IRS Report Recommends Self-Reporting Virtual World Income; Second Life Singled Out Due To IP Rights Policy
In the latest annual report to Congress from Nina Olson, the IRS Taxpayer Advocate, a whole section is devoted to the taxation of income in virtual worlds. You can read the .pdf file on the IRS site here, the pertinent portion beginning on page 213. As the Washington Post notes, the general conclusion is that the US government should explicitly clarify its policies on such income, in order to encourage people to voluntarily report earnings from real money trading. (Julian Dibbell will be pleased to know that his stunt in a regional IRS office is specifically cited as a case in point.) The author does a pretty good job laying out the background, though some of the claims are questionable-- I'm not sure, for example, that 3,100 Residents "had average revenues of $20,000 in real U.S. dollars" in 2006, and in any case, according to more recent stats (reg. req.), only 606 are earning anything close to that. (558 earn $2000/month or more.)
For all Second Life users, however, this, I think, is the key point:
In certain circumstances, we do not tax the acquisition of the right to use another person’s property even if the use itself is valuable... [Footnote comment:] The tax treatment of transactions on Second Life could differ from the treatment of transactions on other virtual worlds because according to the TOS Second Life Residents retain certain intellectual property rights to their virtual creations.
In other words, if I read this correctly, it's less likely that income gained from traditional MMORPGs like World of Warcraft is clearly taxable. Whereas Second Life earnings, due to Linden Lab's intellectual property rights policies, is a far more likely candidate for taxation. Olson cites the analogy of a busy cruise ship: if one passenger sells the right to sit in his deck chair to another passenger, that's not clearly a taxable transaction, since the chair wasn't really the passenger's to sell. On that view, World of Warcraft gold and valuable items are more like deck chairs. Due to Second Life's IP rights policies, however, user-created content in Second Life is owned by its users. And therefore, different. It's more like, say, cartoons a passenger draws on the cruise ship's stationery and pencils, and then sells to other passengers. (If you sold a drawing to a drunk oil tycoon for $10,000, I'm sure the IRS would like to be told.)
This seems like a fair reading of the situation; thus, it's also more likely a policy on Second Life income will eventually be drafted. (Especially with two SLers on Obama's FCC transition team.) There are actually advantages to declaring SL income on your tax form, of course-- you could then write off the cost of your computer, your broadband fees, Photoshop and other software you buy for content creation, etc.
For that matter, you could probably print up a copy of your L$-to-US$ transactions, and declare that on your 1040 tax form now. Will you be more likely to do so, if and when a policy was actually put in place? Hat tip: Kotaku.