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Starting an Online Business: Accounting, Taxes & Other Records

    An online business, like any other business, must keep accurate records of its business transactions and pay income taxes (State, Federal or both depending on the state and the type of entity). There are lots of good tutorials and/or overviews of basic accounting concepts on the Internet (see here and here). Therefore, the objective of this section of the tutorial is not to cover this material, but rather to highlight some information that may not be readily found elsewhere, especially with respect to online startup business issues. In short, we want to present the high level legal issues surrounding accounting, taxes, and other record keeping requirements.

    Presumably before you have started worrying about accounting and taxes you will have selected a business entity (e.g. sole proprietorship, LLC, S-Corp., C-Corp., etc.). Accurate records must be kept regardless of the business entity selected but LLCs and Corporations will generally require more rigorous accounting. One of the primary reasons for this is that LLCs and Corporations provide a business owner (member or shareholder) with limited liability, but that limited liability is only "guaranteed" if accurate records are kept and said records (and corresponding funds) are not intermingled with personal records and funds.

    Essentially, if the rules of the road are followed with these entity types then an owner only stands to lose, at most, what they have invested in the business. The concept of limited liability ensures that an owner's personal assets are protected. If the rules of the road are not followed then a potential litigant may be able to "pierce the corporate veil" and thereby attach a judgment to the owner's personal assets. Obviously, online business owners, like their brick and mortar counterparts, do not want this kind of exposure. Although keeping accurate records is usually the bane of an entrepreneur's existence, it is more than just a necessary evil, ultimately it is the only way that the viability of the business can be assessed as well as providing the aforementioned benefits.

    What other kinds of records does an online business need to track and maintain? The layman's answer to this question is lots, but let's start with the obvious. Most online businesses require a privacy policy and a terms of use. These are essentially online contracts. OK, but why do they have to be tracked? The documents will change over time as an online business model evolves. Most online businesses, especially those with a social networking component and those that sell goods, require a user to register on the website. Registration almost always requires that a user click "I Agree" to the privacy policy and terms of use; so far so good.

    However, as these documents change over time, how does the online business owner know which version of the documents were agreed to? From an evidentiary perspective, a court of law will not likely accept the validity of a contract when the version and date of acceptance cannot be proved with certainty. The best practice is to save the text of these agreements whenever a user clicks "I Agree." Furthermore, a user should be forced to accept modifications to these documents anytime they change.

    Often a privacy policy and terms of use are one of many online contracts that an online business may automate. For example, affiliate agreements and advertising agreements may be automated in a similar fashion. Certainly, automation of contract acceptance is not a legal requirement so why do it? The answer to this question is obvious to online entrepreneurs. Automation reduces the administrative burden of contract acceptance and allows the business to scale. Without the ability to automate the required business formalities an online business is likely to be still born. However, with automation comes the burden of tracking these formalities in manner not usually required in the bricks and mortar world. 

    In addition to online contracts that an online business requires for its own purposes, it is likely to enter into any number of online contracts for online services that it procures in order to conduct business. For example, any online service such as PayPal, AdWords, AdSense, and Quickbooks Online will require a business owner to enter into a contract. Business owners are well advised to keep copies of these agreements for future reference and not simply rely on the service provider's record keeping.

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