After being delayed for numerous years, private companies are required to adopt and implement ASC 842 Leases starting in 2022 (if not already implemented). The good news is that although the lease implementation for GAAP can be complicated and time consuming, the implementation for income tax purposes is relatively nonexistent. The IRS made no changes to the tax law as a result of the implementation of ASC 842, and therefore, the income tax treatment for leases remains unchanged.
Even though there is no change to income taxes as a result of ASC 842 implementation, this is a good time to evaluate the tax treatment of leases to ensure that: 1) the company is on the correct tax accounting method for leases and 2) to determine if a more favorable tax treatment of the lease is available. For taxes, there are two types of leases:
- True Tax Lease – This situation is very similar to the prior definition of a GAAP operating lease. Under this scenario, the lessor retains title to the asset and claims depreciation on the asset and records lease or rental income. The lessee simply deducts rental payments as paid.
- Non-Tax Lease – This situation is very similar to the prior definition of a GAAP capital lease. In this situation, the lessee is the owner of the asset and claims depreciation expense on the asset. In addition, as lease payments are made, interest is deducted for the portion of interest deemed to be paid under the lease payment. From the lessor’s perspective, a gain or loss on the sale of the asset is recognized at the time the asset is transferred, and the lessor records interest income when payments are received.
Going forward, new book to tax differences may arise based on the Right of Use Asset and Lease Liability that is placed on a GAAP balance sheet for a true tax lease. This means that tax deductions for lease payments may be greater or less than the book deductions related to the lease which is dependent on the circumstances of the lease. As long as your tax accountant has copies of your lease schedules, a calculation will be able to be performed on the deductible tax lease payments for the year.
Article written by:
Ryan Kilpatrick, CPA
Director, Tax & Business Advisory Services