Taxable Talk

Let’s suppose you’re playing an online role playing game such as Second Life. You’ve accumulated quite a bit of virtual property, and have a stash of virtual money. James Doe offers you $5,000 for your virtual money and virtual property—that’s 5,000 real U.S. Dollars—and you elect to accept them. Do you have a real taxable event that would interest the IRS or just a virtual event?

I’ve written about this in the past, and I came to the conclusion that sooner or later the virtual world would intersect with the IRS. An article in the New York University Law Review by Professor Leandra Lederman of Indiana University’s School of Law suggests that,

“…in virtual worlds that are intentionally commodified, such as Second Life, tax doctrine and policy counsel taxation of even in-world sales for virtual currency, regardless of whether the participant cashes out. However, as in game worlds, participants should not be taxed on purely in-world trades of non-currency items. This approach would allow entertainment value to go untaxed without creating a new tax shelter for virtual commerce.”

The good news? She doesn’t believe that pure virtual transactions in a virtual world should result in the IRS taking a bite (though a literal reading of the Tax Code could be interpreted that such transactions are subject to tax).

The IRS is aware of this issue and, sooner or later, it will be added to their priority guidance list. I suspect that sometime in the next few years if you trade virtual dollars for real dollars you will also receive a real 1099.

The abstract of the paper is available here. The full paper is not available online.

Thanks to the TaxProf Blog for the heads-up about this interesting subject.

This morning’s New York Times has a brief piece on taxing income producing transactions of virtual worlds. The Times notes that a precedent does exist for taxing such activities: barter. Indeed, back in the 1970s the IRS implemented regulations on the taxation of barter (thus, today’s Form 1099-B).

Luckily for participants in the virtual worlds, it will probably take the IRS some time to determine what they’ll do (besides saying, “That’s so weird.”).

I’ve previously written about taxing the virtual world. Let’s say you’re playing an online game, one of those that have their own worlds, such as EverQuest or SecondLife. I own Russ’ Gold Depot, and you agree to purchase those 100 acres from me for $100 — not 100 gold pieces, but 100 real U.S. Dollars. What’s my income?

The U.S. Tax Code would subject me to tax on the gain. After all, my basis is $0, and now I have $100, right? Luckily, the IRS’ current opinion is “That’s so weird.”

Unfortunately for online enthusiasts, that opinion is unlikely to hold for long. Last Saturday a panel at New York University actually debated this issue. “Tax and Finance at the State of Play/Terra Nova Symposium had several speakers talking about this issue according to a CNet report.

“Given growth rates of 10 to 15 percent a month, the question is when, not if, Congress and IRS start paying attention to these issues,” said Dan Miller, a senior economist with the Congress’ Joint Economic Committee told CNet.

Another interesting issue might confront heirs of online real estate magnates. Suppose I own $1 million in virtual land. Does this virtual real estate factor into my estate?

Or what if I trade assets, going from a red paperclip to a house (like Kyle MacDonald of Canada)? Bartering is absolutely taxable, so wouldn’t I owe real tax on my gains?

Unfortunately for virtual world fans, it’s almost a certainty that the IRS and other government agencies will look into this eventually. So if I do sell my gold depot, I’m also likely to come into possession of a slip of paper: a 1099-MISC reporting the transaction to the IRS.

The TaxProf Blog links to an extremely interesting article by Julian Dibbell on whether virtual profits in online multi-player games are taxable under the Internal Revenue Code. There’s also a link to a second article on CNET titled “The Tax Man Cometh, Online.”

So, let’s assume you exchange your spells for 100 Gold Pieces. Is there any tax due? Well, since it’s in a game, I’d assume not. But if you sell your spells for $100, haven’t you made $100 in income and owe tax? Luckily for online gamers, the IRS’ response was “That’s so wierd.”

I think it would be humorous if every time there were an online transaction in one of these games, a virtual IRS agent appeared and demanded his cut. Actually, this isn’t as far-fetched an idea as you might think.

The people playing these games pay a subscription price to the companies running the games. Aren’t taxes a fair way for the gaming companies to earn their incomes?

Hat Tip: TaxProf Blog