Real Taxes on Virtual Assets?

October 30th, 2006

This is a fascinating area opening up in the frequently mundane area of tax law. Given the sophistication of online games and communities and the relative stability of the markets in those environments, should tax authorities have jurisdicition over virtual transactions?

Reuters reports (through Second Life correspondent Adam Reuters, of course) that the US Congress’s Joint Economic Committee has taken notice of the question and is presently rolling around the various permutations. Wagner James Au also gives the scoop on Gigaom.

It is an established fact that if one makes Linden Dollars in Second Life and sells them in the real world for US Dollars, the IRS wants to know about it.

What makes things interesting is that “virtual” markets have become so stable and robust that virtual gains and losses may start to take on attributes that would be considered taxable in the real world. In other words, if a suit of Elven mail from World of Warcraft could be sold for near-equivalent value to numerous buyers at different times, should that armor be deemed an asset for tax purposes?

The IRS’s barter rules show just how deep this particular rabbit hole might go. Under barter rules, goods received through trade or game winnings have value when they change hands, not merely when sold.

Even further, items obtained as prizes could be subject to taxation as, you guessed it, prize earnings. Does this mean that every gold piece won from every slain orc would have to be declared?

And a moral/legal fun question: if my WoW avatar is a thief, do I need to declare to the IRS my ill-gotten gains? On what tax return schedule should these earnings be presented?

I agree with Au that Congress is likely to spend a long time looking at these questions and probably far longer working with the IRS to come up with a set of rules, if it ever gets that far.

If, however, Congress and the IRS do move to tax these assets, the landscape of game development and hosting may be in for a major jolt. Game publishers might be required to 1099 each subscriber every year for “gains” made. If that happens, Linden Labs will look prescient. By sticking to its policy of providing the environment alone and leaving it to users to build and manage just about everything inside, it strikes me that they will stand the best chance of escaping the administrative nightmare that scenario presents.

  • Frankly, the idea of the federal government trying to climb into all these online virtual economies and trying to sort out, game point by game point, which ones are Americans and which aren’t and then try to tax the users on them is really pretty silly.

    Yes, these virtual currencies do have many attributes of real ones, but there is nothing to be gained in such an effort. For example, some of the characters in these games don’t even have humans operating them. They’re just part of the game. Is the IRS going to try to tax computer programs now?

    These sorts of announcements are made to keep attention-hungry politicians in the news, and are repeated over and over by the media because they boost subscription rates and attract eyeballs. One must keep this in mind when parroting them back to the public, which often views such off-the-wall musings as a presentation of fact or imminent financial peril.

  • It’s a good point- the mechanism for assesing taxable virtual income is not at all clear (hence the 1099 nightmare scenario desribed in my post). In the end, all taxes are self-reported with the threat of audit and penalties keeping most people honest.
    It may end up a situation similar to reporting of tips by restaurant waitstaff, or any of the other myriad kinds of “on the side” income that go unreported each year: those who derive substantial income from virtual commerce will need to report it, and lots of others can “skate” with relative impunity.