Hi, everyone. This is the How to Lower Your Tax
Bill podcast. I'm your host, Terrence Hutchins.
I'm a financial and tax advisor in the Dallas
-Fort Worth area. And the goal of this podcast
is to help you listeners get educated on different
tax strategies that you can implement to improve
your tax situation immediately. Each episode
will break down useful tax tips you can use to
save money. no matter what your personal or business
income situation. Because our motto is, keep
more of what you earn. So let's get into today's
episode. All right, so welcome back to how to
lower your tax bill podcast. We have been going
over a series talking about how to utilize your
business profits, which hopefully you have them.
FYI, but there's really five things we've been
going through. It's how you can use your profits.
So we've been talking about taxes as an expense,
utilizing debt wisely. Today, we're going to
get into reinvesting your profits back into the
business. All right. And then our last two, we're
going to talk about how much should you retain
in the business? And then how much should you
potentially distribute out to yourself? Now,
when it comes to reinvesting, and before I get
into that, say hi to people, Tamiya. Hey, good
people. Hey. So I'm going to ask you this question
because this is a misnomer I get from a lot of
folks, especially people who are new to business.
When I say reinvest back into the business, what
is something you maybe heard or thought? Like,
what does that even mean? Reinvestment for me,
based on my experience, means that if you make
$10, you're going to put that $10 back in the
business for, say, to buy product. I used to
work as a waitress. And so when you think about
profits, they would... reinvest in buy more food
or buy more paper towels or something like that.
Yeah. And so a lot of times people hear that
they're like, Hey, I'm putting all the money
back into the business. But it's like, okay,
but where is that money going? So that's what
we want to talk about today is how should you
think about where to put the money and then what
expensations should you have for what you should
get back as a result? All right. Now I preface
this because many times the business owner is
the biggest asset. And they're also potentially
the biggest liability of the business. How is
the business owner liability? You might ask.
Well, one is they use the business as their personal
piggy bank. All right. So when they have profits,
they don't reinvest anything back into the business.
So you've maybe seen the business where it's
a storefront and the storefront is beat up. It
looks dilapidated. Or if you know that restaurant
where it's not clean, they have old stuff that
they're using. And so depending on the business
you're in, that might speak directly to your
brand. That might speak directly to the service
you provide. And eventually it might impact your
actual sales. So you have to think about reinvesting
to keep up with stuff. But as the business owner,
you want to flash all the money you're making
potentially. And then you just buy everything,
right? I'm, you know, I'm a business owner. I'm
making a lot of money. And so I'm buying all
this stuff. but I'm not putting money back into
the business. I'm not reinvesting back into people.
I'm not reinvesting back into equipment. I'm
not reinvesting back into processes, software,
things that could help me make more money in
the future. And so when you think about reinvesting,
we're thinking about what could you buy or what
could you use money on that's ultimately gonna
help you make more money. And as I said before,
when you value a business, normally it's tied
to the money that it makes. So if I spend money
in the business, that means the business on paper
makes less money, which means if practice is
actually less valuable. So when I spend money,
I need to make more money to make my business
more valuable or I've just effectively made my
business worth less. All right. So real quick,
let me jump in there because that is so good,
right? The owner can be a liability or an asset.
And we talked before about you really need to
have a degree of separation between yourselves
and the business. Have a different checking account
because this is real life, what he is talking
about. I've done business owners taxes and they're
using one bank account for their own personal
gain because they're like, oh, this is the profit,
but it's not. Do you have cash flow? Do you have
things you need to pay? Like we really got to
challenge the way our mindset about how we look
at profits, how we look at our business model.
And like you say, your brand, right? If I am
going to a restaurant and it is not clean or
things are janky or you don't go into some restaurants
and never have any biscuits, then your brand
is saying, I'm not going to come here. Yes, the
owner is pulling up at a nice six -figure car
or whatever. But that's all on you. It's not
in your business. And ultimately, you're going
to hurt yourself. And you're going to impact
the longevity, right? Because just thinking you
want to sell, like Terrence is saying, if I look
on paper and you don't have any cash flow, you
don't have anything, or you're robbing Peter
to pay Paul, I don't want to touch it. So I think
that whole business owner, this is a clarion
call to business owners to really evaluate how
your relationship with the money, with the business
is money. and what you're using it for sure.
So actually made me think about when you were
talking about the whole separation. So imagine,
and I've worked with a lot of couples over the
years and oftentimes a big issue for couples
is having a joint account. Now imagine you have
a joint account that all your money goes into
and you need to go buy something but then you
look in the account and ain't no money in there.
Cause you saw your partner use it on something.
that y 'all didn't discuss beforehand. Now you
get upset and you're like, I'm not doing this
again. I'm gonna keep my money separate. You
have that attitude, but it's like, in the business
case, that could be you, except you're both parties.
Right? Your business might need stuff that would
help you in the long run, but if personally you're
not aligned in your goals and objectives, as
far as personal and business, and you don't have
a distinct separation, then you might be using
money personally that could be going into the
business and that will create internal conflict
versus just external with you and your partner.
So when it comes to reinvesting, the first step
I always talk to business owners about is what
can we do to one, make the business run easier?
All right. And so generally that is going to
be investing in things like advertising. So I
can get more customers. I can invest in people
so that they're either better trained, they're
better equipped to do the job, or I invest in
someone new that can help me do more stuff. All
right. I can invest in systems and processes.
So if I'm more efficient with my time, then I
can do more stuff and I can scale quicker. Or
I can invest in things like equipment. So if
I can buy something that can actually, I can
use to make more money, then ultimately that
will allow the business to grow faster. So those
are things I could commonly reinvest in. And
if you think about it, the difference between
reinvesting cash versus debt is they're not the
associated cost with the debt. All right. When
you think about cost of capital. So we talked
about before that's tied to your debt. So you
remove that element. However, you still have.
the opportunity cost of I could use this money
on something else. Or I could just, you know,
go and get my new whip as we talked about. All
right. The list that you just gave, like advertising
or marketing, those are all things that make
sense. Because if you're saying I want to be
in this business for the long haul, it's not
complicated, good people. It's really not. And
reinvest in things that make sense. for the business
long term. And I'm sure we'll do a podcast on
this, but if you're a business owner and you're
trying to spend the money, then maybe you need
to sit down and find out what type of salary
you need, right? Find out what you're spending
the money on. And again, different. show different
podcasts, but certainly that may be a red flag
for you to really sit down and see what type
of resources you need as the employee versus
the owner if you're dibblin' and dabblin'. But
reinvest in things that make sense or the business
for the long haul so you can get a good ROI for
sure. Yeah, I'm glad you said that because oftentimes
when we are thinking about the profit of the
business, we have to factor in that remember
when you own the business you have two jobs you
have the owner job and you have the actual worker
job so you need to be able to make enough as
a worker from the business to pay for your bills
and then the business owner profits should be
extra so if you're underpaying yourself as a
worker and you're thinking hell you know my business
makes a hundred thousand dollars but if your
quote -unquote salary is 30 ,000, well, then
your business isn't really making 100 because
you're underpaying yourself as the worker. So
ideally your business, as far as the work you
do needs to pay you a base amount. And then on
top of that, that's your true profit. If you're
not, if you have a distorted view of your profit,
what happens when you go to an outside buyer,
they're going to look at your financials and
say, Hey, in a perfect world, when you buy a
business, they could just plug someone else into
your job and the business will continue to run
as it had. So if you're underpaying yourself,
then they're gonna say, hey, look, I couldn't
replace you with your paying yourself on paper.
So I have to distort your earnings to factor
in the higher cost of your replacement. So that
number one gives you an idea of, hey, what are
my actual profits? Which means I have to be paying
myself or at least on paper showing, cause we
talked about, you know, you can kind of fill
that number with the S corp. But, okay, what
is my actual true profit? Which is after I paid
myself a fair market wage for what I do as a
worker. Then when we think about reinvestment,
number one, we got to kind of define, and I'll
get more into this on the retained side, but
generally we have a rainy day fund, which is
kind of how you think about how you run your
personal life. So I'm gonna use that example
because I think this will bring this point home.
So, so you think about, okay, as a person, As
an individual, what do people normally tell you
that you need to keep in your rainy day fund?
Like how much? What kind of rules of thumb? Three
to six months worth of rainy day. Right. Yeah.
So they tell you, hey, keep three to six months
as a rainy day fund. Well, in your business,
ideally, if it has operations, you want to keep
at least two months of your operating expenses.
All right. So if I have X, Y, Z amount of labor
costs, of insurance, all that, I want to keep
at least two months because ideally, you know,
when you keep three to six months, because you
might get laid off, personally and so you want
to be able to bridge the gap to be able to find
another job or whatever right well if your business
isn't making money for three months you probably
got a broken model okay so you say hey I at least
need two months but then also as an individual
I might also factor in stuff that might break
that I need to replace so hey you know what if
I know that my refrigerator goes out every five
years hypothetically and a refrigerator costs
five thousand dollars well hey I want to set
aside a thousand dollars a year to factor in
that, hey, in five years, I'm going to have to
replace this. So instead of me dipping into my
cash, well, now I have money set aside to pay
for my replacement. All right. And then I also
say, could say, hey, what if I want to go reinvest
in something? You know, I want to go buy my new
TV or whatever. Hey, I could set aside money
for that. And in the same concept with your business,
if you want to reinvest into something bigger,
then you might set aside that money to have it
to the side. So that way, whenever you do go
buy it, you're not tapping into your rainy day
fund. Do you know how a person go buy a new hold?
It's like they tell you, listen, we need to have
money saved up. It's something to happen. You
also need to have money to change these filters,
to get the yard mode, like maintenance and just
different things. And then you need to have money
to reinvest and the upkeep of the whole. And
so simply put, you guys, whatever you do in your
own personal life and your whole, how you think
about your whole, you need to think that same
way with your business. You still need a rainy
day fund. You're still going to need a replacement.
You're still going to need maintenance funding.
So all this profit that you're getting. is not
to blow. Reinvestment is going to be our word
for the week. Let's reinvest and identify where
we need to reinvest because I'll tell you right
now, he mentioned that rainy fine. Listen, depending
on the type of business that you're in, you may
not make a profit right away. Those bills still
have to get paid. For sure. So when you think
about as an individual and if you decide to take
on an expense. So let's say, say, for example,
I go buy a car and now my car payment is a thousand
dollars a month, five hundred dollars a month,
whatever. If I'm still keeping my same three
or six months of expenses, that means my rent
a fund would actually need to be higher to factor
in the additional cost that I just took on the
same concept in your business. If you reinvest
back into your business, and this is a tax podcast.
So the positive from that vantage point is if
I reinvest back into my business, my profits
are lower, meaning I save on taxes today. Well,
obviously with the idea of trying to make more
money in the future, but also if I can make more
money in the future. then it should make my business
more valuable overall. So if I can grow my profits
from A to B, the value of my business at B should
be higher than it was at A. But the good thing
is, just in the same way when you own a house,
if your house goes up in value, you don't pay
tax on that increase in value until you decide
to sell it. Well, in your business, when I reinvest
my money and my profits are lower, I actually
have saved ordinary income taxes. So that's based
on my tax bracket. So if I'm in a 24, 32, 35
% tax bracket. If I reinvest a dollar back into
my business, then I'm going to save 35 cents,
24 cents, 32 cents of taxes. The reason I bring
that up is because let's say I reinvest that
back to the business and now the business is
worth more in the future. Well, if I decide to
sell the business in the future, that increase
in value, I will actually pay capital gains tax
on, which capped out at 20 % for a business owner.
So instead of me paying ordinary income at 32,
35, 37, I'll reinvest, lower my profit, save
the taxes, and then hopefully increase the value
of the business where I'll eventually only pay
20 % when I decide to sell. I won't actually
pay it until I decide. So the incentive from
the tax standpoint is you're incentivized to
reinvest back into the business just based on
that dynamic. That's good. That's a good strategy,
y 'all. Y 'all listening? How to lower your tax
bill right on the money. So once again, this
isn't tax advice, of course, but going back to
the illustration, when you have that three to
six month rainy day fund and you take on an expense,
your rainy day fund goes higher or should go
higher to compensate for the higher expense.
in the same concept with your business that difference
so let's say my thousand dollar car means my
rainy day fund needs to go up by three months
so three thousand dollars all right that money
in my business my rainy day fund that would be
called my invested capital meaning that's the
money that stays in the business it's money that
the business has to operate all right that's
my invested capital if my rainy day fund goes
up meaning hey I need if I took on a thousand
dollar expense, my rainy day fund need to go
up by two months or two thousand dollars. So
I have to now think, OK, if my rainy day fund
has to go up by two thousand dollars, that means
the profit I need to get as a result of me reinvesting
should be at least 50 percent of that or in this
case, a thousand dollars. So that would be what
you would call your return on invested capital.
So my invested capital is a thousand. I reinvest.
And now my invested capital needs to be $2 ,000
because my rate of their fund is higher. I need
to be able to make that $1 ,000 back. And Julie,
I want to do that within 12 to 24 months. If
I can't do that, then this is probably not a
good investment for me. All right. And this also
goes back into if I keep too much money in the
business, meaning I have a lot of cash that's
not doing anything, that's actually going to
lower my return on invested capital. All right.
For you real estate people, it's the same concept.
If you have a house that has a lot of equity
in it, but you make very little money in rent,
you have to reassess, hey, should I sell this
house, get the equity out and reinvest it somewhere
else? That'll get me more rent. All right. So
it's the same concept. It's just a different
avenue. So this is why, you know, your personal
life, your business life intersect as far as
how you think about things. We just want to help
you simplify the concept. So you can probably
just make better decisions that are not only
maybe tax efficient, but also help you. grow
the business. So make common sense investments
people okay into people systems and processes
marketing things that will get you profit okay
not your car okay. So ideally if you continue
to reinvest back into the business that's basically
your own piggy bank right I get money in I reinvest
it back it's just more money back out right so
it's similar to if you let's say you had a vending
machine right if you could put a dollar in and
then add a two dollars that spits out you would
do it all day all right and so normally that's
why most businesses are constrained by how much
cash they have if they have a really good opportunity
right it's like hey i need to be reinvesting
as fast as possible because i can put a dollar
in and get two or three dollars back i want to
keep doing that as much as i can but if i put
a dollar and i'm getting 50 cents back i need
to pump the brakes that's not a good that's not
a good use of the money that i'm putting back
all right So you need to be able to identify
this. All right. And you know, one of the clients
we're working with now where, you know, we're
thinking about, okay, how much is this business
actually making? And what are the numbers they
need to be paying attention to, to identify?
Hey, are things in, are they changing? Are the
dynamics changing? Like I was making a lot of
money, but now all of a sudden I'm not making
it much. What's happening? Things could be tied
up. Like what's tied up with. Remember, go back
and listen to our last podcast about debt, about
is this cash flow tied up? Like, why is things
changing? Why is things shifting? Where is my
profit going? Where is the profit going? Yeah,
those are all good questions for sure. So cool.
So just to summarize, we kind of want to think
about when we think about reinvesting, we need
to define where am I going to put the money?
So that could be in the people, systems, processes,
equipment, advertising. I needed to define decide
what is the minimum return I want to get because
if I use debt, I have an extra cost associated
with it. If I use my own cash, I have the opportunity
cost of where that money could go otherwise.
So I have to assume I need to have a certain
rate of return as a result, which we talked about
at least a 50 % return on invested capital. And
then I can prioritize where I do it and have
the process to just continue to reassess so that
I can determine, hey, my returns are going down.
I need to maybe pivot my strategy or figure out
what's happening so that I can continue to get
that higher investment. So my business will continue
to grow and scale as I get bigger. So any parting
thoughts for the people? No, just I say no. I
would just say certainly I think this is a good
opportunity for any business person to just sometimes
take time, sit down once a month, make even quarterly
to just evaluate your finances and see where
you're at, because you don't want to be. caught
in a pickle or it's a rainy day and you don't
have it or it's time to invest or reinvest or
upgrade your systems and you don't have it. And
so this is a really good call to action to make
sure that you know your money, know where your
money is going and understand the ROI with it
for sure. Definitely. So cool. So hopefully you
took some nuggets away. You have some strategies
as far as reinvesting back into the business
that can lower your tax bill, but ultimately
you want to be measuring the long -term impact
of that on the business. So keep more of what
you earn and we will talk to you again next week
about how much you should think about retaining
in the business.