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Get Ready for Virtual Income Tax

The U.S. taxpayer advocate discusses taxation of virtual booty.
January 13, 2009

The annual report from the U.S. taxpayer advocate Nina Olson (published on the IRS website here) includes a discussion of taxing virtual economies. As Ars Technica points out, the question was first raised back in 2003. To me, it is a rumbling of much more to come.

For people who don’t participate in virtual economies, it might seem like a strange idea. Think about it this way: it’s fun to fight monsters and have a powerful character and a nice (virtual) house. But how do you get that awesome character and nice house? Through something that MMO players call “the grind”: repetitive, boring tasks, like plowing through low-level quests. The grind should sound familiar to most of us: it’s washing the dishes, doing the laundry, or shoveling snow from the driveway. Sure, I can do that stuff myself, but I often wish I could pay someone else to do it. It turns out that in games, just as in real life, you can.

And so, virtual goods have real value to players because they represent time spent doing the grind, or tracking down hard-to-find items. There are sometimes black-market exchange rates between game currencies and real currencies. While some online worlds have resisted real-money trading (most famously World of Warcraft), others (like Second Life and Entropia Universe) have used it to attract new players.

My favorite example of the weirdness that this can create is from Julian Dibbell’s book Play Money, which tells the story of the author’s quest to make more money in a year playing Ultima Online than he ever made in a year of writing. Toward the end of the book, he calls up the IRS and tries to ask them about his earnings in the virtual world. The IRS is, of course, clear that any “real” money a player makes must be taxed, but Dibbell’s question was about virtual currency, and his inventory of virtual goods. For someone like him, who could and would sell these things for real money, it seemed that it would make sense to consider these things part of his assets, and therefore subject to appreciation, depreciation, and all the other intricacies of tax law. The problem that Dibbell reveals, which will be important to the IRS one day, is how to deal with “things” that may or may not have value, depending on how you look at them.

The question of virtual economies is filed in Olson’s report under “most serious problems encountered by taxpayers.” The report notes,

The economic activity in virtual worlds is significant. As early as 2001, an economist estimated that time spent in one of the many “virtual worlds” generated about $3.42 per hour, which represented a gross national product (GNP) of about $135 million and a per capita GNP of about $2,266–roughly equivalent to Russia and higher than in many developing countries. Since $3.42 is a decent wage in some developing countries, people in such countries reportedly spend long hours in a virtual world to acquire virtual property and create avatars with favorable attributes that the entrepreneur can sell for real dollars.

The report notes, however, that tracking virtual transactions would be problematic, and that it would often be hard to assign them a value.

For example, how would we value a trade of virtual armor for a virtual sword or the income from picking up a virtual sword?

I love the fact that emerging technologies could make it necessary for the IRS to consider the value of my Crystalline Bio Armour versus that of my Sword of Tonturu in Cthulhu Nation.

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