Reinvesting Profits Has No Tax Advantages

If you start a business with your own savings as seed money, your growth strategy may be to reinvest profits for a few years to build up equity in the business.

The Problem: Non-Cash Taxable Profit Spiral

You earn a profit on paper, but then you re-invest all of it back into your business…

• More Inventory

• More PP&E

• Other Assets…

You have little cash (you may not even be paying yourself) but you need to pay taxes on your increase in assets. This continues as long as you reinvest to grow your company.

Why is reinvesting profits so tax inefficient? It’s a massive hurdle for small businesses that drastically slows growth.

The Solution: Non-Profit Equity

How do you increase assets without a taxable profit?

Investments and loans bring cash into your business without income tax liability. (They affect your Balance Sheet without directly increasing the Net Income.)

You only pay tax on the increase above what was invested or loaned

That means that raising $1,000,000 is actually like raising $1,300,000. (Saving the $300,000 you would pay in tax, growing this sweat-equity yourself over multiple years.)

The IRS doesn’t treat sweat-equity and paid-in-capital the same way.

• If you grow your business to $1,000,000 without outside capital, you owe taxes on the ‘gain’. (~$300,000)

• If you receive a $1,000,000 investment, you don’t owe any taxes until you start earning an income.

Not everyone wants investors or loans, but everyone should be aware that the IRS incentivizes growing a business by raising money and taking on debt, while providing few incentives for reinvesting your profits for business growth.