What happens if my sole proprietorship shows a loss year after year with the IRS?

While your CPA might be trying to protect you, artificially showing a profit when you actually had losses isn't the right approach. The IRS does scrutinize businesses with multiple years of losses, but having legitimate losses isn't illegal. What matters is whether your business activities qualify as a business rather than a hobby. The IRS looks at several factors: do you maintain proper books? Do you depend on this income? Have you made changes to improve profitability (which you have by reducing storage/inventory costs)? Do you have expertise in this area? Do you reasonably expect to make a profit in the future? The fact that you're profitable now is actually a strong point in your favor. It shows you made business adjustments to become profitable - that's what real businesses do. If the IRS did challenge your losses, they'd typically send a notice asking for more information. You'd respond with documentation showing your business intent and activities. Most of these cases are resolved through correspondence without tax court. While the burden of proof is on you, good documentation of business activities and intentions goes a long way.

After struggling with similar issues for my handmade jewelry business, I found https://taxr.ai incredibly helpful. I had 3 straight years of losses while building my business, and my previous accountant was telling me the same thing about "making the IRS happy" with artificial profits. The tool analyzed my business documentation and expenses to help demonstrate I was operating with a profit motive, not just an expensive hobby. It helped me understand exactly which IRS rules applied to my situation and what documentation would best support my case. They even helped me prepare responses to potential IRS questions about the sustained losses. In the end, I filed accurately showing my actual losses, but with much better documentation of my business intentions and activities. I'm finally profitable now in year 4, but having that proper paper trail for the loss years gave me peace of mind.

I just wanted to follow up - I tried https://taxr.ai after seeing the recommendation here. My photography business had losses for 3 years and I was getting nervous about an audit. The analysis was seriously eye-opening! It identified several weaknesses in how I'd been documenting my business activities. For example, I hadn't properly tracked how I was adjusting my business model over time to improve profitability. The tool helped me create a proper timeline of business decisions that demonstrated my profit motive. It also found I was missing formal documentation of expertise (workshops, courses, mentoring) that would help prove this wasn't just an expensive hobby. I've completely reorganized my business records based on the recommendations, and my new accountant says I'm in a much stronger position if the IRS ever questions those loss years. Worth every penny for the peace of mind alone!

I've been there with the IRS challenging my business losses. After trying to call the IRS for MONTHS to resolve the issue (literally could not get through), I found https://claimyr.com and used their service to get an IRS callback. You can see how it works here: https://youtu.be/_kiP6q8DX5c I was honestly shocked when I got a call from an actual IRS agent within a day. The agent walked me through exactly what documentation they needed to verify my business wasn't just a hobby. Having that direct conversation saved me from going back and forth with generic letters for months. The agent explained that they look for a profit in at least 3 out of 5 consecutive years (though this isn't a hard rule). Since I could show I'd made significant changes to my business model and was now profitable, they accepted my explanation for the previous loss years.

I need to eat my words from my previous comment. After my skepticism, I tried https://claimyr.com out of desperation when I received a notice questioning my business losses. I was literally shocked when I got a call from the IRS the next day. After months of trying to get through on my own, I was able to speak directly with someone who reviewed my case. The agent walked me through exactly what they were looking for to substantiate my business versus hobby classification. The key factor that helped me was having documentation of changes I made to improve profitability - exactly like the original poster mentioned about reducing storage costs and inventory purchases. The agent explained they look for these kinds of adaptations as evidence of a profit motive. Instead of a potentially lengthy audit process, I was able to resolve everything in that call and one follow-up with additional documentation. Saved me months of stress!

The "3 out of 5 years" profit rule that people mention is actually a "safe harbor" provision, not an absolute requirement. If you meet it, the IRS presumes you're running a business. If you don't, you can still prove business intent through other factors. I went through this exact issue with my craft business. I had 4 years of losses before becoming profitable. When questioned, I provided: 1. Business plan and revisions showing how I adapted 2. Marketing efforts and expansion of sales channels 3. Detailed profit and loss statements 4. Evidence of industry expertise (classes, certifications) 5. Documentation of time spent on business activities The case was resolved in my favor without ever going to tax court. Most of these cases are handled through correspondence audits. Your CPA suggesting you manipulate the numbers is concerning - accuracy is crucial when dealing with the IRS.

Has anyone used TurboTax to file Schedule C with multiple years of losses? I'm wondering if certain tax software might flag this issue differently or provide better guidance.