The HEART of the Matter

As a multinational Caterpillar employee, it is imperative to understand what the HEART act is, and whether it is applicable to you or your loved ones. The Heroes Earnings Assistance and Relief Tax Act of (the HEART, or 'Heroes' Act), enacted on June 17, , applies new tax rules both to certain U.S. citizens who relinquish their U.S. citizenship and to certain long-term U.S. residents who terminate their U.S. residency.

Relinquishing Citizenship

If you are a Caterpillar employee contemplating relinquishing citizenship, you may want to consider how an individual who has relinquished U.S. citizenship is only recognized as having done so on the earliest of four possible dates:

1. The date that he or she renounces U.S. nationality before a diplomatic or consular officer of the United States (provided that the voluntary relinquishment is later confirmed by the issuance of a certificate of loss of nationality);
2. The date that he or she furnishes to the State Department a signed statement of voluntary relinquishment of U.S. nationality confirming the performance of an expatriating act (again, provided that the voluntary relinquishment is later confirmed by the issuance of a certificate of loss of nationality);
3. The date that the State Department issues a certificate of loss of nationality; or
4. the date that a U.S. court cancels a naturalized citizen's certificate of naturalization.

Caution: Relinquishment may occur earlier under Treasury regulations with respect to an individual who became at birth both a citizen of the United States and of another country.

Terminating U.S. Residency

An individual is considered to terminate long-term U.S. residency when he or she ceases to be a lawful permanent resident of the United States (i.e., loses his or her green card status through revocation or has been administratively or judicially determined to have abandoned such status). Under the HEART Act, however, an individual ceases to be treated as a lawful permanent resident of the United States for all tax purposes if he or she commences to be treated as a resident of a foreign country under a tax treaty between the United States and such foreign country, does not waive the benefits of the treaty applicable to residents of such foreign country, and notifies the Secretary of the commencement of such treatment. If you are a Caterpillar employee looking to terminate your residency, this information may be applicable when planning your future taxes and having a better idea of the laws regarding this subject.

Individuals Covered

The new tax rules apply to any U.S. citizen who relinquishes citizenship and any long-term resident who terminates U.S. residency, if such individual:

1. 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 $171,000 (in , $168,000 in );
2. Has a net worth of $2 million or more on such date; or
3. Fails to certify under penalties of perjury that he or she has complied with all U.S. Federal tax obligations for the preceding five years or fails to submit such evidence of compliance as the Secretary may require.

Exceptions (these exceptions do not apply to an individual who fails to certify under penalties of perjury that he or she has complied with all U.S. Federal tax obligations for the preceding five years or fails to submit such evidence of compliance as the Secretary may require):

• An individual who was born with citizenship both in the United States and in another country; provided that (1) as of the expatriation date he or she continues to be a citizen of, and is taxed as a resident of, such other country, and (2) he or she has been a resident of the United States (under the substantial presence test of IRC Section 7701(b)(1)(A)(ii)) for not more than 10 taxable years during the 15-year taxable year period ending with the taxable year of expatriation.
• A U.S. citizen who relinquishes U.S. citizenship before reaching age 18½, provided that he or she was a resident of the United States (under the substantial presence test of section 7701(b)(1)(A)(ii)) for no more than 10 taxable years before such relinquishment.

The Changes of HEART

In General

The HEART Act imposes the following new tax rules on those individuals affected:

• Such individuals are subject to income tax on the net unrealized gain in their property as if the property had been sold for its fair market value on the day before the expatriation or residency termination ('mark-to-market tax').
• Gain from the deemed sale is taken into account at that time without regard to other Internal Revenue Code (IRC) provisions.
• Any loss from the deemed sale generally is taken into account to the extent otherwise provided in the IRC, except that the wash sale rules of Section 1091 do not apply.
• Any net gain on the deemed sale is recognized to the extent that it exceeds $737,000 (in , up from $725,000 in ).
• Any gains or losses subsequently realized are to be adjusted for gains and losses taken into account under the deemed sale rules, without regard to the exemption.
• Deferred compensation items, interests in nongrantor trusts, and specified tax deferred accounts are excepted from the mark-to-market tax but are subject to special rules, as noted below.
• A transfer tax is imposed on certain transfers to U.S. persons from certain U.S. citizens who relinquished their U.S. citizenship and certain long-term U.S. residents who terminated their U.S. residency, or from their estates.

Deferring Payment of Tax

Under the HEART Act, those employed in Caterpillar may elect to defer payment of the tax imposed on the deemed sale of property. Interest is charged for the period the tax is deferred at the rate normally applicable to individual underpayments. The election is irrevocable and is made on a property-by-property basis. Under the election, the deferred tax attributable to a particular property is due when the return is due for the taxable year in which the property is disposed (or, if the property is disposed of in a transaction in which gain is not recognized in whole or in part, at such other time as the Secretary may prescribe). For those eligible to participate in the HEART Act, and also employed in a Caterpillar company, this information is certainly worthy to consider when planning tax deferrals.

The deferred tax attributable to a particular property is a prorated portion of the total mark-to-market tax (calculated according to the ratio of gain attributable to the property to the total gain taken into account for the mark-to-market tax). For Caterpillar employees, the deferral of the mark-to-market tax may not be extended beyond the due date of the return for the taxable year which includes the individual's death.

In order to elect deferral of the mark-to-market tax, the individual is required to furnish a bond to the Secretary. The individual is also required to consent to the waiver of any treaty rights that would preclude the assessment or collection of the tax.

Special Transfer Tax on Gifts and Bequests

Under the HEART Act, a special transfer tax applies to certain 'covered gifts or bequests' received by a U.S. citizen or resident. For Caterpillar employees, a covered gift or bequest is any property acquired:

1. By gift directly or indirectly from an individual who is a covered expatriate at the time of such acquisition, or
2. Directly or indirectly by reason of the death of an individual who was a covered expatriate immediately before death.

A covered gift or bequest, however, does not include any property:

1. Shown as a taxable gift on a timely filed gift tax return by the covered expatriate,
2. Included in the gross estate of the covered expatriate for estate tax purposes and shown on a timely filed estate tax return of the estate of the covered expatriate, and
3. With respect to which a deduction would be allowed under Section 2055, 2056, 2522, or 2523, whichever is appropriate (these sections allow deductions for transfers for charitable purposes or to spouses, for purposes of determining estate and gift taxes).

The tax is calculated at the highest marginal estate tax rate or, if greater, the highest marginal gift tax rate, both as in effect on the date of receipt of the covered gift or bequest. For those employed in a Caterpillar company, the tax is imposed upon the recipient of the covered gift or bequest and is imposed on a calendar-year basis. The tax applies to a recipient of a covered gift or bequest only to the extent that the total value of covered gifts and bequests received by such recipient during a calendar year exceeds the annual exclusion amount in effect under section 2503(b) for that calendar year (currently $15,000). The tax on covered gifts and bequests is reduced by the amount of any gift or estate tax paid to a foreign country with respect to such covered gift or bequest.

Special rules apply to the tax on covered gifts or bequests made to domestic or foreign trusts. In the case of a covered gift or bequest made to a domestic trust, the tax applies as if the trust is a U.S. citizen, and the trust is required to pay the tax. In the case of a covered gift or bequest made to a foreign trust, the tax applies to any distribution from such trust (whether from income or corpus) attributable to such covered gift or bequest to a recipient that is a U.S. citizen or resident, in the same manner as if such distribution were a covered gift or bequest. Such a recipient is entitled to deduct the amount of such tax for income tax purposes to the extent such tax is imposed on the portion of such distribution that is included in the gross income of the recipient.

Tax strategies become far more effective when you understand how each Caterpillar benefit interacts with your overall tax picture. Caterpillar maintains a defined benefit pension plan that has been frozen to new benefit accruals -- meaning the plan no longer accumulates future benefits for most employees, but those who were already vested may still be entitled to receive the pension benefit they accrued prior to the freeze, subject to the vesting requirements described in their plan documents, meaning the plan no longer accumulates future benefits for most employees, but those who were already vested may still be entitled to receive the pension benefit they accrued prior to the freeze, subject to the vesting requirements described in their plan documents, meaning the plan no longer accumulates future benefits for most employees, but those who were already vested may still be entitled to receive the pension benefit they accrued prior to the freeze, subject to the vesting requirements described in their plan documents. Caterpillar also offers retiree healthcare benefits to eligible employees, which can provide meaningful coverage for those who retire before reaching Medicare eligibility at age 65. A retirement plan that fully integrates your Caterpillar benefits gives you the most accurate projection of your future financial picture.

For purposes of these rules, a foreign trust may elect to be treated as a domestic trust. The election may not be revoked without the Secretary's consent.

Other Special Rules

• For deferred compensation items (including qualified plans, 403(b) plans, 457(b) plans, SIMPLE retirement plans, and any interest in a foreign pension plan or retirement arrangement), two rules apply:

1. If the payer is a U.S. person (or a non-U.S. person who elects to be treated as a U.S. person for purposes of withholding and who meet the requirements prescribed by the Secretary to ensure compliance with the withholding requirements), and the covered expatriate notifies the payor of his status as a covered expatriate and irrevocably waives any claim of withholding reduction under any treaty with the United States, the payer must deduct and withhold from any 'taxable payment' a tax equal to 30 percent of such taxable payment. A taxable payment is subject to withholding to the extent it would be included in the gross income of a citizen or resident of the United States. A deferred compensation item that is subject to the 30 percent withholding requirement is subject to tax under IRC Section 871.

2. Otherwise, an amount equal to the present value of the covered expatriate's deferred compensation item is treated as having been received on the day before the expatriation date. In the case of a deferred compensation item that is subject to IRC Section 83, the item is treated as becoming transferable and no longer subject to a substantial risk of forfeiture on the day before the expatriation date. Appropriate adjustments shall be made to subsequent distributions.

These deemed distributions are not subject to early distribution tax.

• For 'specified tax deferred accounts' (IRAs, 529 plans, Coverdell ESAs, HSAs, and Archer MSAs), a covered expatriate is treated as receiving a distribution of his entire interest in these accounts on the day before his or her expatriation date. Appropriate adjustments are made for subsequent distributions to take into account this treatment. As with deferred compensation items, these deemed distributions are not subject to early distribution tax.
• For the portion of any trust for which the covered expatriate is treated as the owner under the grantor trust provisions of the IRC (determined immediately before the expatriation date) the assets held by that portion of the trust are subject to the mark-to-market tax. If a trust that is a grantor trust immediately before the expatriation date subsequently becomes a nongrantor trust, such trust remains a grantor trust for purposes of the provision.

• Any period for acquiring property which results in the reduction of gain recognized with respect to property disposed of by the taxpayer terminates on the day before the expatriation date. This rule applies to certain incomplete transactions such as deferred like-kind exchanges and involuntary conversions.
• Any extension of time for payment of tax ceases to apply on the day before relinquishment of citizenship or termination of residency, and the unpaid portion of such tax becomes due and payable at the time and in the manner prescribed by the Secretary.
• For purposes of determining the tax imposed under the mark-to-market tax, property that was held by an individual on the date that such individual first became a resident of the United States is treated as having a basis on such date of not less than the fair market value of such property on such date. An individual may make an irrevocable election not to have this rule apply.