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Monday, March 26, 2007

Lederman on Taxing Virtual Worlds

Lederman Ssrn_2Leandra Lederman (Indiana) has posted "Stranger than Fiction": Taxing Virtual Worlds on SSRN.  Here is the abstract:

Virtual worlds, including massive multi-player on-line role-playing games (game worlds), such as City of Heroes, Everquest, and World of Warcraft, have become popular sources of entertainment. Game worlds provide scripted contexts for events such as quests. Other virtual worlds, such as Second Life, are unstructured virtual environments that lack specific goals but allow participants to socialize and engage virtually in such activities as shopping or attending a concert. Many of these worlds have become commodified, with millions of dollars of real-world trade in virtual items taking place every year. Most game worlds prohibit these real market transactions, but some worlds actually encourage it. Second Life, for example, grants participants intellectual property rights in their creations.

Although it seems intuitively the case that someone who accepts real money for the transfer of a virtual item should be taxed, what about the player who only accumulates items or virtual currency within a virtual world? Is valuable “loot” acquired in a game taxable, as a prize or award is? And is the profit in a purely in-game trade or sale for virtual currency taxable? This is an important set of questions, given the tax revenues at stake. Although the Internal Revenue Service has not yet attempted to tax transactions within virtual worlds, it is aware of the issue, and there is pressure on the government to determine how to resolve it, given that the economies of some virtual worlds are comparable to those of small countries. The Joint Economic Committee has announced that it is studying the issue.

Most people's intuition probably would be that accumulation of assets within a “game” should not be taxed even though the federal income tax applies even to non-cash accessions to wealth. This Article argues that federal income tax law and policy support that result. Loot “drops” in game worlds should not be treated as taxable prizes and awards, but rather should be treated like other property that requires effort to obtain, such as fish pulled from the ocean, which is taxed only upon sale. Moreover, in-game trades of virtual items should not be treated as taxable barter. If courts uphold game agreements that purport to provide players with a mere license to use the game, in-game trades do not constitute realization events and thus are not taxable. Otherwise, tax policy considerations suggest that Congress should provide nonrecognition for these exchanges.

By contrast, 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.

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Comments

It's cool let the IRS tax my WOW income and let me claim all my Wow expenses as a deductible. I'm sure I'll come out saving money in the end.

Posted by: zosima | Apr 9, 2007 2:42:11 PM

The Second Life terms of service assign no monetary value to in-game currency, and Warcraft goes further. Assets should only be taxed when converted to U.S. $, anything else is problematic, and frankly just stupid. Too bad Leandra doesn't understand these environments, or the technology.

Posted by: Paul | Apr 9, 2007 7:20:42 PM

Wow. Shouldn't the government be wasting their time on something a little more worthwhile.... like bringing home the troops and getting the _____ out of the Middle East?

Posted by: Ron Ruppel | Apr 10, 2007 1:41:34 AM

Here's what I will be doing:
Once I sell an epic sword on Ebay or through cash exchange, I can get a tax break for playing a game, free internet through business, expense, a new video card to boot. I can actually pay the money for powerleveling since its expensed.

Truthfully, how can someone even think this can be possible. Will the government treat virtual sellers as businesses? Does my character get his/her own tax id number much like businesses have their own tax info.

My Tax form: Business Name: xxHunt3R_l33t_R0x0rxx
Total Income: $50*12 = 600 (sale of legendary sword once per month averge)
Deduction:
60 - Game purchase (first year or if I open multiple accoutns)
15*12 = 180 - Yearly charge subscription
(50*.25)*12 = 45 - Yearly charge - amount covers 25% of internet bill - my game usage
16.40*12 - 1% of rent/home = % occupied by computer as home business
75 - power leveling charge
300 - Video card
1500 - New "office" PC

by all mean tax my $600 a year income as long as I can claim all those business expenses. I use them all to "run" my virtual goods business.

Posted by: JC | Apr 10, 2007 3:47:34 PM