Brace for Economic and Tax Uncertainty After the Election

This is a Guest blog post from Pete Ryan, CPA and Michael Wetmore, CPA, founders of the accounting and consulting firm of Ryan & Wetmore.

Introduction

The next six months will bring a period of uncertainty. Businesses and individuals must plan to react to the many changes in stimulus plans, Covid-19 disruptions, tax laws, estate laws, and other laws and regulations based on election results. This article should not serve as legal advice – companies should plan to consult with attorneys, CPAs, investment advisors, insurance advisors, and others. Regardless of the election results, there will be big changes. Sources of systemic change include:

Comparing Tax Proposals: Income and Capital Gains

  • Tax proposals are subject to change during the legislative process and may get watered down by the other party or moderate lawmakers.
  • Changes in control of government could still bring big changes and tax increases, expert tax planning by tax advisors and CPAs will be essential.

Overview

  • Some notes on the process of passing tax legislation:
    • There is precedent for retroactive tax proposals, so a tax bill passed in 2021 could be retroactive to the first day of the 2021 tax year.
    • Some of Biden’s tax proposals could be phased in over time rather than taking effect immediately.
    • Although it is common for Presidents to have tax proposals, all tax legislation must originate in the House, where Democrats are likely to keep their majority.
    • As changes make their way through congress, they are usually watered down somewhat – especially if control of government is divided.
    • If on party win a simple majority of both houses, they can avert a Senate filibuster by passing a tax bill in a process called budget reconciliation.
    • Many parts of the Tax Cuts and Jobs Act of 2017 (TCJA) are temporary and will expire in the next several years even without legislative action.
  • Biden’s tax proposal includes corporate tax increases and income tax increases for people making over $400,000. Trump’s plan is mainly to expand/extend the TCJA tax cuts, though he has issued few details about second-term tax plans. Both candidates have committed to not raise middle class taxes.

Payroll Taxes

  • Biden’s proposal imposes a 12.4% Social Security Payroll tax on wages above $400,000, creating a payroll tax “donut hole,” where income between $137,700 and $400,000 does not incur the payroll tax. This also affects self-employment taxes for individuals. (It’s not clear when or how this will be implemented.)
  • Trump’s plan institutes a payroll tax holiday for the employee-side payroll tax deferral that is currently taking place.

Corporate Taxes

  • Biden’s proposal increases the C-Corporation income tax rate from 21% to 28% (lower than the top rate of 35% in effect prior to the TCJA) and establishes a corporate minimum tax on book income.
  • It also doubles the tax rate on GILTI and imposes it country-by-country.

Individual Income Taxes

  • Biden’s plan would raise the top individual income tax rate from 37% to the pre-TCJA level of 39.6%.
  • It would cap itemized deductions at 28% of value for those earning over $400,000, temporarily increase the Child Tax Credit to a maximum of $3,000 and the Child and Dependent Care Tax Credit to a maximum of $8,000 from $2,100. Biden’s plan includes other middle class tax relief.
  • It would also bring back a first-time homebuyer tax credit of up to $15,000.
  • Biden’s plan would reduce 199A 20% deductions over 400k.
  • Trump’s plan would maintain and extend the tax cuts in the TCJA and possibly cut middle class income tax brackets.

Capital Gains

  • Currently the top long-term capital gains bracket is taxed at 20%.
  • Trump has proposed lowering the top rate to 15% or indexing it to inflation.
  • He would also expand the TCJA “Opportunity Zones” program, which provides capital gains tax relief to encourage long-term investments in economically distressed areas.
  • Biden has proposed taxing long-term capital gains and qualified dividends at the ordinary income tax rate of 39.6% on income above $1 million and eliminating the “step-up in basis” for inherited assets.
  • Many individuals and businesses will want to consider selling or donating appreciated assets (such as marketable securities) by December 31, 2020 or before new laws are enacted in 2021 – consult your advisors and CPAs.

Estate Planning

Estate Tax

  • The TCJA extended the estate tax exclusion from about $5.5 million to $11.4 million, but this is set to expire in 2026.
  • Biden has previously said he supports both lowering the exclusion to “historical norms” (which could mean the pre-TCJA level of $5.5 million) and returning estate taxes to “2009 levels” (which could mean a $3.5 million exclusion and an increase in the top rate to 45%).
  • Biden also supports ending the “step-up in basis,” which allows estates to realize capital gains without incurring capital gains tax upon the death of their owners.
  • Many individuals are rushing to their estate attorney before December to discuss making large gifts.

Grantor Retained Annuity Trusts (GRATs)

  • A GRAT is an irrevocable trust that is set up for a period (a tax is paid upon establishing the trust). An annuity is paid from the trust every year, and when the trust expires, the beneficiary receives the assets tax-free.
  • The TCJA increased the estate tax exemption to $11.4 million, but it would decrease if the provisions expire in 2026 or if it is repealed, making GRATs more attractive.
  • Also, GRATs are most effective when interest rates are low – as they are right now.
  • Neither candidate has proposed changes to GRATs, but the way they are treated for tax purposes could change in a new tax proposal.

Sales to Intentionally Defective Grantor Trusts (IDGTs)

  • IDGTs are irrevocable trusts where trust income is treated as the grantor’s for income taxes, but the assets are not treated as the grantor’s for estate taxes.
  • Just like with GRATs, the candidates have not talked about IDGTs specifically, but the way they are taxed could change in a new tax bill.

Accelerating or Deferring Income or Deductions

  • Given the potential for big changes to the tax system, accelerating or deferring income or expenses into a certain tax year can have big advantages (though the effectiveness depends on projections of the future).
  • These strategies are complex and depend on future conditions – talk to your advisors and CPAs about them.

Accelerating Income in 2020

  • Accelerating income in 2020 has three main advantages: (1) The TCJA cut the top income tax rate; (2) losses due to the economic downturn may push taxpayers into lower brackets this year; (3) accelerating income increases a taxpayer’s AGI limitation for charitable contributions.
  • If taxes are hiked in 2021, the changes could be retroactive to the first day of the 2021 tax year, so receiving income in 2020 could be preferable to 2021.
  • Some income acceleration strategies include: Converting an IRA to a Roth IRA, electing out of installment sales, triggering an inclusion event for opportunity zone investments, harvesting capital gains, foregoing like-kind exchanges, exercising stock options, and declaring and paying C corporation dividends.

Accelerating Deductions in 2020 or Deferring Deductions in 2021

  • Biden’s tax plan caps the tax benefit of itemized deductions to 28% of value for those earning over $400,000, potentially increasing the benefits of deduction acceleration.
  • On the other hand, income and payroll tax hikes in 2021 could increase the benefits of deduction deferral to 2021 (since they would have a greater tax benefit in 2021).
  • Most cash-basis businesses normally accelerate deductions at the end of year to reduce taxable income. In 2020, they may decide not to this.

The Wider Economy

  • The state of the economy is evolving day-by-day and new stimulus is likely to be the top priority after the election. Be sure to monitor email updates from Ryan & Wetmore.

New Stimulus

  • After briefly ending negotiations on new stimulus, the Trump administration proposed $1.8 trillion in stimulus, but the proposal was immediately rebuked by House leadership (as not enough) and Senate leadership (as too expensive).
  • The Trump Administration also pushed for a bill repurposing $130 billion in unused funding from the Paycheck Protection Program for a second round of PPP, but House leadership rejected it.
  • The House originally passed the $3 trillion HEROES Act (which was rejected by the Senate) and then passed a reduced $2.2 trillion HEROES Act.
  • New stimulus after the election will be a top priority after the election no matter who wins. Make sure you get updates from your advisors.

Other New Bills

  • No matter who wins, stimulus will probably be the top priority after the election.
  • However, if Democrats do well, they will probably push for one or more other big initiatives (such as a big infrastructure package). Some of their priorities include:
    • Healthcare, green infrastructure/climate, police reform, immigration reform, and guns.
  • Two top priorities are expanded on below:
    • Healthcare reform: The House has already passed a bill to expand Obamacare subsidies and lower drug prices. Joe Biden’s plan also includes creating a public option.
    • Green infrastructure: The House has already passed a $1.5 trillion green infrastructure plan (similar to Biden’s $2 trillion plan) that includes money for roads, bridges, transit options, housing broadband coverage while emphasizing reduced emissions and transitioning the electricity grid and generation to renewables.

Long-Term Interest Rates

  • The Fed has cautioned that the pandemic will continue to weigh on growth, employment, and inflation in the near and medium terms.
  • As a result, “dot plots” from the Fed Open Market Committee show that most members do not expect to raise interest rates above 0-0.25% before 2024.
    • Similarly, bond markets imply that traders do not expect the Fed to substantially hike rates until late 2023 or early 2024.
  • In August, Fed Chair Jerome Powell said the fed will likely pursue an inflation target of “moderately above 2 percent for some time,” indicating plans for low rates.
  • Low rates mean that it is potentially a great time to talk to advisors to consider refinancing existing loans.

Banks and Deferred Loans

  • When states began locking down in March, banks rapidly implemented forbearance programs, allowing borrowers to defer loans and avoid default. Stimulus programs also allowed some people to keep making payments when they might otherwise default.
  • In the third quarter, JPMorgan reduced reserves for loan losses, indicating that it expects fewer nonperforming loans, but it also noted a lot of uncertainty.
  • There may be a real estate stimulus plan – all borrowers should monitor stimulus plans and review loans for refinancing opportunities, stimulus, and forbearance agreements.
  • Businesses should be in regular communication with their bankers about extending lines of credit, terms, etc.

State and Local Taxes (SALT)

The SALT Deduction

  • Prior to the TCJA, taxpayers could deduct all state/local property taxes and the greater of income or sales taxes from taxable income, but these deductions were capped at $10,000 annually by the TCJA.
  • In late 2019, the House passed a bill to eliminate the SALT deductions cap except for taxpayers with AGI above $100 million (which then died in the Senate).
  • The Biden campaign has confirmed that he supports repealing the $10,000 cap.
  • Paying your fourth quarter 2020 state income tax estimates between January 1, 2021 and January 15, 2021 may be a prudent planning move for most taxpayers – talk to your advisors and CPAs.

Sales Tax

  • Tax revenues of states and localities are projected to fall a lot in fiscal year 2021 and beyond while spending on public health will soar – and many states have requirements that they balance their budgets.
  • This could lead to big revenue shortfalls and state and local tax hikes if the balanced budget provisions are not repealed and there is no federal government aid.
  • Sales tax is set by states and localities so elections to national government do not have a direct effect on them.
  • However, the original version of the HEROES Act passed by the House included over $1 trillion in state and local aid, which could reduce state budget shortfalls.

Health Insurance

  • Employers expect about 4 to 5% benefit cost growth on average in 2021 compared to 2020, roughly in line with previous increases.
  • People may use more medical services in 2021 because they put off routine care and elective procedures for much of 2020 due to the pandemic, and treating COVID cases carries large healthcare costs (especially given the potential for a case spike in the winter).
  • Some likely trends in health insurance in 2021 include: Cost increases of around 4 to 5%, expanded options for virtual care, increased focus on mental health, more on-site clinics, greater access to “Centers of Excellence” (options that encourage employees to seek specialized care at hospitals known for high quality).
  • Employers and employees should monitor the costs of health insurance, changes in plans, self-insured plans by employers’ costs, changes in taxability in benefits to employees and meet with advisors and CPAs to plan for them.

The State of the ACA

  • On November 10 (a week after the election), the Supreme Court is scheduled to hear oral arguments for California v. Texas, a case that that could render some or most of the Affordable Care Act (ACA or Obamacare) unconstitutional.
  • The ACA could be struck down wholly or partially, and a series of provisions could go down with it, including:
    • Protections for people with pre-existing conditions, individual healthcare subsidies, expanded Medicaid eligibility, coverage of people up to age 26 under their parents’ insurance, coverage of preventative care with no patient cost-sharing, and the tax increases that fund these provisions.

Planning for Increased Economic Activity

  • Current pandemic conditions won’t last forever. Businesses should start preparing for the possibility of increased economic activity (possibly from a vaccine or treatment breakthrough).
  • Over 200 vaccines are in early development. Over 40 are in human clinical trials. At least 10 have reached the final stage of testing (Phase 3) worldwide. At least one vaccine will probably prove effective.
  • It will still take several months to distribute a vaccine widely to the public and significantly decrease risk of transmission.
  • Federal and state governments have already started planning rapid vaccine distribution.
  • Interest in rapid testing (where results are less accurate but can take as little as 15 min) is increasing. HHS has started sending rapid tests to states, and some states say they plan to use rapid tests at schools and nursing homes.
  • Businesses should be prepared to accelerate activity based on testing and vaccine conditions – this may require additional working capital.

PPP Loan Forgiveness

  • A PPP Loan recipient is eligible to have the entire amount of its loan forgiven if it was used for eligible payroll and nonpayroll costs, with at least 60% being used on payroll (subject to certain conditions).
  • Forgiveness will be reduced if full-time headcount or salaries / wages declined during the loan period.
  • Employers may be exempt from the penalty to loan forgiveness that is tied to pay, headcount, or hours reductions if they can show:
    • They restored pay and headcount to original levels.
    • They attempted to restore headcount / hours but were unable.
    • They were unable to operate at pre-pandemic levels due to COVID restrictions from HHS, CDC, or OSHA.
    • (This is not an exhaustive list.)
  • Loan forgiveness applications may be submitted any time before the maturity date of the loan, but loan payments are deferred only until 10 months after the last day of the loan forgiveness covered period.
  • The most important things for business owners and accountants to do now is to document everything to show compliance and use their best judgement. (Payroll reports and other records must corroborate loan / forgiveness application numbers.)
  • Participants in other relief programs (especially healthcare firms and government contractors) should take special care as they usually are not able to “double-dip” and include expenses in multiple programs – consult advisors and CPAs for guidance.
  • Talk to your advisors and CPAs about taxability of loan forgiveness in 2020 or 2021. A second round of PPP is possible – keep up with updates from Ryan and Wetmore. ersonal note: Ryan & Wetmore has been providing tax, accounting, financial analysis, due diligence and M&A services for our portfolio companies and investors since 1986. Great firm and I highly recommend!

Personal note: Ryan & Wetmore has been providing tax, accounting, financial analysis, due diligence and M&A services for our portfolio companies and investors since 1986. Great firm and I highly recommend!

Having CPAs and advisors you can trust is crucial heading into this historic period of uncertainty. Contact us here.

Impact of new Lease Standards on Tech and Life Sciences Companies

This is a Guest blog post from Ling Zhang., CPA.

With many companies struggling to fully implement the last ...

 

When the Financial Accounting Standards Board (FASB) met on May 20, 2020 to address the impacts of the COVID-19 pandemic, they voted on a one-year effective date deferral of Accounting Standards Codification (ASC) Topic 842, Leases, which will result in a modified effective date for private companies and certain private not-for-profit entities for fiscal years beginning after Dec. 15, 2021, and interim periods with fiscal years beginning after Dec. 15, 2022, once the final standard is issued (expected June 2020). Private companies in technology and life sciences, particularly with significant operating lease activity under current lease accounting guidance, can take advantage of the delayed ASC 842 effective date to prepare for implementation.  

FASB originally issued Accounting Standards Update (ASU) 2016-02 in February 2016. Accounting Standards Codification (ASC) Topic 842, Leases, along with several subsequently issued related ASUs, which amended the accounting guidance for leases.

GENERAL ASC 842 REQUIREMENTS

Under ASC 842, a company is required to recognize leases with terms greater than 12 months on its balance sheet. Specifically, lessees are required to recognize the following at lease commencement:

ASC 842 represents a change for operating leases that were historically considered “off balance sheet” obligations. FASB believes a balance sheet presentation of leases will provide a clearer view of a company’s future commitments with operating leases recognized on the balance sheet.

Under ASC 842, leases recorded on the balance sheet will be classified as either finance leases or operating leases, which will determine the presentation of the related expense in the income statement. Finance lease arrangements will result in depreciation and interest expense recorded each reporting period similar in manner to existing capital leases under legacy guidance. Operating lease ROU assets and liabilities will be amortized and accreted, respectively, to develop a straight-line rent expense presented as lease expense in the income statement.

SPECIFIC CONSIDERATIONS FOR TECHNOLOGY AND LIFE SCIENCES COMPANIES

The delayed ASC 842 effective date provides additional time for technology and life sciences companies to prepare for implementation. Specific considerations prior to implementation include:

1. Impact to Balance Sheet and Financial Ratios

Technology and life sciences companies should expect increases in balance sheet amounts (e.g., long-term assets and both current and long-term liabilities) for operating leases. Companies with significant existing operating leases may be surprised by the impact on reported balance sheet amounts. These financial statement changes may impact certain financial ratios, including current ratio, leverage ratio and debt service coverage ratios.

Example: How ASC 842 Can Affect Key Metrics

As many technology and life science companies use cash flow-based lending, the example below provides the potential effects on the balance sheet and the associated debt service coverage ratio. Some do not consider operating lease liabilities as ‘debt’ for purposes of calculating debt-based ratios and you can expect that there may be diversity in practice. Technology and life science companies should confirm with their lenders in advance their view of the treatment of ASC 842 operating lease liabilities with regard to covenant calculations.  Understanding the impact on key metrics early is advised. The following is an example showing the impact on certain ratios when operating lease liabilities are considered debt.

Balance Sheet Impact

Notice how the reporting of ROU assets and lease liabilities increases the total amount of assets and liabilities on the balance sheet after adopting the new standard.1

Balance Sheet
Prior to adopting ASC 842 After adopting ASC 842
Cash  $                    500,000  $                  500,000
Accounts receivable                        750,000                      750,000
Inventory                     2,000,000                   2,000,000
Total current assets                     3,250,000                   3,250,000
PPE                        500,000                      500,000
Capitalized software                     1,500,000                   1,500,000
Operating lease ROU asset                                 –                      900,000
Total non-current assets                     2,000,000                   2,900,000
Total assets                     5,250,000                   6,150,000
Deferred revenue  $                 2,100,000  $               2,100,000
Accounts payable and accruals                        550,000                      550,000
Long-term debt, current                        100,000                      100,000
Operating lease liability, current                                 –                      250,000
Total current liabilities                     2,750,000                   3,000,000
Long-term debt, net of current portion                        400,000                      400,000
Operating lease liability, net of current portion                                 –                      650,000
Total non-current liabilities                        400,000                   1,050,000
Total liabilities                     3,150,000                   4,050,000
Equity                     2,100,000                   2,100,000
Total liabilities and equity  $                 5,250,000  $               6,150,000

1) In this example, it is assumed that the lease liability in an operating lease. However, if the lease liability was classified as a finance lease, the ROU asset could be included within PPE.

Debt Service Coverage Ratio Impact

Debt service ratio coverage is a common financial covenant found in debt agreements. As illustrated below, the ratio may significantly change with the adoption of the Standard.

Debt Service Coverage Ratio
Prior to adopting ASC 842 After adopting ASC 842
Net income                                  500,000                                500,000
Depreciation expense                                    50,000                                  50,000
Interest expense                                    20,000                                  20,000
                                 570,000                                570,000
Interest expense                                    20,000                                  20,000
Current portion debt
and capitalized leases
                                 100,000                                350,000
                                 120,000                                370,000
Debt service coverage ratio                                        4.75                                       1.54

 

Many technology and life sciences companies may find that certain metrics and loan covenants are impacted due to the changes in the balance sheet as a result of adoption. Companies should give priority to their financial statement and disclosure changes for the purpose of maintaining compliance with their loan covenants. As previously discussed, companies should also engage in early communication with their lenders regarding the potential impact on financial covenants and whether the lenders will take these changes into consideration when analyzing the company’s performance.

2. Lease Population Completeness Considerations

During the ASC 842 transition, all leases should be identified. While many leases may seem straightforward, such as leases for real estate or equipment, others may be embedded within other service contracts. For example, a router that is utilized as part of an internet service arrangement may be considered a leased asset. By electing the package of three transition practical expedients, companies are allowed to not reassess the following:

  • whether any expired or existing contracts are or contain leases;
  • lease classification for any expired or existing leases; and
  • indirect direct costs for any existing leases.

 

Embedded leases are commonly found in the following arrangements:

A lease exists if a contract conveys to a company the right to obtain substantially all of the economic benefits from use of the identified asset and the company directs the use of the identified asset. An identified asset must be physically distinct and specified in the contract. The existence of substitution rights may indicate a specific asset has not been identified. Under Topic 842, substantive substitution rights exist when a supplier has the practical ability to substitute alternative assets throughout the period of use, and the supplier would benefit economically from the exercise of its right to substitute the asset. When evaluating the existence of a lease, companies also need to assess if the use of the identified asset is significant. If another party’s use of the identified asset is more than insignificant, the contract does not convey control of the identified asset, therefore, the contract does not contain a lease.

 

The following are some examples where judgement and further analysis may be required to determine the presence of a lease component.

 

REVENUE CONTRACT WITH CUSTOMER – SUBSTITUTION RIGHT

A: SaaS contract with hosting arrangement – identified asset without substantive substitution rights

Facts: A software company enters into contracts with its customers to host software on the software company’s servers, each of which is designated to a specific customer. The contracts do not allow the software company to substitute the server for another one without consent of its customers.

 

Analysis: An embedded lease may exist (even without an explicit lease agreement) considering that the server is dedicated to a specific customer, and the software company does not have “substantive substitution” rights for the server.

 

B:  SaaS contract with use of equipment – identified asset with substantive substitution rights

Facts: A company enters into a contract with a customer that includes SaaS services and the use of a designated computer medical cart through the term of the SaaS services. The company has the option to swap the medical cart with another one at any time.

 

Analysis: The Company can swap the medical cart with another one at any time during the term of the contract. Therefore, the “substantive substitution” rights criteria has been met, and the use of the computer medial cart is not considered a lease.

 

MEDICAL SUPPLIES PURCHASE CONTRACT – IDENTIFIED ASSET WITHOUT SUBSTANTIVE SUBSTITUTION RIGHTS

Facts: A bio-tech company enters into a medical supplies contract, which requires the purchase of consumables and test kits for research and development purposes exclusively from this supplier for the term of five years. As part of the arrangement, the supplier also provides the equipment for testing at no charge. The equipment is installed and customized for the bio-tech company, and the contract does not allow the supplier to substitute another equipment without the approval of the bio-tech company.

 

Analysis: A lease may exist since the equipment is specified in the contract and designated to the bio-tech company; At the inception of the contract, the supplier does not have substantive substitution rights to the equipment and it is not feasible that the equipment can be easily substituted by the supplier.

 

INFORMATION TECHNOLOGY (IT) SERVICE CONTRACT – IDENTIFIED ASSET WITHOUT SUBSTANTIVE SUBSTITUTION RIGHTS

Facts: A technology company enters into a network services and security agreement with an electronic data storage provider. The services are provided through a centralized data center and use a specified server (Server No. 9). The supplier maintains many identical servers in a single accessible location and determines, at inception of the contract, that it is permitted to and can easily substitute another server without the customer’s consent throughout the period of use.

 

Analysis: Based on the facts above, the vendor can interchange the underlying asset without the customer’s consent. As the asset is interchangeable in nature and service and is not dependent upon the specific asset, there is no lease based upon the “substantive substitution” rights criteria.

 

ADVERTISING CONTRACT – SIGNIFICANCE OF USE

Facts: A company enters into a marketing services agreement which encompasses a variety of marketing and advertising vehicles, one of which includes electronic billboards.

 

Analysis: Although this contract could be written as a marketing services agreement, the right to use one or more billboards may result in a lease if the billboard is specifically identifiable and dedicated to the company, and the company obtains significant use of the billboards throughout the term of the contract. Understanding if other parties have the right to advertise on the billboards and the significance of those other arrangements will be important to determining if a lease exists.

 

Considerable judgement is involved for each example when reviewing a contract for embedded leases. A slight alteration in facts and circumstances may result in a different conclusion. Keep in mind that if there is a specifically identified asset dedicated to a party, it is likely to contain a lease. Further, predominance and significance of the activity will impact lease related decisions and conclusions.

 

3. Negotiation of Future Arrangements

The impact of ASC 842 may be an important factor in evaluating whether to structure the acquisition of assets as lease arrangements or purchase arrangements going forward. Further, Topic 842 may have implications on other accounting standards such as revenue recognition. The consideration of future arrangements will be particularly important for companies with significant lease activities as many such lease arrangements may move on to the balance sheet under the ASC 842. Technology and life sciences companies should identify and perform an inventory of all existing leases, including embedded leases, in conjunction with forecasting needs for future assets. The company can then evaluate and plan for these future needs with a clear understanding of the trade-offs between lease and purchase arrangements.

 

4. Tax Impact

ASC 842 will have a noticeable impact on financial reporting for lessees, but the effect on taxes may not be obvious. The new lease standard does not change lease accounting for federal income tax purposes. Therefore, without a corresponding change in tax basis, deferred tax accounting may be impacted. Implementation of ASC 842 could result in new deferred tax assets, liabilities or additional book to tax differences in a company’s income tax provision. Under ASC 842, lease assets are subject to impairment, which is often reversed for tax purposes. Technology and life sciences companies should understand and plan for the potential tax impact.

 

5. Assurance Perspective

Technology and life sciences companies audited by an independent public accounting firm should maintain relevant documentation of the ASC 842 implementation process, as the independent auditor may require the documentation in order to complete the audit. Such documentation should include evaluation of lease classification as finance or operating, selection and application of the transition method, discussion of any practical expedients applied, basis for significant assumptions such as discount rate and the company’s lease identification completeness procedures, including evaluation of embedded leases.

 

6. Future Operations, Processes and Related Controls

To comply with ASC 842, companies will likely need to implement changes to their current control environments and business processes. Companies should establish policies and procedures to address ongoing considerations such as initial assessments of new contracts, appropriate interest rates and lease modifications, as well as develop methods to appropriately capture financial disclosure information. Significant judgement will be required to assess lease terms through an ASC 842 lens, specifically related to lease term, allocation of lease payments to lease and non-lease components, and remeasurement events.

 

CONCLUSION

By delaying the effective date for non-public business entities, FASB has created an opportunity for technology and life sciences companies to fully consider the impact of ASC 842 and prepare for the upcoming transition.

 

As a Senior Manager in the DHG Technology practice, Ling Zhang, CPA, works closely with client management and C-suite executives to provide audit, financial accounting advisory, and risk advisory services to multi-national publicly-traded corporations and private companies with revenues ranging from $10 million to $50 billion. She advises clients on SEC filings, complex debt and equity transactions, merger and acquisition, new accounting guidance implementation, internal control system design and implementation, and financial statements reporting and disclosures. She can be reached at ling.zhang@dhg.com.