Business tax implications of Federal Reserve interest rate cuts

This article was originally published on Sept. 20, 2024, after the Federal Reserve’s 50-basis-point interest rate cut two days prior. It is updated to the reflect the 25-basis-point reduction on Dec. 18, 2024.

Executive summary: Tax issues at play as the Fed cuts rates

The Federal Reserve’s third and final interest rate cut of 2024 continued a significant shift in monetary policy aimed at stimulating economic growth and investment. The rate reductions began in September with wide-ranging implications for businesses, according to RSM US Chief Economist Joe Brusuelas.

Rate cuts have a variety of potential tax ramifications that businesses should consider to help drive growth and investment strategies. This article explores just a few key tax considerations related to:

• Business expansion
• Refinancing
• Debt-financed distributions
• Pricing considerartions
• Mergers and acquisitions activity

How rate cuts may affect business tax issues

For businesses seeking to strengthen cash flows and minimize tax obligations in response to the rate cuts, it will be important to remain focused on potential business growth opportunities, many of which can be achieved through prudent tax planning. Some areas to consider:

1. Business expansion

The reduction in interest rates will likely encourage many businesses to commence or resume expansion plans and strategies, which could lead to increased investments in capital, inventory and hiring.

Capital expenditures: With lower borrowing costs, businesses may accelerate their capital expenditures. In this regard, it’s crucial to consider the implications of bonus depreciation and how it interacts with the federal tax rules.

Bonus depreciation allows businesses to immediately deduct a significant portion of the cost of eligible property, which can provide substantial tax savings.  However, businesses must also look at how potential future tax rate changes, as well as scheduled changes to the expensing rules themselves, could affect how they time capital expenditures and larger projects.

Business interest limitations: The interest rate cut may lead to increased borrowing. However, businesses must be aware of the limitations under section 163(j), which caps the amount of business interest expense that can be deducted for taxes. This limitation, which recently became more stringent, can affect overall tax liability, especially in an environment of increased borrowing.

Hiring: The availability of funds for hiring can lead to discussions around tax credits such as the Work Opportunity Tax Credit (WOTC). Additionally, expanding into new markets can raise state tax considerations, including apportionment and nexus issues, and potential opportunities around jurisdictional-specific incentives and credits.

Inventory: Changes in inventory levels stemming from increased purchases can affect taxable income and cash flow, suggesting that inventory management must be carefully considered.

Research and development: To the extent that lower borrowing costs release pent up demand for research and development initiatives, companies can more accurately project their return on investment by considering the requirement to capitalize and amortize domestic R&D expenses over a five-year period (or 15 years for research conducted outside of the United States). The ability to immediately deduct R&D costs ended in 2022.

2. Refinancing

Lower interest rates present an opportunity for businesses to refinance existing debt. When considering refinancing, it’s important to evaluate the tax implications of capitalizing versus expensing refinancing costs. Properly managing these costs can optimize tax outcomes and improve financial performance. In addition, it’s crucial to understand the effect of debt restructuring on tax attributes.

3. Debt-financed distributions and recapitalizations

Interest rate cuts could lead to an increase in debt-financed distributions and recapitalizations. Such transactions come with a host of tax considerations, including:

• Treatment of interest expense
• Impact on earnings and profits
• Potential implications for shareholder distributions

4. Pricing considerations

With the potential to purchase goods and services at lower prices due how lower rates may decrease the cost of capital and debt in supply chains, businesses should consider the tax implications of rebates, discounting and other incentives. These pricing strategies can affect taxable income and require careful planning to maximize tax benefits.

5. M&A activity

The lower cost of funding transactions may spur an increase in M&A activity. Businesses should be prepared for the tax implications of M&A transactions, including:

• Treatment of transaction costs
• Effect on net operating losses
• Structure of deals to optimize tax outcomes

6. Business succession

One of many factors in the valuation of a business is the cost of capital that’s directly related to the prevailing interest rate. As these rates decrease, business values can start to increase.

For many businesses considering a succession to the next generation through a gift, making the gift before subsequent interest rate cuts could allow for a lower cost of transition.

Seizing growth opportunities

By understanding and planning for the tax implications of interest rate cuts, businesses can better position themselves to take advantage of the current economic environment. Work with your tax advisor to understand how the tax implications of rate cuts apply to your unique business and tax profiles. Your advisor also can keep you informed of policy developments, which will be key to navigating these opportunities.