The Tax Impact of Lower Interest Rates
By Mark Sipos, LFG Tax Director
Federal Reserve interest rate drops indirectly impact taxes by influencing the economy, which can affect how and what you're taxed on. Lower rates can lead to higher asset values or increasing potential capital gains taxes, but they also reduce inflation's effect on tax bracket adjustments, potentially pushing more income into higher tax brackets. Additionally, lower rates encourage borrowing and spending, which can be inflationary and impact future tax policies, and can make certain charitable giving strategies more attractive.
Impact on Income and Capital Gains Taxes
- Inflation and Tax Brackets:
Lower interest rates are often linked to slowing inflation. Since federal tax brackets and standard deductions are adjusted for inflation, a slowdown in inflation means smaller adjustments, potentially pushing more of your income into higher tax brackets and increasing your tax liability.
- Asset Values and Capital Gains:
Lower borrowing costs from rate cuts can boost asset values. This increased value can lead to higher capital gains when those assets are sold, potentially resulting in higher capital gains taxes.
- Higher Interest Income Tax:
Lower rates mean lower interest earned on savings accounts and investments, but this lower interest income is still taxable at ordinary income tax rates. Tax-free investments or qualified dividends may be more tax-efficient.
Impact on Tax Policy
- Shifting Tax Structures:
Sustained low-interest-rate environments can lead economists to consider shifting preferences from income taxes towards consumption taxes.
- Government Borrowing Costs:
Lower interest rates reduce the cost of government borrowing, potentially impacting the government's ability to fund various programs and influencing future tax decisions.
Impact on Charitable Giving
- Strategic Giving:
Lower interest rates can make certain planned charitable giving strategies, such as a charitable lead trust (CLT), more advantageous.
What You Can Do
- Analyze Your Tax Strategy:
Given the potential for higher capital gains and less inflation-related bracket adjustment, it may be beneficial to review and adjust your tax strategy.
- Consider Tax-Loss Harvesting:
To offset potential increases in capital gains taxes, you might consider strategies like tax-loss harvesting to offset those gains with losses from other investments.
If you have any questions on how any of these highlighted changes could impact you, please reach out to us. We are here to help!
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