In Part 1 of our series on the final Exit Tax regulations issued by the IRS on January 14, 2025, we looked at §2801 tax implications for US individuals who receive certain gifts or bequests (either directly or indirectly) from someone who has expatriated and been subject to the Exit Tax.

In Part 2 of our series, we looked at how long US recipients and their tax preparers should maintain records substantiating the §2801 tax reporting. We also examined tax preparer liability related to filing Form 708.

In this last part of the series, Part 3, we will highlight changes to the Form 8854, Initial and Annual Expatriation Statement, and other miscellaneous items related to the US Exit Tax.

A Notable Change on the 2024 Form 8854 Expatriation Statement

The IRS has updated IRS Form 8854 to include new Question #3. Here is a snip:

This new question may present challenges to individuals who plan to expatriate and hoped to use gifting strategies to reduce their net worth below $2 million so that they can pass the “Net Worth Test” and avoid paying the Exit Tax.

The instructions to Form 8854, Part II, Question 3, say the following:

“Check the “Yes” box if there have been significant changes in your assets and liabilities during the 5 years preceding your expatriation date. If your net worth was $2 million or more at any point during the 5 years preceding your expatriation date but was less than $2 million on your expatriation date, there have been significant changes in your assets and liabilities. You must attach a statement to Form 8854 that explains the changes.

Example. During the 5 years preceding her expatriation date, Maria’s net worth exceeded $2 million. However, after Maria made a gift of real property to her child on October 31, 2024, Maria’s net worth decreased such that it was less than $2 million on her expatriation date. Maria reported the gift on a federal gift tax return. Maria must check the “Yes” box. Maria must also attach a statement that explains that her net worth decreased because she made a gift of real property to her child on October 31, 2024, and that she reported the gift on a federal gift tax return.”

The IRS’s intentions for introducing this question are unclear, but there are a couple of likely explanations.

Explanation 1. The IRS may be seeking to clarify the ambiguous terminology found in the law—and specify that gifts in the 5 years prior to expatriation will be included in the Net Worth Test calculation.

Internal Revenue Code Chapter 12, Subtitle B, defines which gifts can be pulled back in to calculations of net worth when determining whether an expatriator’s net worth is below the $2 million threshold. Under this section, for purposes of the “Net Worth Test,” a taxable gift is includable in net worth calculations if the individual was a citizen or resident of the United States and transferred the interest immediately prior to expatriation.

For individuals considering “gifting strategies” to reduce net worth prior to expatriating, this is often interpreted to mean that any gifts made in the same calendar year as expatriation will still be includable in the Net Worth Test and thus ineffective in reducing net worth for Exit Tax purposes.

However, one could make a reasonable argument that any gifts made in years prior to the calendar year of expatriation would not be drawn back in to the Net Worth Test.

It is possible that by adding question 3 (and requiring a statement to explain any gifts made in the 5 years prior to expatriation), the IRS is signaling that it interprets “immediately prior to expatriation” to mean the last 5 years.

Explanation 2. The IRS may be seeking to confirm that the expatriating individual is fully in compliance with all filing and reporting requirements for the past 5 years.

In addition to the “Net Worth Test,” expatriating individuals must meet several other tests, including a “5-year Compliance Test,” in order to successfully avoid the Exit Tax.

The “5-year Compliance Test” requires expatriating individuals to certify under penalties of perjury that they have fully complied with all US tax return reporting and filing requirements for the past 5 years.

It is possible that the IRS added question 3 (and the required statement of 5 years of gifting) to confirm that the individual has met all gift tax filing requirements, in addition to income tax filing requirements, for the past 5 years.

Regardless of the IRS’s intent in adding the new question and required statement, both the IRS and individuals who are expatriating are operating in an area of uncertainty, given the absence of clear laws and regulations.

In considering Exit Tax planning strategies, it is important to understand the current landscape of tax litigation in this area. In Aroeste v. United States, 655 F. Supp. 3d 1053 (S.D. Cal. 2023) , the taxpayer successfully challenged the validity of IRS Notice 2009-85, which provides guidance for individuals who are subject to the Exit Tax (per IRC §877A).

The Court held that “Notice 2009-85 is not binding authority as it fails to comply with the Administrative Procedures Act.” It then added that “[B]ecause Notice 2009-85 has not been subject to a notice-and-comment procedure, it does not comply with the APA and thus is not binding. As such, [Taxpayer] was not required to file Form 8854 with his amended returns.”

Lastly, there are no proposed or final regulations for IRC §877A, just the less authoritative guidance of IRS Notice 2009-85.

Before implementing any gifting strategies related to the Net Worth Test for the US Exit Tax, individuals should be aware of the benefits and potential drawbacks given the new question on IRS Form 8854. We would urge all individuals considering expatriation (or actively expatriating) to continue to monitor the IRS regulations and litigation related to this issue so that they can make the most informed decision.

Clarifications for Green Card Holders Who Wish To End Their US Tax Residency

In emailed advice (ECC 202501011) issued on January 3, 2025, the IRS highlighted the importance of administratively abandoning the Green Card to end the US tax filing obligations. Administrative abandonment is normally completed by filing Form I-407 with the U.S. Citizenship and Immigration Services (USCIS).

In many cases, Green Card holders will let their Green Cards expire believing that this will end their tax filing obligations as a resident of the United States. This is incorrect. Individuals in this circumstance must either take the affirmative step of administratively abandoning the Green Card or have a judicial hearing occur where the Green Card is removed.

The emailed advice details an interesting situation where the taxpayer, “Green Card Holder,” has filed a “treaty tiebreaker” position under a valid US tax treaty to be treated as a resident of a foreign country but has not taken the additional step of administrative abandonment. In the advice, the IRS has indicated that both must occur to end the tax residency rules for the individual. Thus, when taking a treaty tiebreaker position, the individual must also complete the additional step of administratively abandoning the Green Card to end the US tax filing requirements.