Do you run a small business? Hold on tight. Rising interest rates may be putting real pressure on your cash flow.
With higher loan repayments and more cautious capital investment, the squeeze is real. But here’s the good news: despite rates nearly doubling over the past five years, a smart tax strategy can help you preserve working capital and navigate this environment in the best possible way.
Maximize Deductions – Especially Interest
In a high-interest environment, every qualified deduction counts – especially interest. Why? Because as borrowing costs climb, more of your cash goes toward interest payments. You can, however, deduct those costs to reduce your taxable income. But the rules have tightened.
To claim the full benefit, your records must meet specific IRS criteria.
Under Section 163(j), interest deductions are limited to 30% of adjusted taxable income for businesses with average gross receipts over $29 million (2024 threshold). Businesses under this threshold are generally exempt, but would still need to substantiate all deductions.
The IRS also requires that the interest be tied to a genuine business loan, not equity disguised as debt. To meet this standard, you’ll need to support your deduction with:
A written, enforceable loan agreement,
A fixed repayment schedule,
A market-rate interest charge,
Proof that payments are actually made,
To preserve your deductions:
Ensure business interest expenses are properly documented and allocated.
Clearly separate mixed-use funds (business vs. personal).
For related-party loans (e.g., between the business and its owners), confirm the loan is at arm’s-length – meaning the terms are fair and reflect what an independent third party would agree to. Without this, you risk losing the deduction altogether.
Adjust Timing: Accelerate Deductions, Defer Income
Every penny counts in a high-interest environment. Being strategic about the timing of your income and expenses can help you manage tax liability and retain liquidity when it matters most.
Accelerate expenses: Prepay items like rent, insurance, or office supplies before year-end to reduce your current-year taxable income. Just be sure the expenses are ordinary and necessary to your business.
Defer income: If your cash flow allows, delay billing or recognize income after year-end. This can help lower your overall tax bracket or keep you under the Section 163(j) deduction threshold.
Review your accounting method: Cash and accrual methods offer different timing advantages. Cash-basis taxpayers, for example, can control when income is received and expenses are paid. This would allow you to shift your taxable income between high- and low-margin years.
These aren’t one-size-fits-all strategies, though. You would need to consult with your CPA to model different timing scenarios. You want to ensure that the moves you make now don’t create a bigger tax burden later.
Make the Most of Depreciation Deductions
When capital is tight, investing in equipment or other assets might feel risky, but strategic spending can unlock meaningful tax savings through depreciation.
Section 179 Expensing: Deduct the full purchase price of qualifying business assets (like machinery, software, or vehicles) in the year they’re placed in service – up to $1.22 million in 2024. This is especially helpful for smaller-ticket items when you need immediate relief.
Bonus Depreciation: For larger investments, bonus depreciation lets you deduct 60% of the asset’s cost upfront in 2024 (dropping to 40% in 2025, unless extended). This applies even if the asset is financed, making it valuable despite rising interest costs.
Lease vs. Buy: Leasing may preserve cash, but buying could unlock bigger deductions. Modeling both options helps you weigh the short-term liquidity benefits against long-term tax savings.
These strategies can significantly reduce your taxable income, but the eligibility rules are complex and would require expert input to make them work for you.
Rethink Your Entity Structure
Your business structure has a direct impact on your tax obligations. In a high-interest environment, it’s worth revisiting whether your current setup still supports your financial goals, especially if your borrowing or cash flow strategy has shifted.
S Corporation: Electing S Corp status over default LLC treatment can help reduce self-employment tax by allowing you to split income between salary and distributions. This can result in significant annual tax savings, especially when margins are under pressure.
Partnerships and LLCs: These structures offer operational flexibility, but profits are typically taxed as self-employment income. Without the right strategy, you could face higher effective tax rates on your full earnings.
C Corporation: C Corps benefit from a flat 21% corporate tax rate, which can be appealing for retained earnings. However, they’re subject to double taxation – once at the corporate level, and again when dividends are paid to shareholders.
Update Your Estimated Tax Payments
With updated costs and profits, you can’t really rely on last year’s tax figures to estimate current payments. You must review your current-year performance, because:
Overpaying ties up cash you may need for daily cash flow.
Underpaying can lead to IRS penalties and a surprise tax bill.
At Fusion CPA, we can help you run projections based on current and forecasted interest rates and investigate whether your entity structure and estimated payments are working together to avoid costly missteps. Contact us for help.
_______________________________________________________
This blog article does not replace legal, accounting, tax, or other professional services. We base articles on current or proposed tax rules at the time of writing. This site does not update older posts to reflect tax rule changes. We expressly disclaim all liability regarding actions taken or not taken based on the contents of this blog. The same applies to the use or interpretation of this information. We do not provide all-inclusive information on this website, and you should not treat it as a comprehensive source.