ID 113629614 © Thodonal | Dreamstime.com

5 Ways Higher Interest Rates May Affect Your Business

ID 113629614 © Thodonal | Dreamstime.comThe Federal Reserve has raised its federal funds rate (referred to as the fed funds rate) several times this year 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 prepare for in a rising interest rate environment.

1. 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.

2. Credit Card Payments

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% for underpayments by individuals and corporations
  • 8% 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% for individuals
  • 5% for corporations
  • 5% 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.

Conclusion

Most business owners today may not remember when the fed funds rate reached a high of 20% 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.

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