5 Ways Higher Interest Rates May Affect Your Business

Tax expert Barbara Weltman explains how even a small increase in the federal funds rate can cost your business significant dollars.

Barbara Weltman By Barbara Weltman

The central bank, which monitors economic growth, raised interest rates numerous times in 2018. Rate hikes impact the cost of borrowing. (Credit: Rawpixel on Unsplash.)

The central bank, which monitors economic growth, raised interest rates numerous times in 2018. Rate hikes impact the cost of borrowing. (Credit: Rawpixel on Unsplash.)

The Federal Reserve is meeting this week. While we’re not sure what will happen (most analysts expect a temporary pause in hikes), it raised the federal funds rate several times in 2018 and expects to have additional increases in 2019, depending on the performance of the economy and fears of inflation. The rise in the benchmark interest rate by the Federal Reserve has a trickle-down effect on your business. Some of this may be direct while some is indirect.

Here’s what to watch out for in a rising interest rate environment.

1. A higher monthly cost on your line of credit

If your business has an outstanding line of credit, the interest rate you’ll pay is the current interest rate set by the borrower. This rate, which is likely geared to the bank’s prime rate, is effectively fixed according to the fed funds rate. As the fed funds rate increases, so does the prime rate, and thus the rate you pay on your line of credit.

What to do: Pay down outstanding balances to the extent possible before there are even more interest rate increases.

[Related: 6 Major Money Moves Made by Women in 2018]

2. An increase in credit card interest rates

It’s a fact that many small businesses use credit cards to help finance their businesses. This may be through cash advances or paying off purchases over time. As the Fed Funds rate rises, expect to see increases in credit card interest rates. This is because credit card rates are tied the banks’ prime lending rate, which in turn is keyed to the fed funds rate.

What to do: Owners and businesses with outstanding credit card balances may still consider balance transfers to other cards offering zero percent for a certain period (e.g., six months or one year). But check for credit card fees and other features before selecting a new credit card.

3. Advancing credit to your customers

If you’re not paid on the spot for the goods and services you provide and instead invoice for them, in effect you’re financing your sales to customers. The longer they have to pay with no additional cost, the more you’re giving them an interest-free loan.

What to do: Review your “lending” policy and obtain payments upfront (e.g., with down payments or advances) or at the point of sale or service. If you think you must continue to invoice for goods and services, then consider using shorter payment periods (e.g., net 10 instead of net 30 or 60 days).

4. Below-market loans to owners

Business owners who need money for personal reasons may look to their company as a piggyback. However, the tax law imputed interest income to the business when the loan is below the “applicable federal rate” (APR) set monthly by the IRS; the rates vary for the term of the loan.

What to do: Check the APR when borrowing from your company to match it and avoid imputed interest. If you want the loan to be tax free, then recognize the tax consequences to the company.

5. Higher IRS rates on tax underpayments

Each quarter the IRS sets rates that are applicable to tax underpayments by individuals (business owners) and corporations. These rates also apply to estimated tax underpayments. The rates for the first quarter of 2019 are set to rise slightly over what they were in the fourth quarter of 2018. More specifically, the rates for underpayments in Q1 2019 are:

  • 6 percent for underpayments by individuals and corporations
  • 8 percent for large corporate underpayments (amounts exceeding $100,000)

Complementarily, the rates that the IRS must pay to taxpayers on overpayments are also on the rise. For Q1 2019 they are:

  • 6 percent for individuals
  • 5 percent for corporations
  • 5 percent for the portion of corporate overpayments exceeding $10,000

What to do: The rise in IRS interest rates means that business owners and corporations should pay attention to tax payments and avoid underpayment penalties.

[Related: Why You Should Start Thinking About the 2019 Tax Season]

Conclusion

Most business owners today may not remember when the fed funds rate reached a high of 20 percent in 1979 and 1980; that was a period of extreme inflation. Today, the fed carefully monitors the economy to help control the money supply through the fed funds rate. While there are no indications that rates will zoom from where they are now, even a small increase can cost your business significant dollars. Work with your financial advisor to minimize the impact of increases in the fed funds rate.

Barbara Weltman is the founder of Big Ideas for Small Business, Inc., which publishes
Idea of the Day. She is the author of J.K. Lasser’s Small Business Taxes 2019 and
other books that inform the small business community of tax, financial, and legal
information they should know about. 

Posted: January 28, 2019

Barbara Weltman5 Ways Higher Interest Rates May Affect Your Business