In the fourth installment of our series on leases, we look at the tax impact of the new standard.
Tax law did not change as a result of the new leases standard, and for tax purposes leases will continue to be a true tax or non-tax lease. However, as with most changes to GAAP, there is potential for additional book-to-tax differences for all types of entities, from C Corporations to pass-through entities.
Review the key taxation considerations below to help minimize additional surprises once you have fully implemented the new standard.
Considerations for All Types of Entities
Lease Origination Costs Incurred by Lessees
Lease origination costs are generally capitalized for tax unless they do not exceed $5,000 in the aggregate per lease. Under ASC 842, many types of origination costs will not meet the definition of initial direct costs (defined in ASC 842 as incremental costs of a lease that would not have been incurred if the lease had not been obtained). Instead, they will be expensed for book. Specifically:
- Costs expensed for book and capitalized for tax will create a book-to-tax difference.
- Costs capitalized for both book and tax may use different lives, creating book-to-tax differences.
- Taxpayers will need to analyze what comprises the Right-of-Use (ROU) asset for book to ensure they identify tax differences for initial direct costs, deferred rent, lease incentives and prepaid rent.
Certain Tax Calculations
The calculation of state and local income taxes may change due to changes in the apportionment formula. Franchise tax base may also be impacted.
Additional Considerations for C Corporations
Recognition of Right-of-Use Assets and Lease Liabilities for Lessees
The recognition of ROU assets and lease liabilities on the balance sheet for operating leases under ASC 842 will require C Corporations to recognize new deferred tax assets and liabilities, which may not offset each other due to uneven lease payments and/or initial direct costs:
- True tax leases will create new deferred tax balances, since lease assets and liabilities will be created for book yet have no tax basis.
- Non-tax leases will have smaller deferred tax balances, since there will be lease assets and liabilities for both book and tax going forward — though those assets may be at different amounts with different lives.
The primary concern for lessors is deferring any selling profit, which for some direct financing leases under ASC 842 could create new or larger deferred tax assets.
Sale-leaseback transactions could result in new deferred tax assets/liabilities if accounted for as a sale-leaseback for tax purposes but is a failed sale or failed purchase under ASC 842.
Considering these potential differences while planning for the transition — and keeping detailed records of what comprises the ROU assets and lease liabilities created for book — will help ensure proper treatment in accordance with GAAP and lessen the tax burden down the road.
Contact Jessica Foster at email@example.com or a member of your service team to discuss this topic further.
Cohen & Company is not rendering legal, accounting or other professional advice. Information contained in this post is considered accurate as of the date of publishing. Any action taken based on information in this blog should be taken only after a detailed review of the specific facts, circumstances and current law.
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