Affiliate Marketing, the IRS and You

This article is a reprint of Wise Bread's contribution to OPEN Forum from American Express -- where small business owners can get advice from experts and share tips with each other.

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Affiliate marketing can be a great way to increase your sales by letting other people sell for you. But it is important to keep abreast of regulations. If you aren’t careful, your phenomenal affiliate marketing campaign might turn into your terrifying encounter with the IRS.

Your Obligations as a Business Owner

Your affiliates earn income from your business, creating some obligations for you as a tax payer.

Neil Johnson, a tax professional, points out exactly what your obligations are: “It is very important to have all affiliates complete a W-9 form and the parent company keep them on file. Whenever the affiliate has more than $600 in sales during a calendar year, the parent should issue a 1099-MISC form.”

Failure to keep records on file and report sales and tax information accurately can result in stiff penalties:

• The penalty for failing to file 1099s can be $30 per missed 1099, up to a maximum of $250,000.
• The penalty for filing inaccurate 1099s is $250 per 1099, with no maximum penalty.
• Additionally, the IRS might determine that the lack of 1099s indicates the parent should have been withholding taxes for the affiliate and could impose a 28% income tax on 1099 amounts. In effect, the parent would be paying the affiliate’s income tax.

The Trouble with 1099s

Dreama Lee’s company, Intern Profits, has experience with affiliate marketing, including two programs in two very different niches. But it took some additional expertise for the company to get on track for handling 1099 forms and other tax documentation in a way that keeps the IRS happy.

“For several years,” Lee says, “we never collected W9s or filed 1099's for various reasons. We didn't make that much money (or hit the threshold), our bookkeeper and accountant were not familiar enough with the process to insist upon it, and we didn't fully understand the implications of not filing.”

That all changed when Lee hired a new bookkeeper – one who understoof both affiliate marketing and the IRS’ reporting requirements. Under Lee’s new system, an affiliate can’t be paid unless there’s a W9 on file. New affiliates are asked to provide W9s once they’ve earned their first commission, but not when they first sign up. This saves Lee’s company and her affiliates some paperwork since not every new signup goes on to earn a check.

“It’s a very easy system for everyone involved,” Lee says.

Put the Right Person in Charge

Finding a bookkeeper or accountant who already knows the ins and outs of affiliate marketing is not easy, although it is becoming easier.

Lee’s new bookkeeper learned on the job with previous employers that had affiliate programs. If you aren’t in a position to hire a bookkeeper with similar experience, you need to make sure that the person who does your accounting has the opportunity to learn the details.

Many companies manage their affiliate programs through software that handles most or all of the tax reporting details. But not all programs do a good job of it. Consulting with a technical professional who is familiar with multiple affiliate management tools can help you make sure that you’re fulfilling your obligations to the IRS.

Whether you use software or a contractor to manage your affiliate tax reporting, ultimately you are responsible. It’s important that you understand the process and confirm that it’s followed correctly.

Coming to Terms with Your Past

If you’ve found that you may have overlooked some of your reporting obligations with past affiliate promotions, it is important to involve a tax professional as early as possible. Getting the situation resolved can be tricky without tax expertise.

But this is a case where the best defense is a good offense. Get ahead of the game and make sure your affiliate program is in compliance with IRS reporting requirements and you won’t need to worry.