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IRS reports to Congress: Virtual worlds/MMOGs have always been taxable

Tateru Nino

Section 7803(c)(2)(B)(ii) of the Internal Revenue Code requires the National Taxpayer Advocate to submit a report to Congress each year and in it, among other things, to identify at least 20 of the most serious problems encountered by taxpayers and to make administrative and legislative recommendations to mitigate those problems. Thus, the statute requires that the report focus on problems and areas in need of improvement.

Of the 20 "most serious problems encountered by taxpayers", number 13 is The IRS Should Proactively Address Emerging Issues Such as Those Arising From "Virtual Worlds".

For the impatient, who just want the sound-bite, it boils down to the position that the existing US Tax Code already covers much of what takes place in virtual environments, with respect to assets, virtual currencies and transactions. Indeed most of the Code already deals with many things that are no less virtual and no more corporeal than are virtual environments. The only real issue the IRS seems to have with it is a lack of information on the part of the taxpayer about if, when and how to report and pay their taxes relating to virtual environment activities, and the lack of any uniform positional advice.

Granted there are some basic errors in some of the Advocate's research data, Linden Lab's name is gotten wrong about as often as it is gotten right, and some of the business initiatives listed as taking place in Second Life are things that never got past the initial press-release stages (announced, but vaporware, essentially). Nonetheless, overall it is a good treatment of the topic.

Primarily if virtual goods/land and/or virtual currencies can be exchanged for some other taxable medium, then they themselves are taxable (whether or not the operator of the virtual environment or MMOG actually permits that exchange as a part of their terms-of-service).

Many countries (such as Australia and the USA) can and do tax barter transactions (the exchange of one type of goods and/or services for another type), but usually no reporting of such transactions is required if they are assessable in value at less than one dollar.

In some cases, however, many sub-threshold transactions may take place, or a non-corporeal item may appreciate significantly in value (virtual land, for example, or shares in a company, or simply the steady accumulation of game-currency that could be exchanged for US dollars). In those cases, Capital Gains Tax kicks in, and the difference in value of corporeal and incorporeal assets are assessed over a period of time, and tax is applied to the difference.

If you're a US citizen, all of that is supposed to be reported on your good friend, Form 1040, Schedule D and may be subject to Tax Withholding and Estimate Tax, per Publication 505.

Didn't know that? Well, that's the basic problem that the Advocate's report to Congress seeks to address.

The winner of this year's inaugural Linden Prize will be subject to taxation on the prize amount, under the existing US Tax Code.

The core problem that the Advocate outlines is that taxpayers aren't fully aware of their obligations to report assorted virtual earnings and assets, how to do so, and if or when to do so. The Advocate suggests that some activities should simply be made exempt from assessment and collection (presently they are not any more exempt than they would be in the atomic world) simply to improve overall taxpayer compliance.

Additionally, the National Taxpayer Advocate recommends that the IRS:

  1. Work with the Office of Chief Counsel and the Treasury Department to issue guidance addressing how taxpayers should report economic activities in virtual worlds (or at least ask the Office of Chief Counsel to put it on the priority guidance plan) along with other emerging issues; and
  2. Invite the Taxpayer Advocate Service to appoint a representative to the E-Business and Emerging Issues policy group.

In short, if you're running a business in a virtual world, or making real profits from MMOG game characters and items, all of that is presently -- and indeed always has been -- taxable under the US Tax Code. The Advocate's report may spur initiatives that will remove some of these activities from assessment and collection ... eventually.

By all means check out MSP#13 in the National Taxpayer Advocate's report. Your member for Congress has likely already read it.

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