Hot Profits

The marketing of adult entertainment is a lot like any other segment of the affiliate industry, except that it is nothing like any other. The business model and best practices are the same, with skills that easily translate to this sector. But the content makes this a world apart. X-rated sites commercialize one of the deepest human drives, one that’s idealized, demonized, desired and feared.

Sexual expression is one of the most contentious cultural issues. And pornography has been condemned in Western culture for most of recorded human history. Those who create, distribute and market it are well aware that they’re working on the fringe.

Why do they do it? Fun and money. To some people, it’s an exciting industry, enjoyed by millions of hard-working, productive and otherwise average adults who choose to view adult entertainment legally and safely from the privacy of their homes. It can be lucrative, too. According to “Online Adult Entertainment Report 2003,” a research report published by Reuters Business Insight, only 1.5 percent of Web sites contain adult-oriented content, but those sites reaped 66 percent of all online content revenues in 2001. The entire adult entertainment industry is estimated to be worth at least $2.5 billion, and perhaps four times that. Getting in on that while working with exciting content seems like a dream come true to some of us.

Different Strokes

Let’s start with how the X-rated sector of the affiliate marketing industry is different. Like it or not, most of the obvious differences are negatives.

First off, adult-oriented affiliates work with material that’s deemed offensive by many of their peers, as well as the general public, so they may find themselves stigmatized. Next, that same material tars them with the brush of the most egregious form of spam. Finally, they’re subject to more regulations than mainstream affiliates, so they’re also more likely to have legal troubles, even if they try to obey the law. The public face of the adult entertainment industry – the bionic babes and overbuilt guys – is quite different from the reality for those who toil behind the scenes. You couldn’t pick adult affiliates out of the crowd at a computer trade show. But the negative stereotype of the pornographer is a powerful cultural image, one that many avoid by trying to stay anonymous.

For example, the head of Booble, a guide to X-rated content that’s also a parody of popular search site Google, has carefully hidden all traces of his identity. He is known only as Bob. Bob says he heads an interactive advertising agency that works with a variety of traditional clients and started the site for fun. While he thinks his advertising clients would laugh at Booble, he isn’t about to bet his agency on it.

“My suspicion is that most of my clients would think it was pretty funny, but I certainly don’t want to test them,” Bob said. “Plus, I have an ex-wife and kids, and I have to respect my private life. That’s why I choose to remain anonymous.” Many affiliates are like Bob, maintaining a firewall that keeps the quotidian world of jobs, family and friends separate from this secret avocation. But they should realize that there’s always the risk of being exposed.

Even other affiliate marketers look down on those in the X-rated line of business. “Most of our clients see the pornographic sites as the scourge of the earth,” said Drew Jackman, business development manager for 10x Marketing, a company that manages pay-per-click campaigns and provides statistics on Web searches – except for the adult industry.

Another issue that every upright affiliate in the business must contend with is X-rated spam. Triple-X spammers have a special place in hell. Their dirty tricks, from innocent-sounding headers to spawning windows that can’t be closed, are a primer on how to give commercial email a bad name. “The tactics that a lot of the porn Web masters use is really unscrupulous. They use search engine spam, they create an inordinate number of popups, they make users frustrated. We try to stay away from them as much as possible,” said Haiko de Poel, CEO and administrator of ABestWeb.com, an affiliate marketing forum. He said that while those who promote the X-rated sites are affiliates, they’re not part of the mainstream – and not of interest to most merchants. In short, he said, “We see them as the scum of the earth.”

Affiliates use tactics to trick users into opening emails because they work. People who might never seek out an X-rated site can be tempted to click on an explicit picture to see more. Unfortunately, this quirk of human nature makes it nearly impossible to stop sneaky spammers. “Particularly in the adult marketplace, you know they’re doing [spam], but no one will own up that they’re doing it,” said Colin Daniels, CEO of Phoenix Group, merchant of a network of X-rated photo galleries. While his company mails a weekly newsletter only to those who have asked to receive it then confirmed the request in a process known as double opt-in, he acknowledged that over-eager affiliates are a big part of the problem. “It seems to be primarily affiliate-based. If you look at codes, buried beneath the HTML, there is affiliate code buried in there.”

While legitimate X-rated merchants like Daniels are as diligent as any others in warning affiliates against spamming, it’s impossible for them to police the thousands of anonymous affiliates that drop in and out of their programs. But spam-happy affiliates run the risk of having their email service shut off or getting blacklisted by ISPs.

Unfortunately, this is the company you’re keeping if you’re an adult entertainment affiliate. You may have a triple-opt-in list, but, unfortunately, in this hot-button segment, the public is a lot less willing to take the time to separate the ethical affiliates from the spammers.

Lawyer Trouble

Booble, the search-for-X site, got itself into legal trouble not for its sizzling content, but for the staid old rap of copyright infringement. Lawyers at search engine Google, a former iconoclastic upstart itself, sent Booble a cease-and-desist letter, claiming Booble is an encroachment on its world-class brand. Did Google pick on Booble because of its content? In their response to Google’s complaint, Booble’s attorneys argued the search company hadn’t objected to other Web sites with similar URLs and graphic design, such as the European search site Elgoog.

There’s a lot more for adult-oriented affiliates to worry about. Those who affiliate with the wrong site can find themselves linked to illegal material or practices, for example, providing X-rated content to minors.

Most X-rated sites use possession of a valid credit card number as the de facto proof of age, said Jake Ludens, spokesperson for affiliate network ARS. Merchants only provide censored content on their premium sites until someone registers – and they need a credit card to do that. “That’s the age verification,” he said. When it comes to members of the ARS network, he admitted that there’s no way to stop all juniors from getting inside the gate. In such cases, he said, the site is responsible. “Age verification is on the affiliate.”

ARS regularly polices its affiliates, checking the sites for illegal material. Because affiliates choose which merchants they want to represent, the attitude of the industry seems to be that it’s up to affiliates to perform equal due diligence on a site before signing up to promote it.

According to Dorn Checkley, director of the Pittsburgh Coalition Against Pornography, studies show that anywhere from 70 to 85 percent of teenagers have been exposed to explicit material on the Web, most of them by accident. Seeing this stuff at an to problems ranging from inappropriate behavior to sexual violence. Unfortunately, Checkley said, the requirement of a credit card to view paid sites does little to keep minors away from content that’s illegal to show them. “Sure, you need a credit card to download or to see more, but you don’t have to pay a dime to see the most explicit stuff out there,” Checkley said.

Sizzling Success

While the challenges for XXX affiliates are many, there are rewards for those who get it right. Here’s where the segment begins to look like the rest of the industry. To succeed, adult-oriented affiliates need to work hard, find a way to rise above the clutter of mediocre sites and provide value to their visitors.

The adult affiliate marketplace has gone through changes in the last few years, according to Phoenix Group’s Daniels. Like the rest of the affiliate industry, it moved from pay-per-click to revenue sharing, typically on a 50/50 basis. The business moved to today’s flat pay-out model, where affiliates receive set payments for referrals that convert to paid memberships. Pay-outs zoomed from $25 or $30 to $50 and up, as merchants competed for affiliates’ referrals. Life was good.

But the big payouts and privileged access to X-rated content flooded the market with low-end affiliate sites. “All the affiliates had little sites with a few pictures and advertisements all over them. There was this huge influx of free [material],” Daniels said. The problem was, merchants want their affiliates to entice visitors just enough so that they’ll click through to the premium site and spend some money there. Too often, he said, after they spend a half hour looking around the affiliate sites, they’ve had enough.

Daniels said that to be successful today, X-rated affiliates should concentrate on building one or two quality sites. “Unless you have some exclusive content, it looks like everything else,” he said. Phoenix Group’s most successful affiliates write reviews and guides. “This is the type of pre-selling that’s almost critical at this point,” he said.

Booble is a prime example of combining useful reviews with unique style. Although it masquerades as a Web search site, in fact, it’s an extremely well-indexed body of original reviews created by a team of volunteers and freelance writers. All the links that show up in searches lead to sites with which Booble is affiliated – about 150 at press time; Bob said that represents about half of all available programs.

Affiliates who show they can produce traffic that converts can often forge special relationships with merchants, Phoenix Group’s Daniels said. They can negotiate for exclusive content to use on their sites, a tactic that further differentiates affiliate sites.

Scratching a Niche

Creating a niche can work as well in the adult industry as in the mainstream world. Sssh.com is a woman-oriented erotica site operated by the Phoenix Group that’s extended the market by catering to the sensibilities of female affiliates. Its program, SpiceCash, uses the same technology as the hard-core merchants, but with a softer front end.

“We made a page specifically for women, so when they sign up they don’t see the hardcore or stronger Web sites. So women feel okay about it,” said editor Angie Dapery. Because of this, Sssh.com gets a different sort of traffic, devoted not only to erotic writing and artsy photography but also things like astrology or psychics.

Many affiliates operate a mix of explicit and mainstream sites. ARS widened its purview from erotica in order to accommodate its multitasking affiliates. Founded in 1996 as the Adult Revenue Service, its acronym now stands for Affiliate Revenue Service. Last year, it relaunched its private network as a full-fledged affiliate network, and began seeking mainstream marketers and retailers to take advantage of its network of some 5,000 affiliates generating a reported 70 million unique visits a month. “We’ve noticed that a lot of our merchants had to turn to other affiliate networks in order to promote mainstream products,” said ARS vice president of customer relations and marketing John Valigorsky. “We figured, why make them go anywhere else? Let’s incorporate the companies that they’re also promoting in their mainstream sites [into our network].”

Just as in the wider world of affiliate marketing, there are a glamorous few affiliates promoting adult entertainment who have hit it big, flashing the cars, the clothes and the rings. Most are hard-working aficionados who haven’t quit their day jobs.

Said Booble’s Bob, “We’d like this little adventure to pay for itself. If we weren’t having to pay lawyers, we might make a little bit. But not enough to pay for a whole other employee.” But hey, it’s not all about the money. XXX affiliates get the thrill of being insiders in an industry that still pushes all kinds of buttons.

SUSAN KUCHINSKAS has covered online marketing and e-commercesince their beginnings for Revenue, Business 2.0, and othermedia. She also has published erotic fiction.

Snake Eyes

Five’ll get you 10 that online gambling is here to stay. Cyber casinos already take wagers from around the globe on everything from five-card stud to the first race at Belmont. Even the industry’s harshest critics concede online gambling revenue has soared tenfold in the past six years to about $4.2 billion.

With generous payout packages and surging demand, it’s no surprise that affiliate sites are jamming the search engines like blue-haired ladies at a Tom Jones concert. Affiliates are anxious to collect their piece of the action, with a few lucky superaffiliates raking in five figures a month.

But it’s an election year in the US, where online casinos are outlawed, and affiliates are feeling a chill wind from lawmakers and federal prosecutors who allege online gaming is linked to ID thefts, personal bankruptcy, money laundering and, you guessed it, even terrorism.

As Revenue went to press, the US Senate was preparing to debate a bill that would ban the use of credit cards, wire transfers or other financial instruments for online gambling. A similar bill sailed through the House of Representatives last year on a 319-104 vote, authorizing five-year prison terms and hefty fines for violators.

“From a family perspective, the home may be considered a castle, but it should never be a casino,” said Rep. James Leach, R-Iowa, who authored an earlier version of the anti-gambling legislation in the House.

The strong rhetoric, combined with aggressive tactics used by federal prosecutors, has frightened many affiliates so much that they are reluctant to discuss their activities on the record out of fear they may be targeted by the government. Other affiliates, however, have become vocal proponents for legalized online gaming in the United States.

“I think there’s a lot of posturing going on right now,” said Cynthia Carley, outspoken owner and manager of the 150- member Gaming Portal Webmasters Association at GPWA.com. “There are a lot of legal attempts to intimidate people, but they don’t have any legal grounds at the moment. And getting those legal grounds is going to be more difficult than they believe it will be.”

To be sure, there are several other challenges in this controversial sector:

  • Some affiliates complain they have trouble collecting commissions from offshore casinos, and they get little sympathy from US authorities.
  • Many longtime affiliates think the sector is simply too crowded, with hundreds of new affiliates joining the throng each day.
  • Longtime stigmas of gambling addictions and organized crime still haunt the industry despite legal gambling in most of the US and lotteries in 39 states.

But it’s the legal issue more than any other that has affiliates on the edge. Cynthia Fanshaw, the 27-year-old marketer featured in our cover story, told Revenue she abandoned the shifting legal sands of gaming five years ago for the relative stability of the adult entertainment industry. “I started having conversations with a few Internet industry attorneys, and nobody could give me a straight answer,” she recalled, saying she feared being declared guilty by association. “By promoting an online casino, you’re getting in bed with them. If you’re promoting them, and they’re not doing business correctly, you’re just as guilty as they are.”

Fanshaw was just one of many affiliates, program managers, casino operators and others who complained that authorities have failed to provide clear guidelines on what is legal and what is not. Revenue repeatedly pursued the question with the US Justice Department, but the clearest response we obtained was from department spokeswoman Casey Stavropoulos, who simply said affiliate marketing of online gaming remains “a gray area.”

Active Enforcement

That, however, hasn’t stopped the Justice Department from going after parties they feel are too far into the gray. In mid-2003, PayPal Inc. and its parent, eBay, agreed to pay $10 million to settle federal allegations it had “aided” in illegal offshore and online gambling by transmitting millions of dollars in funds derived from “criminal offenses.” Prosecutors said the offenses involved the processing of illegal gambling transactions in Missouri, coincidentally the home state of US Attorney General John Ashcroft.

“Offshore sports books and online casino gambling operations which do business in the United States generally do so in violation of federal criminal laws. Therefore, we will continue to investigate and pursue such activity,” said Raymond Gruender, the US Attorney whose office pursued PayPal.

Not surprisingly, PayPal no longer services gambling transactions. Neither does Commission Junction nor BeFree, the two popular affiliate networks recently combined into a single division by ValueClick.

About the same time, the Department of Justice in Washington sent a warning letter to several media organizations regarding “Advertising for Internet Gambling and Offshore Sportsbooks Operations.” The letter was widely circulated, including on the Web site for Interactive Gaming News, where Revenue obtained a copy. It said, in part:

“The sheer volume of advertisements for offshore sports books and online casinos is troubling because it misleads the public in the United States into believing that such gambling is legal when in fact, it is not.”

The letter went on to reiterate that Internet gambling was illegal within the United States “whether or not such operations are based offshore.”

A few months later, the operator of a portal site was subpoenaed to testify before a federal grand jury investigating advertising for online gambling, according to published reports. Several media organizations, including radio giant Clear Channel Communications, also were subpoenaed in connection with the advertising probe.

Revenue asked Jan Diltz, the spokeswoman for Gruender’s office, for confirmation of the reports and clarification of the laws surrounding affiliate marketing, but received only a Kafkaesque series of responses. Diltz said she could not comment on any ongoing investigation until indictments were issued. Asked if that meant there was an ongoing investigation, Diltz said she could not comment. Nor would she comment generally on whether affiliate marketing of online gaming was legal or illegal. Asked how affiliates could know if they were in danger of violating the law prior to being indicted, Diltz said she could not comment.

Unclear on the Concept

Diltz said department regulations prevented her from saying anything else about the matter. Instead, she pointed to the press release that included Gruender’s comments months earlier at the conclusion of the PayPal case, but that said nothing about affiliate marketing. The lack of clear guidelines has left many casinos, program managers and affiliates feeling frustrated.

“With all the subpoenas that were sent out to radio stations, magazines and a lot of different merchants that took online gaming advertising, it’s been more of a threat than anything else,” said Daniel van Dijkman, global affiliate manager for VIPProfits.com, a network with about 3,500 active affiliates serving eight online casinos. About 70 percent of his affiliates operate in the US.

Without clarity on the legal limits, or even on whether the grand jury has completed its probe, Carley said her association’s members were equally divided over how to proceed. “We have people who are ready to jump out there to do battle, and we have people who do everything they can to fly under the radar,” she said. “They don’t want to be seen, they don’t want to be tracked, they don’t want to be known.”

Attorney Larry Walters, who has represented casinos in First Amendment cases, said the power of the US government to regulate advertising is not as extensive as its ability to regulate a service like gambling and therefore affiliates would be somewhat less constrained than the casinos themselves. Casino operators tend to see the enforcement campaign as a tactic to silence affiliates.

“I think a few people in the United States with dogmatic opinions are trying to frighten affiliates and advertisers out of conducting their business in a proper manner,” said David Caruthers, CEO of BetOnSports.com, which operates a 1.2-million-square-foot casino in Costa Rica. The company also has operations in the Dominican Republic, Antigua and South Wales, all of which Caruthers states are “licensed and legal and I would defend that position very, very, very robustly.”

Caruthers hinted the legal climate had worsened under the Bush administration. “I think we’ve seen in recent times … correspondence from the Department of Justice that is very ambiguous and very threatening, with really no substance or legal fallback for their accusations,” he said. “I see that as aggressive, dogmatic and unfair.”

Rep. Bob Goodlatte, R-Va., was among the most ardent supporters of the bill that cleared the House and the bill now pending in the Republican-controlled Senate. When the House bill passed, he hailed it as a step that would help to “close off opportunities for money launderers, terrorists and organized crime.”

“The director of the FBI has testified that Internet gambling remains a loophole in America’s fight against terrorism,” Goodlatte said at the time.

Part of Leach’s bill, HR 21, could be blended with the Senate version in conference committee if the measure progresses through the Senate. “Internet gambling increases consumer debt, makes bankruptcy more likely, money laundering an easy endeavor, and identity theft a likely burden,” Leach said.

Social Costs

Goodlatte also stated that Internet gambling has “contributed to a whole host of social ills.” To be sure, online gaming certainly makes it easier for gambling addicts to place wagers, said Marc Lefkowitz, director of training for the California Council on Problem Gambling. However, he said his group has no opinion on whether gambling is good or bad. Neither does Gamblers Anonymous, the leading counseling group for the 5.4 percent of American adults who are believed to have a gambling addiction.

Lefkowitz said the important thing is that land-based and online casinos adopt a number of responsible gambling practices. “We want them to be able to refer [problem gamblers] to us, to post a help-line number, and perhaps train employees in responsible gambling practices,” said Lefkowitz, who has led numerous training sessions at land-based casinos. “We’re starting to get a good response from some gambling Web sites who are interested in making sure they have the same thing.”

Caruthers, the CEO of BetOnSports.com, said the need to help problem gamblers was among the reasons that he favored regulation and control of the online gaming industry. “Any proper operator worth his salt would have procedures in place to protect the business from being exploited by underage people or people with gaming problems,” he said, pointing to information on his site that advises customers to wager responsibly and to seek help if they need it.

“We are very, very acutely aware and sensitive to running our business with the highest degree of probity,” Caruthers said. “And looking after your customer is No. 1 in this field.”

The Glut

For all the political sound and fury in the US, all sides agree that online gaming is growing faster than anyone expected. Goodlatte estimated online gaming revenues grew from $445 million in 1997 to $4.2 billion in 2003. And Carley, who runs seven gaming portals in addition to GPWA.com, notes there were only 300,000 listings for “video poker” in Google when she launched VideoPokerJunkie.com in December 2000. Today, she said, there are 4 million listings.

Carley warns there is a glut that makes the affiliate business very tough. She said her group has members who are self-supporting and others who’ve been doing it for years but don’t make $1,000 a month.

“I believe we’re in a glut and we have been for the past year,” she said. “I’ve seen people getting out of the business and casinos failing. It’s a tremendously competitive business.”

Adding to this is the risk that an unscrupulous offshore site might just decide not to pay an affiliate. “I have had situations with the larger companies where they refused to pay me,” said Allen Schneider, a former director of the Interactive Gaming Association who now runs the Internet marketing firm RUOnTheNet.com. Schneider claims that he had to fight one Israeli company for eight months to get the $5,000 in commissions. Affiliates recommended that newcomers seek sites that pay commissions based on a portion of what the client deposits at the site. Two other common models offer a share of the client’s losses, which may be small, or a modest bonus for bringing on new clients, a model called cost-per-acquisition or CPA. Carley offers another, simpler piece of advice: “Use common sense.”

All things considered – legal risks, competition, social ills – this might not be the right area for all affiliates. To succeed, affiliates need to find the right niche for themselves, whether that is gambling or, say, baby clothes. There is no right or wrong answer here. However, Marc Lesnick, conference organizer for the Casino Affiliate Convention, argues that throughout history, the people who took the biggest risks got the biggest rewards.

“It’s like the 1920s when you had prohibition,” he said. “The people who took the risk, the rum-runners, got rich. The affiliates are, if you want to say it, breaking the law by enabling gambling. But nevertheless, they’re getting some hefty rewards for it.”

TOM MURPHY is editor in chief of Revenue

Side Effects

Affiliates promoting pharmaceuticals online can earn lifetime commissions and five-figure paychecks while helping consumers purchase the drugs they need for a fraction of what they would pay at the corner drugstore. But the price also can be unacceptably high.

It certainly was for Ryan Haight. Using a debit card his parents gave him to buy baseball cards, the 18-year-old honor student went online and purchased 100 tablets of hydrocodone, the generic version of the painkiller Vicodin. He died after mixing the pills with morphine and other drugs.

“What happened to my son shows that kids today can easily buy drugs online,” said Haight’s mother, Francine. “It’s just like buying candy in a candy store. I was worried about the street drugs like marijuana, cocaine, and the other drugs you hear about, not prescription drugs.”

The tragedy illustrated the enormous risks that cloud one of the fastest-growing and most controversial areas of affiliate marketing. While the vast majority of affiliates and merchants conduct business in a safe and ethical manner, the lack of clear regulations and potential for abuse have resulted in a chaotic marketplace of conflicting laws and even criminal conduct.

Online pharmacies offer rich rewards to affiliate marketers who accept the risks. It’s not uncommon for affiliates to make thousands of dollars a month in commissions, largely through pharmacies located outside the US. The US Food & Drug Administration (FDA) estimates American consumers received 5 million offshore drug shipments in 2003 alone. That was up from 1 million in 2001 and 2 million in 2002.

Industry on the Edge

The bigger the business gets, the more attention it attracts from consumers, affiliates, online drugstores, regulators, prosecutors and others with a stake in the industry. “The business is teetering to the point that it may be gone tomorrow or it may survive,” said Marc Lesnick, who organizes the Conference for Online Pharmaceuticals. “The odds are stacked against the affiliate.”

The FDA has no regulations that specifically address the online sale of pharmaceuticals, although there are many laws related to traditional drug sales that may apply in certain cases. The US Drug Enforcement Agency (DEA) does have regulations about online drug sales, but has difficulty enforcing them. Therefore, the responsibility for making sure programs are safe and legal often lies in the hands of each affiliate marketer and director. That’s a lot of responsibility, and potential liability, to be leaving in the hands of the very people who earn revenue by marketing the products.

The problems inherent with self-regulation hit home recently for Brian Johnson, an affiliate marketing manager for MyRxForLess.com. A recent news report aired by Dallas TV station WFAA alleged the Mexico-based pharmacy sold Zoloft that had nearly 20 times the acceptable level of certain heavy metals. When Revenue contacted Johnson, he said he didn’t have enough information to comment. “I’m just an affiliate running a business,” he said. “A lot of people can say a lot of things, but the jury is still out. Besides, what online pharmacy isn’t being investigated by the FDA? Until it’s illegal, I’ll keep doing it.” Indeed, as we went to press, no charges had been filed against either Johnson or the pharmacy.

Numerous other affiliate marketers who were contacted for this story declined to discuss their efforts. Their tendency to shy from publicity is in stark contrast to their colleagues in more traditional industries. Lesnick understands this reluctance to enter the debate in an industry where, essentially, there are no guarantees. “If I was an affiliate, my name would be Billy Joe Bob, and that’s all you get,” he said. “The bottom line is that affiliates may try their best to promote a reputable pharmacy, but they don’t know what these guys are doing.”

Lesnick notes it can be tough to avoid legal problems when they arise. “In pharmaceutical cases, the lawyer names every single person involved, from the hospital to the doctor to the insurance company to the pharmacy to the Web site. There are some affiliates I know who stay away because it is a legal nightmare.”

A New Wave Is Coming

Indeed, this industry has been placed under the microscope, and as proposed new laws and regulations threaten to restrict the market many affiliates have stayed away from this potential moneymaker altogether because of the uncertain future.

“We need regulations because we have seen a significant increase in bad operators, drugs being given without prescriptions, and offshore transportation of drugs, which is illegal,” said Drugstore.com CEO Peter Neupert. “The bottom line is people are looking for low-cost alternatives. They find those lower prices online, but it comes at the price of their safety.”

To promote safety between affiliates and pharmacies, the Internet Pharmacy Board (IPB), a nonprofit association, promotes safe tele-medicine practices in compliance with the national and state boards of pharmacy and medicine, federal agencies, the medical community and patients. “I suggest the IPB to any affiliates or pharmacies that are getting involved in this area of online marketing,” said Aaron Sallade, CIO and affiliate program director for Millennium Pharmaceuticals.

It’s easy to see that other changes are on the way. One is a new program from National Health Services and Millennium Pharmaceuticals that, in theory, will make the affiliate marketing of prescription drugs safer. The program follows a legal and ethical code and screens for drug abuse patterns. If abuse is suspected, those records will be sent to a doctor for review. “We are creating a health care network rather than a pill store,” Sallade said. “It’s a program that we feel will be fully supported by the FDA and DEA.”

Affiliate marketers can also be more selective in the drugs they promote. Millennium is among the companies that make a good profit without selling controlled drugs. Sallade said his top affiliate averages 300 orders a day. With an average commission of $30, that earns the affiliate $270,000 a month. The average affiliate earners complete five orders daily, for about $4,000 per month, he said.

Other companies have reported similar results. “We have paid out over $100,000 per month to our top performers and have numerous affiliates that earn five-figure commission checks each month,” Steve Yasher, affiliate director of Medical Web Services LLC, said in an email interview. About 90 percent of the company’s revenue comes from affiliates.

Commissions paid to affiliates depend on the program, and there are two popular types. One provides lifestyle drugs such as Viagra, Propecia or diet pills. The other provides maintenance medications such as blood pressure, birth control or antidepressant medications.

Lifestyle medication programs pay out an average of $40 to $50 per order. These programs often offer a hybrid payout model, which is a flat rate per each sale plus a percentage of the sale. Lifestyle programs are popular not only because of the higher payout, but also because they give affiliate marketers more control, allowing them to set their own price. Maintenance medication programs typically pay a commission of about 10 percent – comparable to many other areas of affiliate marketing.

From a business perspective, who wouldn’t be attracted to lifetime commissions? And getting into the business is not difficult. Some programs will provide you with a pre-made template to give you a jump-start. No degree or medical experience is required. Like other affiliate programs, you just need patience, Internet marketing knowledge, dedication and creativity.

“The biggest downfall of new affiliates is that they feel that they can quickly make good money with little effort or maintenance,” Yasher said. “Internet marketing and the online prescription industry are both evolving very rapidly, and if you do not stay on top of your marketing strategies, you can very quickly waste your money on ineffective campaigns in a very competitive marketplace.”

Under the Microscope

You may be asking yourself, if buying pharmaceuticals online is so risky, why do so many people do it? The answer is simple. It’s convenient, private and, most importantly, relatively inexpensive.

“As long as the astronomical costs of pharmaceuticals remain in [the US], we will always be the better alternative, providing the cheaper, authentic product, with fast reliable and professional service,” said Laura Hunt, affiliate director of US-based Impact Health Care.

David Gross, senior policy adviser for AARP’s Public Policy Institute, said his group tells members to do their homework before attempting to buy prescription drugs, whether online or otherwise. “If someone is going to buy offshore, which we don’t recommend, they need to make sure they’re getting a pharmacy that is licensed, that is accredited,” Gross said.

“The bottom-line is people are looking for low-cost alternatives. They find those lower prices online, but it comes at the price of their safety,” said Neupert of Drugstore.com.

No Doctor in the House

Another risk lies in the fact that people who order prescription drugs online often are not required to consult a physician in person or, even worse, at all. The DEA has a problem with that. According to the agency’s guidelines regarding dispensing and purchasing controlled substances over the Internet, “It is illegal to receive a prescription for a controlled substance without the establishment of a legitimate doctor-patient relationship, and it is unlikely for such a relationship to be formed through Internet correspondence alone.”

Ryan Haight bought his drugs from Main Street Pharmacy, a Norman, Okla. company that exemplifies what authorities call “rogue” pharmacies. The only requirement to order his lethal dose of drugs was the completion of a medical history statement, which then is reviewed by a doctor who consults for the online pharmacy.

Daniel Guess, an assistant US attorney in Dallas, successfully prosecuted 33-year-old Clayton Fuchs, owner of Main Street Pharmacy, on six felony counts that carried penalties of up to 20 years in prison. “Online pharmacies that tell a patient they ‘don’t need a prescription’ should be a red flag to consumers,” Guess said.

“When you think of a drug dealer, you think of a person standing on a corner selling marijuana or cocaine,” the prosecutor said. “These guys online selling pill after pill after pill are really no different. But they are perceived differently. There are no differences between the online pharmacy and the typical cocaine or marijuana dealer.

“We’ll start looking at them that way.”

Rogue pharmacies make most of their money by pushing highly addictive medications like hydrocodone or dangerous diet drugs over the Internet. Trouble is, diagnosing or confirming a medical condition is complicated and cannot be accurately done without a physical exam.

“The biggest risk ordering prescription drugs from an online source is that since you aren’t seeing a doctor, you are essentially diagnosing yourself and just choosing what medication you need,”said Dr. Vince Iannelli, professor of pediatrics at the University of Texas Southwestern Medical School. “Figuring out a medical problem is much more complicated than that since many conditions have similar symptoms. And an evaluation is never complete without a physical exam, which isn’t possible when ordering prescriptions online. Simply filling out a generic form isn’t enough.”

Haight’s story proves that. And the publicity it has generated has inspired self-regulation in high places. Internet search engines Google, Yahoo and Microsoft have all barred advertising from unlicensed pharmacies. Others, like pay-per-click search engine Overture, have amended contracts and policies to address the issue of online pharmacies.

What can affiliates do to make sure they’re promoting safe and legal companies? “I would ask the affiliate program to provide me with the DEA registration for their pharmacy and doctors, and I would request a copy of their professional license,” Sallade said. “If an online pharmacy states that they are certified, the question to ask is, ‘Where did the certification come from and what were the requirements for that certification?'”

The bottom line is that, at least for now, caution is the order of the day. Says Yasher: “I would advise all affiliates to engage the services of legal counsel to review their business practice.”

LAURA SCHNEIDER is the marketing editor for About.com. Her articles on marketing have been published by more than 4,000 Web sites and magazines. She is also partnership development and marketing manager for Revenue Partners, where she has developed and managed online marketing ventures for a decade.

The Spam Jam

What a mess. Jim Gordon is hell-bent on collecting some of the $600,000 or so he thinks Commonwealth Marketing Group owes him for sending more than 1,500 emails advertising credit cards. He says the emails had inadequate subject lines and the transmission paths – the list of computers that passed along the email – had been doctored.

Gordon, who runs an online health and nutrition business in Richland, Wash., said his email address was harvested, and now the spewing of spam is unstoppable. “I get roughly 1,500 emails every single day of my life,” he said. “Last summer, I got fed up and sent out a bunch of demand letters. Commonwealth was one.” This tactic, attempting to collect a charge from spammers for each email they send, then suing if they don’t pay up, is advocated by anti-spam activists. Activists encourage pissed-off consumers to strike back and try to hit the spammers where it hurts – in the pocketbook.

On Dec. 15, Gordon sued Robert Kane, the CEO of Commonwealth, in his home state. At that time, Washington had tough anti-spam laws that let individuals bring private suits against alleged spammers. We can relate, right? Who among us doesn’t have to wade through lines and lines of email subject headers cleverly disguised to look like they’re from a friend, or, perhaps worse, that stridently proclaim their icky content?

But wait. Robert Kane had a different story to tell. He said Commonwealth works with one Internet marketing company that maintains a network of affiliates. Some of those affiliates may have email marketing lists that they use to market Commonwealth’s credit cards. “We rely on the affiliate to provide opt-in information, and in other cases when [someone has complained], they’ve been able to provide the exact time and date when the person opted-in.”

Kane said Gordon is out to get him, that he’s making a business out of threatening to sue legitimate marketers, hoping to get a payoff. Indeed, Gordon does have suits against two other companies in the works. “I’m seeing an increase over the course of the last year where individuals will go out and sign up for a barrage of offers,” Kane said. “Then they file these actions saying, ‘You’ve been spamming me, and I’m entitled to X number of dollars, but I’ll settle for this.'” According to Kane, Gordon’s demand letter said he’d settle for $10,000. Kane refused, because he verified that Gordon had opted-in.

Where does that leave Gordon’s suit? Like we said, it’s a mess. The hearings go on. Gordon is trying a variety of legal maneuvers, such as complaining of harassment or unfair business practices instead of spamming, while Kane parries by dishing dirt on Gordon’s family. The only sure thing is that both are expending oodles of resources that could be better used trying to end world hunger. Let’s be glad we don’t have to decide who’s right.

But everyone has to be concerned about spam. It could kill the affiliate marketing industry. Incessant emails touting reputable products can tarnish the merchant’s reputation and turn consumers off to the brand in every channel. Merchants also run the risk of being legally liable for their affiliates’ illegal emailing practices. Irate consumers like Jim Gordon and trigger-happy state attorneys general show a tendency to press charges and let the courts sort it out. In February, the nations’ first criminal spam trial began, with a North Carolina man facing four felony counts of sending unsolicited bulk email.

Legal issues aside, spam is bad for business. The gush of stupid and offensive emails creates delete-happy customers. A recent study from the Nielsen Norman Group, a company that consults on making technology more usable, showed that, while the public is getting better at differentiating between opt-in newsletters and unsolicited messages, they’re feeling increasingly stressed dealing with their inboxes, and now have even less tolerance for newsletters they feel waste their time.

While few email marketers would admit to spamming, it’s clear that affiliates are a huge part of the problem. According to Brightmail, a provider of anti-spam services for corporations, products pushed by spammers are closely related to holidays. For example, last Valentine’s Day, 15 million messages hyped flowers, chocolate, dating services and sex toys – all categories that rely on affiliate marketers.

If you dare, open the next 10 pieces of spam you get and click on the links. Except for the ones advising you to “use this patch immediately” and infect your computer with a virus, they’ll be either affiliates linking back to a retailer, or affiliates linking to other affiliates in the Internet’s big Ponzi scheme.

When affiliate marketing consultant Shawn Collins polled affiliate managers in January 2004, 23 percent said they planned to forbid affiliates from sending email. At the same time, 60 percent of them hadn’t taken any steps to educate their affiliates about the issue, and 35 percent of them hadn’t even read the entire law.

That’s scary. Any marketer who uses email needs a crash course in spam.

Living Under the Law

The CAN-SPAM Act of 2003 whisked through the US Congress at the end of ’03, focusing the nation’s attention on legal retribution for spammers. Die-hard privacy advocates say it’s not enough. Marketers say they still can’t be sure they’re inside the law.

“Some of the spam problem is classic spammers, but the majority of it is not from people who are actually attempting to do anything fraudulent,” said Margaret Olson, chief technology officer for Constant Contact, a company that provides email-marketing services for small and mid-sized businesses. Unwitting spammers are merely naïve, she said. While the best practices for email marketing and rules to follow may seem clear to large corporations, affiliates are often new to the game, and many are part-time marketers. “If you have another whole job to do,” Olson said, “you probably haven’t been following the law that carefully.”

Olsen said legitimate affiliate marketers can shoot themselves in the foot with simple mistakes, such as failing to drop names from the list if they haven’t been contacted in the past year, or buying someone else’s list and assuming it’s okay to email everyone on that list.

This federal law supersedes state anti-spam laws where they’re contradictory -but states still have the right to sue spammers in federal court. And, although individuals will no longer have the right to sue spammers under state anti-spam laws, there’s a backlash movement teaching them how to bring suit under a variety of other laws, including harassment.

Ben Livingston, president of ISP Innovative Access, actually wrote a primer on using the courts to get back at spammers; it’s posted online. He’s won cases against spammers, junk faxers and telemarketers -although, he said, collecting is another story. “I know that people will fight back,” he said. “I don’t know how many, or if it will make a difference, but with all these litigious individuals, it could.”

Guys like Livingston are bad news for bad guys. If you’re reading this, you’re one of the good guys. But it can be all too easy to stray.

CAN-SPAM and You

Compared to some very stringent and punitive state laws, the CAN-SPAM Act is relatively marketer-friendly. In fact, it doesn’t prohibit unsolicited email ads at all, as long as marketers follow some guidelines.

The law focuses on three things: ensuring that consumers can recognize commercial email, see who it’s coming from and make it stop. To that end, affiliate marketers should use their business names in the FROM header and create a SUBJECT line that gives the recipient a solid clue as to the content. Within the email itself, the affiliate must provide a working email address where the consumer can ask to be removed from the list and a physical address for the sender.

These measures are no more than good marketing, said Anne Mitchell, president of the Institute for Spam and Internet Public Policy, a consultancy that advises marketers and public institutions. “Ethical marketers are already doing more than CAN-SPAM requires anyway. The reality is, no legitimate marketer who’s trying to do the right thing needs to worry,” said Mitchell, who is also author of “CAN-SPAM and You: Emailing Within the Law“.

One other aspect of the law may become worrisome in 2005, when the Federal Trade Commission, the government agency responsible for administering CAN-SPAM, is required to report to Congress on a plan to require subject-line labeling of all commercial email in the subject header. Some email advertisers already have begun starting their subject lines with ADV, one of the labels under consideration. (The FTC will devise a separate label for sexually oriented ads; that’s expected to kick in some time during 2004.)

Such prefixes make it easier for consumers to keep commercial email from ever appearing in the inbox. However, they would eliminate the ability of marketers to use email to prospect for new customers. Meanwhile, it’s unclear whether real spammers, who usually hide their identities, would comply with the rule.

The law does hold merchants responsible for affiliates’ spam, if it can be proved that they knew or should have known about it and did nothing to stop it, said Mitchell. Merchants who haven’t controlled their affiliates are responsible for polluting the affiliate model, she said.

“People were littering spam under affiliate programs with complete immunity because, while the company had a statement on the Web site that they wouldn’t tolerate it, nudge nudge, [sending spam was] just what they wanted people to do.” In those cases, the way the law gets at the affiliate spammers is through the principle company. Now, companies can’t just shift the blame to their affiliates. “If you have any control over the channel, you should exercise it,” Mitchell said.

One more worry: While the federal law supersedes state laws against spam where they conflict, said Mitchell, “it’s also absolutely true there are all kinds of other laws people can use. Marketers shouldn’t get complacent.”

It isn’t hard to imagine other prefixes that might follow. But how US authorities would stop offshore spammers is unfathomable.

SUSAN KUCHINSKAS has covered online marketing and e-commerce since their beginnings for Revenue, Business 2.0, and other media. She says she has already received her lifetime dose of spam.

Cyber Creeps

When thousands of consumers got emails asking them to help electronics retailer Best Buy combat Internet fraud, they were eager to help. But those who clicked on the link and entered credit card and Social Security numbers learned the ugly truth too late: They’d been had.

The link took them to a “spoof” page that looked just like Best Buy’s home page but was actually operated by thieves. “The trust we worked so long to achieve was threatened by this rip-off,” said Dawn Bryant, a spokeswoman for Best Buy. “This is some- thing a business should never have to contend with.”

Neither should consumers. But the reality is that identity theft, predatory advertising, spamming, spying and other sleazy practices have left Internet shoppers understandably wary of buying goods on line. The number of complaints of Internet fraud nearly tripled last year to more than 48,200, according to data from the Internet Fraud Complaint Center operated by the FBI and the National White Collar Crime Center. The Federal Trade Commission says the Internet is now the focus of almost one-in-five of the complaints it receives.

“If these kinds of practices continue, it will run the whole thing out of business,” said Ray Everett-Church of the Coalition Against Unsolicited Commercial Email (CAUCE), an activist and lobbying organization.

Honest affiliate marketers face a double threat. Not only do they have to overcome consumer skepticism, but they have to compete with unethical rivals. Several industry organizations have teamed up with consumer groups and government agencies to educate affiliates and corporate program managers about ways to build consumer trust while combating ethically bankrupt practices.

All the ugly horses

One notorious practice involves Trojan horse software that bundles one or more secret programs along with an application that an Internet user desired.

“A surfer might go to a site and download something that looks interesting or might be fun,” said Jim Sterne, the author of five books about online marketing, including World Wide Web Marketing. “Unbeknownst to them, the download includes a piece of spyware, parasiteware, or thiefware as it is sometimes called.”

In its most benign form, a program might serve ads in a window within the application interface. For example, Cydoor is an ad-serving application that rotates ads in a window on the user interface of applications such as file-sharing software from Kazaa and Grokster.

“No one really likes ads, myself included,” said Robert Regular, Cydoor’s vice president of sales and marketing. “But we are just an ad delivery mechanism showing ads only when you’re in the application, to make money to pay the developers who wrote the software.” He said that Cydoor does not gather any personal information on its uses.

Advertising-supported software gets on shakier ground when it includes technology to track people’s movements on the Web. People who provide this software say this tracking technology improves their ability to show more relevant marketing messages. The problem is, most consumers wouldn’t know they’re being watched.

“The user agreement might have a buried reference, or there might be a box to click to accept the other software, only it doesn’t fully explain what is being accepted,” said Jason Catlett of Junkbusters, a privacy advocacy group. Catlett said this is “another example of junk consent creeping into the fine print of transactions. Even if it’s buried somewhere in the legalese, ethical marketers should not give customers stuff from others that [the consumers] don’t expect.”

What really infuriates affiliate marketers are hidden programs that pop up advertisements for competitors while someone is shopping on the affiliate’s site. Sterne said Gator, a marketing company that offers a free electronic wallet for consumers, “waits quietly until the surfer goes to a merchant site that sells a product that is competitive to one of Gator’s clients. Gator then pops up their client’s ad.”

Conceivably, shoppers might benefit from a better deal, but it is a bit like waving an ad for Fords in front of someone test-driving a Chevrolet. Affiliates call this predatory advertising because they feel their commission has been stolen after they converted the shopper into a buyer.

Sterne noted that many people intentionally download Gator, but said “the sticky part is when Gator comes included in something and the surfer is unaware they agreed to install it.”

Gator executives declined to be interviewed. A company representative referred questions to a FAQ on the company’s Web site, where the home page clearly states that users must agree to see ads in return for the free software.

Can the spam

Unsolicited commercial email now accounts for more than half of all messages, but nobody seems to want it. That leads to a curious question: Why would anyone want to send out emails that nobody wants to read? The answer may stem from the type of commission offered to affiliates by merchants selling those products.

“If a program rewards the affiliate for clickthroughs and not sales, it’s more apt to be abused,” Everett-Church said. “If all [the affiliate has] to do is get the person to go to a site, you are more apt to spam.” On the other hand, he said, programs that pay only for leads that result in sales don’t experience the same kind of abuse, because affiliates must add value in the form of information before users will click on their links.

Everett-Church recommends that affiliate programs that pay commissions based on clickthroughs institute checks and balances to make sure users aren’t gaming the system. “If you’re rewarding people for volume but there aren’t controls in place, you’re unwittingly encouraging abuse,” he said.

The worst spammers buy CDs containing millions of email addresses, then use software to automatically spew out millions and millions of ads touting prescription drugs, low-cost mortgages or what-have-you. But the problem doesn’t end there. If you send your email newsletter to someone who didn’t specifically ask for it, you could be in trouble.

“Spamming is against the law in most states,” said Marc Rotenberg, president of the Electronic Privacy Information Center in Washington, D.C. “Most affiliate agreements have clear usage guidelines on how you can advertise them. If you’re caught spamming, you could be fired as an affiliate for the merchant on whose behalf you spammed.”

The fallout can radiate beyond your network and get you into hot water with your Internet service provider, said Brian Huseman, a staff attorney for the Federal Trade Commission. “Your ISP may shut you down, and then you can’t send any email at all,” Huseman said. Worse, you could be placed on a blacklist so that even if your ISP reinstated you, your emails would be bounced by many other ISPs.

“An affiliate marketer who intends to be around for any length of time can’t use these kinds of marketing approaches,” said David Nielsen, founder and principal of consumer information resource FightIdentityTheft.com. “Overall, they’re a threat to the legitimacy of the industry.”

Got ethics?

It’s not the technology that’s to blame, industry experts say. It’s the unethical or uneducated businesses that abuse that technology. Unfortunately, it can be hard to know where to draw the line.

“What makes the difference between ethical and unethical is, the person has to know what is happening. You have to be straight with your customers as to why you collect information [like email addresses] and what you use it for,” said Rotenberg from the Electronic Privacy Information Center.

Smart affiliates use their tech tools wisely. For example, there’s a very simple guideline for email marketing. “If the person has asked for an e-mail, it’s okay, but otherwise, don’t send it,” said Steven Salter, director of operations and administration for BBBOnLine, the Internet arm of the Better Business Bureau in the United States.

Huseman agreed e-mail ads are fine on an “opt-in” basis where the user makes a choice to receive messages. That can happen when a consumer makes a purchase or registers on a Web site. Typically, a box will be provided with the prompt, “Click here to receive messages about promotions from this merchant.” The very best approach is double-verification, when users who sign up for promotions get a second email that confirms their interest.

BBBOnLine and other groups are anxious to help rebuild consumer trust. “The whole BBBOnLine program was created as a way to give online businesses a way to show they can be trusted,” said Salter. BBBOnLine.com has a reliability seal for Internet businesses. To qualify, affiliates must join the BBB chapter where their company is headquartered and agree to participate in the BBB’s advertising self-regulation program.

You can also bolster consumer confidence by designing a professional-looking site. “If your site doesn’t pass the visual inspection, users will think it’s not very credible,” said B. J. Fogg of Stanford’s Persuasive Technology Lab, author of a study on Web credibility conducted in partnership with Consumer WebWatch. According to Fogg’s research, design was the top factor consumers used when deciding how trustworthy a Web site appeared to be.

To differentiate yourself from spoofers, it’s a good idea to let consumers know who you are. Be clear in your advertising and on your Web site that you’re an affiliate of the merchants you mention, not the merchant itself. To maximize credibility, it’s a good idea to provide actual contact information, not just a “contact us” form, on your site, according to Leslie Marable, research project manager for Consumer WebWatch.

It’s not enough to have your heart in the right place. Ethical affiliates must constantly monitor their own activities to make sure they stay firmly on the side of the good guys.

And if the affiliate marketing industry doesn’t cleanup its own act, others will likely step in to do the job.

Abused consumers are taking up arms against unethical merchants and affiliate marketers, encouraging state and national legislators to consider tough laws to prevent spam and to punish scamsters. The question for affiliates and program managers is whether to work with them or against them.

JANIS MARA covered interactive advertising and marketing as a senior writer for Adweek. Her articles have appeared extensively in a variety of print publications.

Taxing Times

The lure of affiliate income is a magnet for people with drive and imagination. It’s particularly attractive to the impoverished, those in debt or people wanting to purchase a home. It’s a powerful draw to women yearning to stay home and for men raising children alone. And, of course, it’s like mother’s milk to the tax collector.

Affiliate income takes many forms. Sometimes, you don’t even think about it as income. Have you joined Amazon.com’s affiliate program just to get a kickback on your purchases? That’s income.

Some affiliates get rich. Most earn little. Regardless of earnings, or whether you think of it as income, there are tax consequences that you very simply just can’t ignore.

Let’s start with a couple of forms of taxation that many people don’t even know about when they start up: your business license and your DBA form.

A business license requires paying a fee that generates revenue for your city and/or county. If you get caught without one, you’ll probably have to pay them back for the last couple of years, like Donna Schwartz Mills did in Los Angeles. She wanted to be at home when her daughter was growing up, so she started FamilyContent.com and a series of related sites to help other parents find ways to make a living from home. What she didn’t know is that her little business needed a license.

Some cities are now starting to compare state income tax filings with their database of business licenses to determine who claimed to be operating a small business and didn’t have a license. In addition to paying what you owed in the past, you also may have to pay a fine and interest. This may sting you, but it won’t cripple you. Some cities are nice enough just to warn you and let you start clean. Still, without a license, if you have any trouble or need to sue, even in small claims court, your case will be thrown out.

In case you haven’t heard the term before, DBA stands for “doing business as” and refers to the process of recording your fictitious business name in the county where you set up shop. It establishes a public record that allows people to look behind the name of your business to find out who owns it. It also prevents anyone else in your county from using the exact same business name.

Sales Taxes

As an affiliate, sales taxes will not be an issue. To sell anything, even as an affiliate, you need to have customers. However, once you have your following, it’s tempting to create solutions for them. The minute you get clever, coming up with a product, sales tax rears its ugly head. And that’s what happened to Matt and Jamie Garrison when they first established Aluria Software LLC.

Matt Garrison was practically living in his car when he met his future wife. Soon afterwards, while partnering with Jamie’s master programmer brother, Jim Kruse, they gambled all they had on an affiliate income idea. CBS had just debuted the Big Brother TV show, and they created a fan site with lots of pop-ups and affiliate links. Within 6 months, they’d earned over $35,000. They didn’t expect that, but it didn’t take them long to see how to capitalize on it.

Since then, they’ve formed Aluria, with offices in Florida, to develop their own products. Sales taxes came into play as soon as they sold their first copy of Kid Surfer, a Web browser they designed for youngsters. These days, they operate on a budget of about $50,000 a month, and sales taxes are a big part of that budget.

Simply put, sales taxes are based on the destination state. So, if the Garrisons only ship to Florida, they collect Florida sales taxes. On the other hand, if they ship to California, they must know the tax rates in the city and county, too. California has a different sales tax rate almost everywhere you go. Watch out: your state might have several rates, too.

Starting out small, you’ll probably file sales tax returns annually. But you’ll collect sales taxes from customers all year long. To avoid shock when paying the annual bill, keep good records. Make sure the sales tax money is set aside monthly. Coming up with a year’s tax money at the last minute really hurts.

Remember, this isn’t your money. You collected it from customers. The government isn’t friendly when you’ve squandered their money.

If you haven’t been paying sales taxes, don’t worry. You won’t go to jail. You’ll simply have to pay it. Some states insist you pay several years’ taxes. California audits your sales for the life of your business. Few other states are as aggressive. Generally, you may expect to pay approximately three years’ back taxes.

Avoid all this trouble by simply keeping books and filing returns, even if you plan to just dabble in being an affiliate, using affiliate codes for personal purchases. Jamie Garrison advises that all affiliates should set up their operations like a business from the first day. Then, if it suddenly takes off as her business did, you won’t have to scramble to catch up with government and licensing requirements.

Bookkeeping Isn’t That Hard

Looking at the volume of transactions Schwartz Mills decided she could track the activity without a costly bookkeeping system. FamilyContent.com is maintained in QuickBooks and spreadsheets, as needed. For the longest time, Aluria accounting was scribbled on worksheets. With most income coming from affiliates or ClickBank.com, the Garrisons got quick summaries of income. Matt Garrison simply added expenses at year’s end.

That’s perfectly fine. You needn’t spend a fortune if you can use a spreadsheet (whether paper or electronic) to list your checks and income. Go to the office supply store. Pick up a Dome bookkeeping record book. Many small businesses use them. They’re inexpensive and understandable.

For many people, paper systems are too unstructured, while the big, full-featured accounting programs are too complicated. There is a really nifty, very basic program, The Internet Tax Helper [InternetTaxHelper.com] for accounting-phobes. It’s perfect if you are not reporting to banks or investors. Most people never need a balance sheet.

Are you willing to tackle double-entry? There’s QuickBooks, Microsoft’s Money, Peachtree, One-Write Plus or other software packages. All offer a panoply of capabilities in addition to bookkeeping – invoicing, payroll, banking, electronic bill paying, fancy graphs, cost accounting, complex financial statements. They’re remarkably versatile.

Accounting software produces information for tax returns and financial statements any time. When refinancing your home or trying to get a business loan, you needn’t rely on your accountant or tax professional. Simply print off a report.

Don’t go it alone. Have a professional review your work quarterly. Verify that your entries are done properly. Otherwise, you might think you have a loss, then suddenly learn you have a profit of $50,000 or more.

For some, like the Garrisons, not paying taxes until they file their return is a deliberate strategy. They don’t use bank loans or other debt to cover their operating expenses throughout the year. Instead, they use the money that should go towards quarterly payments. With IRS interest rates as low as 7 percent, this can be cheaper than bank loans, even with a possible penalty and they didn’t need to qualify. This is their choice, but a risky one. It’s against regulations,and if you don’t have the cash to pay the tax and penalties, you may find yourself in more trouble than you avoided.

Donna Garrison deals with estimates by having her husband increase his payroll withholding to cover her profits. That’s easier than remembering to make quarterly payments. But if you don’t have a working spouse, remember, payments are due in April, June, September and January, each year.

Employees or Freelancers?

Being in business means you may need help. Jamie and Matt hired staff, on payroll, with benefits. They didn’t go cheap, treating employees as freelancers. That kind of thing usually backfires. If you have freelancers, give them a Form W-9 to fill out, with their names, addresses and Social Security numbers. In January of each year, send out Form 1099-MISC to each freelancer.

IRS uses a list of 20 points to decide if someone is an employee or not. (You will find the list and explanation at http://www.taxmama.com/Articles-cur/semyth2.html)

The importance of each quality on that list is subjective. IRS looks at each item, applying it to your outside staff. IRS decides if you’re an employer.

Here are questions to ask yourself:

  • Carefully examine your working arrangement with freelancers. Do they work just for you? Do they have a key to your office? Do they use your telephone, your equipment, your supplies? Do their business cards have your company’s phone number?
  • Do they have a “risk of loss?” Are they using your facility, but paying you rent? If they don’t come in, do they still have to pay you rent? Do they buy their own computers and software? Work from their home or office? Pay for their own education? Can they simply quit at any time with no consequences? Or would they be in breach of contract?

If you answered “yes” to questions in the first group, or “no” to questions in the second group, then run, don’t walk, to the nearest qualified tax professional.

What if you didn’t put your buddy on payroll and got caught?

There are “safe harbor” provisions in the law. While you won’t get out of paying the payroll taxes, you might reduce some taxes, penalties and interest. It will help if you can prove your freelancing friend actually reported the income and paid taxes.

How far back will they go? IRS will go back for three years. States may go back even more. If auditors contact you, treat them well. Don’t be rude. Don’t yell, don’t accuse them, and don’t blame them. Be respectful and courteous. Ask them to help you. Typically, they’ll go as easy as they possibly can.

Lots of Affiliate Income – No Tax Returns – Don’t Worry

It’s not uncommon for people who start dabbling in affiliate income not to realize what they’re earning. Starting with no business intent, you join dozens of programs, receiving small checks from each. Perhaps no company sent you a 1099 because no single company paid you $600 or more.

Overall, perhaps you earned $300 each from 10 companies during the year – $3,000 – and didn’t realize you had to file a tax return. You did.

And perhaps you’ve now expanded to 50 programs, still not keeping track. You’ve been so busy, you’ve never realized your earnings are $20,000 per year from these little bits of commissions.

Here’s a good rule of thumb: If you covered your rent, ate, wore new or clean clothes, and drove a car, you certainly had substantial profits and you will owe substantial taxes.

Suddenly, a letter comes from IRS. They want tax returns. You never kept records. You panic. Where do you begin?

Don’t worry. It’s fairly easy to reconstruct this data. Start with your bank statements. If you don’t have them, they’re easy to get. Ask the bank for copies. Even if they charge you, there are only 12 statements each year. That’s not too expensive.

When you get the bank statements, add up all the deposits for the year. Deduct anything that is obviously not income: cash advances from credit cards, loans from family, money drawn from savings, inheritances, child support. Whatever’s left is your income.

If you cannot get bank statements and all your income came from affiliate programs, send an email to each merchant. They have records. Usually, they can run a report summarizing your earnings from them.

Canceled checks, though, are expensive to replace. You must pay for each check. Hopefully, you still have those stashed in a box somewhere. On the other hand, credit cards are great for purchases, as long as you pay the bills each month. Practically all credit card companies will provide free copies of prior year statements. Since many of them also offer lovely summaries, get those printouts. Half your bookkeeping will be done for the year.

If you’re unable to recover the data (you never had a bank account, or the bank was destroyed in storms or riots, with all records), do your best to estimate the expenses. Make a list of all the things you pay each month. Remember your Internet connection, Web host, telephones, cell phones and other expenses.

If your list makes sense and the numbers are reasonable, the IRS must accept them based on the Cohan Rule, named after George M. Cohan, the entertainer. Since Cohan was always on the road, he couldn’t carry huge filing systems. In his day, there were no Pocket PCs for tracking data. Cohan established that even without receipts, if your expenses are “ordinary and necessary,” the IRS must take them into account.

While it’s really in your best interest to do it all right, don’t worry about messing up. There’s usually an easy fix. All you’ll have to do is pay the bills, which, in all fairness, you do owe. If you do the right thing, you won’t go to jail. If you try to cheat, well, things may go a little harder on you.

If you are so hard-up that you can’t pay, there are even ways to cut a deal. But we’ll have to save that for another day.

EVA ROSENBERG, MBA, is publisher of TaxMama.com and an enrolled agent, licensed to represent taxpayers before the IRS. She has a quarter century of experience dealing with tax issues faced by small and Internet businesses.