Tax Implications of the New Leasing Standard ASC 842
ASC 842, the new lease accounting standard from the Financial Accounting Standards Board (FASB), has been in effect since December 15, 2018, for public companies and will go into effect for private companies on December 15, 2021. The GAAP lease accounting standard, ASC 842, mandates that leases lasting more than 12 months must be recognized as liabilities and assets on balance sheets to improve transparency between companies and investors. The Financial Accounting Standards Board (FASB) introduced this new standard to prevent certain leases from being excluded from financial analysis ratios under the previous GAAP lease accounting standard, ASC 840, which categorized them as “operating leases” and did not require them to be capitalized on the balance sheet. These exclusions could give an investor a false depiction of a company’s performance.
Under ASC 842 standard, companies must now determine whether their leases are operating leases or finance leases, which will impact how they are treated for tax purposes. Operating leases are now recognized on the balance sheet as a right-of-use asset and a lease liability, while finance leases are recognized as both an asset and liability equal to the present value of lease payments. Prior to implementing ASC 842, many taxpayers had general ledger accounts such as “Deferred Rent” or “Prepaid Rent” that allow visibility into identifying and computing major/book tax differences, but those accounts are going away and have been replaced by a right-of-use asset and a lease liability.
The tax implications of ASC 842 are primarily related to the timing of deductions for lease payments. For operating leases, the rent expense is deducted over the lease term, while for finance leases, the interest expense and depreciation are deducted separately. This could result in a larger tax deduction in the early years of a finance lease compared to an operating lease, which could have a significant impact on a company’s tax liability.
Secondly, the standard may affect a company’s ability to take advantage of tax incentives or credits related to leasing activities. For example, if a company leases qualified property for purposes of the investment tax credit, changes in the lease classification under ASC 842 could impact the company’s ability to claim this credit.
Thirdly, companies must consider the impact of ASC 842 on their state and local tax liabilities. Some states may require companies to use different depreciation methods for tax purposes than they use for financial reporting purposes, which could result in different tax deductions and liabilities.
Fourthly, the standard could impact a company’s ability to deduct rent expenses for tax purposes. Under the new standard, companies may need to allocate rent payments between lease payments and non-lease components, which could impact the deductibility of these expenses.
Overall, ASC 842 has significant tax implications for companies, and it is important that they work closely with their tax advisors to understand the impact on their tax liability and to ensure compliance with tax laws and regulations. Companies should also consider the impact of ASC 842 on their financial statements, investor relations, and debt covenants.