IRS to tax Second Life/World of Warcraft earnings?

The Internal Revenue Service, the American tax authority, is looking into the possibility of taxing transactions that take place in virtual worlds, such as World of Warcraft and Second Life, based on the claim that revenue generated within these environments is nearly equivalent to the GNP of Russia and significantly greater than the GNPs of many more countries.

The National Taxpayer Advocate: 2008 Annual Report to Congress, Volume One, states: "Where there is economic income, there is likely to be tax due from someone." (p. 217)

Certainly it is true that monetary conversions from many such virtual world currencies into real-world currencies are both possible and fairly common. For example, the going rate in early 2008 for 1000 World of Warcraft gold pieces was between US$12 and US$22. Second Life in particular is proving problematic for the taxman. This is because that virtual world's terms of service allow users to generate virtual goods for which they retain copyright and to sell those virtual goods for "Linden Dollars", which are then not uncommonly converted into real-world currencies (at a rate in early 2008 of about 266 Linden Dollars to one US dollar).

In both cases, there is real-world money being made (and perhaps not being properly reported to the IRS). In the case of Second Life, one encounters novel creations being made by people who are then given intellectual property rights over them (as part of Second Life's terms of service)--intellectual property rights that can generate in-world and, hence, out-world income in a manner similar to, say, a published novel or piece of music.

But what about exchanges that take place entirely within virtual worlds? The National Taxpayer Advocate continues, "[I]s a person subject to tax each time he or she acquires virtual property? How about when the person exchanges one virtual property for another, or for virtual currency? [...] What, if any, information reporting, withholding, backup withholding, and recordkeeping requirements apply to these transactions?" (p. 218)

These are difficult questions, as the National Taxpayer Advocate readily admits, but the IRS is working on finding the answers.

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