The Federal Reserve, after months of telegraphing its move, raised its key interest rate targets by a quarter of one percent last month (just 0.25%.)
It is momentous not for its size, but for its signal. The Fed has raised rates for the first time since 2006, which means it sees the economy headed in a positive, if not grand, direction as we end 2015.
One quarter point rise in rates, however, does not by itself impact businesses: A business loan of $100,000, for example, now costs an additional $250 to borrow for one year. However, business planning has to factor in a series of rate rises over the next few years, assuming the economy maintains a slow but steady growth. With each quarter point rate rise, another $250 gets added to the cost of that loan.
Tax planning is driven in part by the anticipated cost of money. When I find a tax benefit for a client, for example, I use interest rate estimates to calculate the net present value of the taxes that are deferred or saved. Doing so gives a clearer view about whether or not implementing a given tax planning move will be beneficial to the company and, ultimately, to its shareholders. Decisions to pay taxes now or later are partially driven by where we think interest rates will be over the next decade. If the Fed is serious about raising rates, we will have to adjust our forecasting assumptions.
Rising interest rates, of course, make money saved today more valuable in the future. To illustrate, if invested wisely at a 5% annual growth rate, the money saved on taxes today will grow and become more valuable with each passing year.
The interest rate rises will likely be slow, however, as the Fed is once again telegraphing its expected changes: “The Committee expects that economic conditions will evolve in a manner that will warrant only gradual increases in the federal funds rate,” the Fed’s statement said.
Given that, the impact of December’s rate increase is expected to have little material impact on the tax planning work I will be doing in 2016. More critical factors like tax bracket changes, revisions or renewals to depreciation rules, and the hard work of properly characterizing expenses and revenues all have a far greater impact on tax planning than do changes in the interest rates.