Second Life Content Creator Couple Double-Taxed $66K by the IRS - Here's How to Avoid That Fate

One day not too long ago, a young American couple who create and sell content in Second Life were going through their real life mail, and found themselves with a rather massive bill from the IRS:

That's right: Over $66,000 dollars, all of it based on income the couple (who are also married) had earned from Second Life, as longtime SL entrepreneurs Washu Zebrastripe and Damien Fate, who own the coldLogic brand in SL. As small business owners, this wouldn't necessarily be a problem in itself, but here's the thing: They had already paid these taxes, and the IRS was double-taxing them.

Unsurprisingly, Washu felt like throwing up.

Here's what happened: "When you work in Second Life you get money sent to PayPal. PayPal then sends the money to your bank account. Unfortunately, both LindenLab and PayPal reported my earnings for 2013 separately. Now the IRS thinks I made double because of both companies reporting my earnings."

So now Washu and Damien are being forced to scramble to find data proving that they've already paid these taxes, and that's proving pretty difficult:

"I pulled a list from Paypal of all my received payments," she tells me. "They're all from Linden Lab. I'm also trying to get our process credit history from Linden Lab, but that's a bit harder. You can't list by 'This date to that date', and you can't see what PayPal email each transaction is sent to unless you go into the details of each one. I certainly can't print out 300+ pages of transactions."

At the very least this experience illustrates some important points about US taxes and income earned in Second Life:

Washu and Damien in SL when they met 2004; in real life with their son Linden, who they named after SL's creator

"So when you earn money from a third party network (Both Linden Lab and PayPal count as that)," Washu explains, "they have to create a form 1099-K for you, IF you make over $20,000 in one year AND have over 200 transactions. Here is the form to understand that more." That's what caused the double-taxing dilemma: "Damien and I pulled money from Second Life every day. This means we had over 200 transactions in one year."

For other content creators in SL, this suggests some crucial advice: "Either make sure you pull out money from Linden Lab less than 200 times a year, or don't send your money from Linden Lab to PayPal." (Emphasis mine, because it bears emphasizing.)

And so now Washu and Damien, who are raising a family in great part from their Second Life-based income, are in the somewhat surreal position of explaining to the US government that they're being taxed twice on the real money they made from virtual content, and hoping the IRS even understands what that means. Hopefully there's good news to share on that front soon.

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Comments

[Angery Resident]

" and you can't see what PayPal email each transaction is sent to unless you go into the details of each one. I certainly can't print out 300+ pages of transactions."

Yes,yes you do! 300 or 3000 whatever makes the case with more provided facts the better. that is why they have hired accountants as well.

[Amanda Dallin]

Pay Pal shouldn't be reporting this on a 1099K. The IRS might tell them they have too but they shouldn't. Pay Pal isn't the source of the money just a conduit. This is like the Post Office reporting they paid you income when they deliver the check from someone else or a bank reporting income when you take your money out.

[zz bottom]

A law suit seems in place against paypal.

[Dartagan Shepherd]

Yep, said this back on the merchant forums that when they started that people were going to get double taxed because they'd get double reported.

LL is also asking people to provide information for people that don't qualify for minimum reporting requirements.

And no, PayPal is not in the wrong for reporting.

But hey, if you're running your SL business as a corporation you can send your own reporting requirements right back at LL.

[Below the Upper]

Firstly, Paypal is NOT a bank. Unless you are just cashing out small money ,then by all means use Paypal. Otherwise direct bank deposit is better and will make it a ton easier for reporting/tax purposes. Get a lawyer. Get a good one.

[Ciaran Laval]

@Dartagnan there are two issues whereby Linden Lab gather information. The first is Tax requirements, which are triggered at certain thresholds and activity levels.

The second is Account requirement, this one is Patriot Act related, not tax related and the triggers are unclear but I suspect it's around USD$2k because Linden Lab lowered the limit on what level 1 accounts can withdraw from USD$2,500 to USD$2,000.

[Dartagan Shepherd]

@Ciaran Ah, thanks. Hadn't known about the Patriot Act requirements.

[Washu]

If I came across as blaming LL or PayPal, then I do apologize for the miscommunication. Both companies were reporting as they were required to by law. There is simply a disconnect where the IRS thinks we earned the money twice.

When we learned about the 1099K report, we weren't worried because we report all income anyway. We reported our LL income to the IRS and didn't worry about the PayPal "income", which is what the IRS is mad about. PayPal was simply the middle-man between the LindeX and our bank account, and I do wish the IRS realized that.

[Ezra]

Sorry for your troubles Washu and Damien, but thanks very much for sharing the details with us, it's educational. Please share any resolution you arrive to as well. I hope that's soon.

[norman]

66k and assuming a tax rate of 33% puts their earnings at approximately $200,000.

Next time, hire an accountant guys. You can afford it.

[Damien Fate]

We did have an accountant, and your estimate is way off.

[Washu]

Norman, you're a bright one. I like how you gather all the facts and give constructive criticism.

1. We were double taxed. The IRS thinks we made twice as much as we did. This put us in a higher tax bracket, plus over $10,000 in fines. I already paid them $27,000 for that year. That's quite enough. If they wanted us to pay an extra $66k, that would nearly be 100% of what we earned.

2. An accountant has nothing to do with any of this.

[Gwyneth Llewelyn]

Whew I'm so sorry to hear about this, Damien & Washu. I certainly hope that you can figure out a way out of that mess. You don't deserve that extra trouble to deal with the robotic morons at the IRS — taking away your precious time dealing with stupid bureaucracy, instead of spending it with your child and/or creating amazing content...

I remember having had similar issues with Portugal's IRS, even though in that case the issue was not PayPal, and the money 'earned' from SL did not come from LindeX. But still 'our' IRS was confused about why I had earned a lot of money one year but didn't report anything the next year (because, well, sadly enough, that second year's income was no way near the first year, and was actually well below the minimum amount for reporting). At the end, the IRS 'won' (by default — my lawyers couldn't step in in time, the actual period for complaining was measured in days, not weeks or months) and I had to a huge amount of taxes for money that I didn't ever receive. I learned that Portugal's IRS are actually allowed to file tax forms on your behalf, not telling you anything about it, and not allowing you to complain — and once 'their' tax forms are in the system, they override anything you might have declared! (And, suspiciously enough, they will NOT show you THEIR tax forms, unless you have a court order to look at their records...). Fishy? Oh yes, very. My only luck — as opposed to your situation — is that I had earned just a tiny fraction of what you do with content :) so it didn't ruin me, and I was at least allowed to pay the 'fake' taxes in monthly installments over a period of two years.

The lesson I learned was, for the future, to get the best lawyers I can afford, and make sure they move FAST — something that my current poorly underpaid lawyers were unable to do. :( And, again, the accountants had nothing to do with my case, either. They had reported everything correctly to the last cent. It was just the stupid IRS that did not 'believe' them.

[Damien Fate]

Just a little update, the IRS issue has been resolved. Thankfully!