The Internal Revenue Service doesn't care how you receive income. You can work for an hourly wage or a salary, have self-employment income, receive interest on your savings or dividends on your stock portfolio — as far as the IRS is concerned it's all taxable income unless specifically exempted from taxes by law. That includes any profits you receive from your investments, business or sales of personal property, regardless of whether you reinvest that money.
A profit is your reward for taking a risk. For example, when you buy stock you take a risk of its market price going up or down. If the price increases and you sell your stock for more than you paid, you earn a profit. The same concept applies to your business. You risk your time, money and expertise in exchange for income from your products or services. If your business income exceeds your expenses, your business is profitable.
Reinvested Investment Profits
If you sell your stock for a profit, you might reinvest that money into another stock. Your mutual fund company might offer to automatically reinvest your dividends and capital gains into additional shares. Whether or not the check ever made it into your hands or into your bank account, once the profit from your investment transaction was made available to you, the IRS considers that money to have been constructively received. That profit is taxable income, and you can't take a tax deduction for reinvesting it.
Personal Property Profits
The IRS considers most of your stuff, including your car, your home, your clothes and your silverware, to be capital assets. Most personal property items decrease in value as they age. For example, your car is probably worth less today than when you bought it. But some items, such as your home, might increase in value. If you sell a capital asset for more than you paid for it, you have a profit. The IRS calls it a taxable capital gain, which is not tax-deductible. On the bright side, if you sell your main home, the IRS lets you exclude up to $500,000 in profits from your income as of the 2013 tax year, provided you file a joint return.
Reinvested Business Profits
If you take the profits from your business and use them for your personal living expenses, your profits are taxable income. If you want to grow your business it might make more sense to plow those profits back into new equipment, advertising or even hiring new workers. While your business profits are not tax-deductible, you can take a deduction for qualifying business expenses you paid for with those profits.
Mike Parker is a full-time writer, publisher and independent businessman. His background includes a career as an investments broker with such NYSE member firms as Edward Jones & Company, AG Edwards & Sons and Dean Witter. He helped launch DiscoverCard as one of the company's first merchant sales reps.