Virtual Gold Could Draw Real Taxes Congress is investigating whether the IRS should tax online game loot. Julian Dibbel Monday, January 29, 2007 05:00 PM PST Source: http://www.pcworld.com/article/id,128270-page,2-c,onlineentertainment/article.html
Imagine getting a tax form and a warning to report taxable income from the IRS every time you collected rent on your hotel-stuffed Boardwalk and Park Place. Only in a bad dream, you might think; but don't underestimate the U.S. tax code's potential for surrealism. While the IRS won't be taxing Monopoly cash anytime soon, another variety of play money--earned and spent by millions of online gamers each day--may not be so safe. Sometime in the next few months, the Joint Economic Committee of Congress will publish the results of an ongoing investigation into the economies of World of Warcraft, Second Life, and other massively multiplayer online game spaces (MMOs). The report's number-one bullet point will address a question that the inhabitants of these spaces may soon wish had been left unasked: Do the tax laws of the real world apply to virtual-world transactions?
For most people unacquainted with MMOs, of course, it's a mystery how the question could be asked at all. If you're among the mystified, you are probably unaware of the key feature that distinguishes most virtual game currencies from Monopoly money: an exchange rate.
At this writing, the Azerothian gold coin--the in-game currency used by World of Warcraft's 7.5 million players to buy and sell the game's magic armor, weaponry, and other items--trades on eBay at an unofficial rate of seven to the U.S. dollar. Though most game companies try to ban or discourage these free-wheeling out-of-game markets, Second Life actively encourages a real-world type of economy with an official market-driven rate of roughly 50 cents per 100 Linden dollars (Second Life's currency). But whether the game companies like it or not, where there's an MMO, there's a way for players to buy what they want in the game with real money.
And naturally, where there is a way to pay real money, there is a way to collect it. From the player who sells his WoW character on eBay for a quick $300 profit to the laid-off factory worker making $7000 per month selling Second-Life animations he creates that let game couples dance and assume other poses, virtual worlds have blurred the line between work and play almost past recognition. Successful entrepreneurs like Second Life real-estate magnate and real-life millionaire Anshe Chung are the pixel-perfect face of a fast-growing "real-money trade" that is estimated by Steve Salyer, former CEO of online game item and currency retailer IGE, at nearly $1 billion worldwide--every penny of it as taxable as any other industry's real-money revenues.
But as any accountant can tell you, real-money revenues are not the only kind of income that draws the tax man's eye. The labyrinthine U.S. tax code includes many provisions that can leave you owing income taxes without ever earning a dollar.
Consider "bartering" and "prizes" as outlined in IRS publication 525 ("Taxable and Nontaxable Income"): Anyone who acquires goods or services either in trade or at play must report as income the "fair market value" of those goods or services. Give your plumber a rare baseball card in exchange for fixing your pipes, and you both owe taxes on the dollar value of your respective ends of the deal. Win an SUV on Wheel of Fortune, and the government will want its share of the sticker price, whether you sell the car or not.
So if virtual loot can be sold for real money and therefore has real value, what's to stop the government from concluding that every time a fallen virtual monster gives up its prize, or a fistful of Linden dollars is traded for a virtual hair weave, a taxable event has occurred?
Don't ask the IRS. Pressed for an official opinion on the taxability of virtual trades, IRS spokesperson Nancy Mathis would say, via e-mail, only that "whether exchanges constitute bartering depends on the facts and circumstances of each case." As to whether that magic helmet won from a slain dragon is a taxable prize, the answer was similarly noncommittal. "[The] bottom line," Mathis wrote, "is this: You can receive income in the form of money, property, or services. Generally, your income is taxable unless it is specifically exempted by law." Translation: The IRS is keeping its options open. And according to former IRS lawyer Bryan Camp, now a professor of tax law at Texas Tech, those options definitely include taxing virtual gold. "Section 61 of the Internal Revenue Code says that gross income is any income received from any source," says Camp.
"And if someone in the IRS thinks that a [virtual-world] transaction represents the receipt of either cash or services or property, and that has a fair market value, then yes, that's going to be income." When and if that that decision is made, Camp explains, there are only two ways to override it: Take it to the courts, which may or may not disagree with the IRS's interpretation of the law, or take it to Congress, which can pass new laws that leave no room for interpretation.
Congress Steps In
Enter the Joint Economic Committee, an advisory Congressional committee influential in framing the debates that shape many laws. When the committee launched its research project on virtual economies in October, then-JEC chair, Representative Jim Saxton (R-New Jersey), made it clear that he wants to restrict the IRS's reach into virtual worlds: "There is a concern that the IRS might step forward with regulations that start taxing transactions that occur within virtual economies," he said. "This, I believe, would be a mistake."
The antitax position isn't surprising coming from a solid Republican like Saxton, but there's more to it than that. His chief economist, Dan Miller, is a veteran gamer, with hours of World of Warcraft under his belt and the level 41 night-elf priest character to prove it. "We're not approaching this as a partisan issue," says Miller. "But if there's a new issue, you want to set the terms of the debate...to make sure that we're talking about this in a sensible manner, not waiting until it's too late. I don't think it's a good idea to wait until the IRS has already started writing rules."
That's not to say the JEC could forever banish the IRS from the economies of virtual worlds. Estimates vary, but some put the total wealth created annually within those economies (not just that part of it bought and sold for real money) at somewhere around $10 billion. And that figure will only grow as established businesses get in on the game: American Apparel now runs a Second Life store selling virtual versions of the clothing chain's fashions for Linden dollars. With serious money at stake, it may become harder and harder to resist the political imperative to tap into the wealth of virtual worlds.
Even Miller concedes the point. "Maybe down the road, it becomes something that's unavoidable," he admits. But in the meantime, he argues, any tax grab would be penny-wise and pound-foolish: "I just see so much potential in these virtual worlds, beyond simple gaming and social interaction, that it'd be a real shame to shut the door on these opportunities before they ever get started."