. The practical consequence is that a client who holds a USD 5 million interest in a family limited partnership that holds operating businesses in three jurisdictions can defer the tax until the interest is sold or the taxpayer dies, but the compounding interest at approximately 8 per cent (as of the first quarter of 2026) erodes the benefit over time. For a deferral period of 15 years, the interest alone can exceed the original tax liability. The election is rarely advantageous unless the asset is expected to be sold within five years or the taxpayer has insufficient liquidity to pay the tax on the date of expatriation. ### Exceptions for dual citizens and certain minors Section 877A(g)(1)(B) provides an exception to covered-expatriate status for individuals who were born with dual citizenship, who have not been US residents for more than 10 of the 15 years preceding the expatriation date, and who certify compliance with US tax obligations for the five preceding years. This exception is narrow and does not apply to individuals who acquired US citizenship by naturalisation. A separate exception exists for individuals who expatriate before reaching age 18.5, but only if they have not been US residents for more than 10 taxable years before the expatriation date. These exceptions are not elective; they require the taxpayer to file Form 8854 (Initial and Annual Expatriation Statement) and attach a statement explaining the basis for the exception. The IRS has issued limited guidance on these exceptions, and the burden of proof falls squarely on the taxpayer. ## FATCA’s enforcement architecture and the compliance certification FATCA, enacted in 2010 as part of the Hiring Incentives to Restore Employment Act, does not itself impose an exit tax, but it creates the compliance infrastructure that makes the Section 877A certification requirement enforceable. Under FATCA, foreign financial institutions (FFIs) are required to report accounts held by US persons to the IRS through intergovernmental agreements (IGAs) or directly under the FATCA regulations. When an individual renounces citizenship, the FFI’s obligation to report that account as a US account ceases, but the IRS cross-references the expatriation filing with the last known account data reported by FFIs. A failure to certify compliance with all US tax obligations for the five preceding years — the third test under Section 877A — is often detected through this cross-reference. The certification is made on Form 8854, which requires the taxpayer to list all foreign financial accounts, trusts, and entities in which the taxpayer held an interest during the five-year lookback period. An incomplete or inaccurate certification is treated as a failure to certify, making the taxpayer a covered expatriate regardless of net worth or tax liability. ### The 30 per cent withholding penalty for non-compliant expatriates A covered expatriate who fails to file Form 8854 or who files an incomplete form is subject to Section 877A(c)(1), which imposes a 30 per cent withholding tax on all US-source income and gains received after the expatriation date. This penalty is not a one-time assessment; it applies to every dividend, interest payment, rental payment, and capital gain from US sources for the remainder of the individual’s life. For a client who retains a USD 5 million portfolio of US equities and bonds, the annual income stream of approximately USD 200,000 would be reduced to USD 140,000 after the 30 per cent withholding, and the sale of any appreciated US asset would trigger the withholding on the gross proceeds, not the gain. The only way to avoid this penalty is to comply fully with the certification requirements and to file Form 8854 on time, even if the taxpayer is not a covered expatriate. The IRS has not provided a mechanism for retroactive relief, and private letter rulings on this issue are rare and fact-specific. ## Composite case study: the Singapore-based principal Consider a principal, resident in Singapore since 2015, who holds citizenship by birth in the United States. Net worth as of 2026 is USD 18 million, comprising a Singapore residential property valued at USD 4 million (cost basis USD 2.8 million), a global equity portfolio of USD 6 million (cost basis USD 3.2 million), a 30 per cent interest in a Hong Kong trading company valued at USD 5 million (cost basis USD 1 million), and a USD 3 million term life insurance policy with no cash surrender value. The principal has filed US tax returns for all five preceding years but has not filed FBARs for the Singapore and Hong Kong accounts, which held an aggregate balance of USD 2.1 million at their peak. The principal wishes to renounce citizenship in 2026. The failure to file FBARs for the five-year lookback period constitutes a failure to certify compliance with US federal tax obligations, making the principal a covered expatriate under the third test regardless of net worth. The exit tax under Section 877A applies to the unrealised gain in all assets, calculated as follows: Singapore property gain of USD 1.2 million, equity portfolio gain of USD 2.8 million, Hong Kong company gain of USD 4 million (after a 25 per cent marketability discount on the fair market value of USD 5 million), and no gain on the insurance policy. Total unrealised gain is USD 8 million. After the USD 866,000 exclusion, the taxable gain is USD 7.134 million. At the 23.8 per cent long-term capital gains rate, the federal exit tax is approximately USD 1.7 million. The principal has no losses to offset and insufficient liquid assets to pay the tax without selling part of the equity portfolio, which would itself generate a taxable gain. The 30 per cent withholding penalty under Section 877A(c)(1) applies because the principal did not file FBARs, meaning the certification is incomplete. The principal is advised to file delinquent FBARs through the Streamlined Filing Compliance Procedures before the expatriation date, then file Form 8854 with a complete certification. If the FBARs are filed and accepted, the principal may still be a covered expatriate under the net-worth test, but the 30 per cent withholding penalty is avoided. The exit tax of USD 1.7 million remains due, but the principal can elect deferral under Section 877A(d)(1) for the Hong Kong company interest, posting a bond of USD 952,000 (the deferred tax amount) and paying interest at the Section 6621 rate. ## Planning checklist for the advisor and principal - Verify the client’s FBAR and Form 5471 filing history for the five-year lookback period before any discussion of expatriation, and remediate any delinquent filings through the Streamlined Filing Compliance Procedures at least 12 months before the intended renunciation date. - Calculate the client’s average net income tax liability for the five preceding years using the net amount after foreign tax credits, and compare it to the inflation-indexed threshold for the year of expatriation, using the most recent IRS published figure as of the planning date. - Reduce net worth below USD 2 million through a structured gifting programme that transfers appreciated assets to a non-grantor trust or to non-US-resident family members at least three years before expatriation, observing the gift-tax annual exclusion and lifetime exemption limits. - Identify any asset that qualifies for the deferral election under Section 877A(d)(1) and model the interest cost over the expected holding period to determine whether deferral or immediate payment produces a lower net present value of tax. - File Form 8854 on or before the due date of the tax return for the year of expatriation, even if the client is not a covered expatriate, and retain a copy of the certification and all supporting documentation for at least seven years after the expatriation date. ## Sources - Internal Revenue Code Section 877A (26 U.S.C. § 877A), as amended by the Heroes Earnings Assistance and Relief Tax Act of 2008, Pub. L. No. 110-245, 122 Stat. 1624 (2008). - Internal Revenue Service, "Inflation-Adjusted Tax Year 2025 Amounts," Revenue Procedure 2024-40, 2024-47 I.R.B. 1 (November 2024). - Internal Revenue Service, Form 8854, Initial and Annual Expatriation Statement, and accompanying instructions (revised January 2024). - Internal Revenue Service, "Streamlined Filing Compliance Procedures," updated December 2024, available at https://www.irs.gov/individuals/international-taxpayers/streamlined-filing-compliance-procedures. - Hiring Incentives to Restore Employment Act of 2010, Pub. L. No. 111-147, 124 Stat. 71 (2010) (enacting FATCA provisions as Sections 1471-1474 of the Internal Revenue Code).