Commonsense CPA: Interest Income

On September 15th, 2008 Lehman Brothers, a 158 year old investment bank, declared bankruptcy – a stunning development that was widely viewed as the high water mark of the Great Recession fueled by speculation in derivatives based on American mortgages. The next month to avert a systemic collapse, the Federal Reserve dropped the Federal Funds Effective Rate (a key “benchmark” rate that many other interest rates are based on) to under 1%, unprecedented in history.

Rates stayed there for the next 10 years – even falling to almost zero. In Europe the interest rates went negative – meaning that banks were charged money to hold their cash with the central reserve banks. Interest rates started ticking up in the United States in 2019 only to be brought back down during the COVID-19 crisis. The reason that interest rates were able to stay so low for so long is that inflation also stayed low, never rising above 2.5% in the decade of near-zero interest rates.

A combination of supply chain snarls and government stimulus programs created high inflation when the United States returned to normal from lockdowns. Raising interest rates is the most important tool in the Fed’s toolbox to bring down inflation by curbing demand in the economy so the Fed responded to this inflation by hiking interest rates from 8 basis points (.08%) in January 2022 to 410 basis points (4.1%) in December 2022.

Since the Federal Funds Rate is a key benchmark rate, interest rates and borrowing costs raised sharply throughout the economy. This made mortgages, auto financing and personal loans more expensive. But this article addresses the flip side of that equation – what to do if you have cash on hand.

Your spring cleaning should be figuring out what to do if you’re sitting on a significant amount of cash. We don’t give investment advice around here but we want to highlight that for the first time in 10+ years there is actually interest income that can be generated by cash. Additionally, the flip side of higher interest rates is usually higher inflation so any cash sitting in a bank account is actually losing real purchasing power.

There is a robust fixed income security market of corporate offerings with various risk profiles and returns so ask your financial advisor if increased bond exposure is something you are looking to get in your portfolio. We’re focused in this article on three ways to generate relatively risk-free interest income: Certificates of Deposit, US Treasury Securities and Municipal Bonds.  From a tax perspective, interest income is generally treated as ordinary income and reported on a 1099-INT.

A certificate of deposit is a type of savings account that offers a fixed rate of interest for a specified amount of time. CD accounts are similar to deposit accounts because your money is FDIC insured. CD accounts are currently returning 4.5%+ percent over the duration of the CD.  They differ from traditional bank accounts because they come with stipulations that you must leave the money in the account for a certain period of the time, known as the term, or face penalties. Certificate of deposit interest income is treated as ordinary income on the federal, state and local level and is recorded on a 1099-INT.

Treasury Securities are segregated into bills, notes, and bonds depending on the duration of maturity of the bond – or when the face value of the loan will be repaid. Treasury securities are identical to corporate bonds in that they are marketable securities that pay an interest rate (except T-Bills). There is some complexity in the various forms of treasury securities so consult your financial advisor but all treasuries are backed by the full faith and credit of the United States government, so they are considered one of the safest investments around – debt ceiling fights notwithstanding. Interest income from Treasury securities are taxable at the federal level but not at the state and local level – making them attractive to people in high tax states.

The last type of interest generating security is a Municipal Bonds or “Muni Bonds”. Muni bonds are issued by government entities (cities, states, counties) to finance day to day activities and capital projects. The credit-worthiness and interest rates of these bonds can vary widely but interest income from Muni Bonds are generally exempt from Federal income tax and state tax if purchased from the state you’re domiciled.

At CommonSense CPA, we don’t give investment advice – just common sense advice for you to ponder. Given the change in interest rates and yields that were static over the past decade, we think it’s prudent to look at how any cash you have on-hand is generating income in this environment. The type and form of individual investment is subject to a number of personal factors but it is well worth your time to explore options with your financial advisors.

And don’t forget to include all your 1099-INTs in the tax information you are sending to us – or better yet, have already sent.

Journal Entries

Time Theft - and it's Not Christopher Nolan's Next Movie:

Canadian accountant was forced to repay her employer $2,756 after a Canadian court found that she engaged in time theft – or reporting hours on her time sheet for compensation which she didn’t actually work.  The employer was able to prove the case through the use of time tracking software that records how long work documents were accessed. American employers can try to recover pay from employees they prove falsified their time sheet but it’s rarely done – and even this case came from a wrongful dismissal counterclaim. Tracking employee keystrokes or through “always on” webcams seems draconian (it’s an invasion of privacy in Europe) but making sure that you can effectively track productivity of remote employees will remain a challenge. At Harmony we advise focusing on what deliverables matter most to your business and building productivity checks around that work-product.

Survey of Small Business Gives Government a "C"

Goldman Sachs (not a small business) did a survey of over 1,000 small businesses and the results that came back weren’t encouraging. The most common grade for the government was a “C”, reflecting a level of dissatisfaction with government programs designed to support small business. Chief among frustrations: byzantine and hard to understand tax credits that were poorly communicated, antiquated federal agencies, and inflation which hits small businesses harder because they usually don’t have the buying or pricing power to manage well. Luckily if you’re reading this newsletter you have Harmony Group to help you manage and maximize your tax credits, deal with the federal agencies, and be a resource for strategic decisions (or could by e-mailing matt.h@harmonycpa.com). For a dose of pure American exceptionalism, 68% were optimistic about the financial trajectory of their business in 2023 but 55% predicted a recession over the next 12 months.

Powell Urges Caution as People Get to Work

January’s job report was strong… Arnold Schwarzenegger strong. The US added 517,000 jobs and unemployment dropped to 3.4%, the lowest level since 1969 (when Schwarzenegger got second at his first Mr. Olympia). Normally scorching hot job growth would be something to cheer but the Fed’s mission is full employment AND stable inflation. The January CPI Report had mixed results, with the overall inflation and the price of goods falling but services still posting high inflationary numbers. Powell acknowledged that inflation is coming down but signaled that further rate increases may be necessary, especially given the runaway inflation in the services sector compromising restaurants, travel and health care.