Taxing your loot

***WARNING – THIS ARTICLE IS GOING TO TALK ABOUT U.S. TAXES AND GAMES.  MOSTLY TAXES.  IT IS A WALL OF TEXT. CONSIDER YOURSELF INFORMED.  USE OF A TEN-KEY IS ENCOURAGED. ANY FURTHER READING OF THIS ARTICLE IS DONE AT YOUR OWN RISK.***

Via Massively, it has come to my attention that the IRS has released a publication to Congress that may one day affect our little hobby.  This publication is the yearly report by the National Taxpayer Advocate (Nina E. Olsen is her name).  For those that care, this person’s office is charged to:

“assist taxpayers in resolving problems with the Internal Revenue Service, identify areas in which taxpayers have problems in dealings with the Internal Revenue Service, to the extent possible, propose changes in the administrative practices of the Internal Revenue Service to mitigate those problems identified, and identify potential legislative changes which may be appropriate to mitigate such problems” (thanks, Wikipedia!).

Among other issues raised and discussed, this document highlights the 20 “most serious problems encountered by taxpayers”, one of which is as follows: “The IRS should proactively address emerging issues such as those arising from virtual worlds.”

Before I go further, a bit of background is in order. Only longtime readers of Schlotzky’s will remember that in RL, I am a tax accountant. That’s right, I’m in the upper nerd echelon. An accountant that enthusiastically plays video games, then writes about them on his video game blog. At any rate, tax being my career of choice, this document is right in my wheelhouse*.

So, what exactly do we have with this new document? In short, nothing really of substance, other than a recommendation that the IRS release some clear guidance as to how taxpayers should deal with income resulting from their activities in virtual worlds. In long form, it’s a lot more complicated than that.

Let’s start off with an easy one. If you make actual, tangible real money from a virtual world, whether it be selling widgets in Second Life, selling your WAR account to another person, or exchanging your WoW gold for real money, you will most likely owe tax on the real world income. Pretty much anything you make money from, you owe tax on. Don’t believe me? Bribes received are taxable. Money acquired from theft is taxable. Just ask Al Capone.

Simply put, “income, broadly defined, is subject to tax”. The question then becomes if the money you are making from your MMO activity constitutes income. If you are making widgets in Second Life and selling them for Lindens that are easily converted to US$, then most likely the answer is yes.

What about though, when you pick up weapons or armor in an MMO that have a market value in the real world? Say you have a full set of Invader gear on multiple characters in your account, and say that you would be able to sell access to that account on ebay (regardless of rather that is allowed by the EULA, which it isn’t). Is the acquisition of that gear taxable each time you pick up a piece? Or is that income taxable only when you sell it on the open market? If you trade items with other players, are those trades then taxable in much the way a barter transaction would be in the real world?

To me, there are many problems with the arguments that would make virtual loot taxable in any form until sold for real world dollars. Typically, taxpayers will pay tax on any gain on the sale of assets, “gain” being the difference between the sale price over the amount of their basis in a piece of property, “basis” being typically the price they pay to acquire that property. Two problems appear just on that point. 1) The value of such loot at the time of acquisition would be nearly impossible to determine, considering the natural fluctuations of the game market, server differences, and the omnipotent power over the world of the developer (ie. if Mythic wanted to hand out Invader gear to newly rolled toons, the value of Invader set pieces would plummet). 2) How do you go about determining a player’s basis in such property? Conversion of value in game money to real-world money? Some sort of formula based on subscription fees paid over amount of time invested? The questions really are endless.

To get even more insane, are the developers responsible for withholding taxes of their players? Will you one day get a 1099 with your loot drop? And if so, at what threshhold is such reporting frivolous and overly burdensome on the taxpayer? $10? $1? Further than that, if you have been paying tax on the items you acquired when building up your character, are you then entitled to a huge taxable loss (and possible subsequent refund) if a game closes its doors, thereby making all your pixels worthless?

These are the kinds of questions that this document asks. And in the end, it seems to come on the side of making in-world transactions non-taxable, as the arguments on that side of the fence seem a lot more plausible than those to the contrary. When it comes down to it, all this report is recommending is for the IRS to issue guidance on the issue, one way or the other.

It seems pretty clear to me* that taxable income will be related only to real-world transactions (although that opens its own can of worms – Second Life’s $1 transactions say hello!). To try and tax in-world transactions would be not only nigh-impossible to track and enforce, but would be unduly burdensome on the developers.

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WOAH. Where am I? I blacked out there for a second. You’re still reading? Well, as a closing I’d like to add how surreal it is to see World of Warcraft referenced in an IRS document.

*Note that I am not an expert in this area, nor do I know much about it.  I do corporate taxes – what do I know?.  As such, any advice or comment contained in this article may not be used by any taxpayer, living or dead, in any country, state, province, city or locality, to avoid taxpayer penalties under any section of the Internal Revenue Code, or for any purpose other than entertainment. And maybe not even for that.   This is simply stream-of-consciousness rambling, most likely without merit.  Seriously, people – pay your taxes.  We all like roads.  I’ve also had a couple drinks tonight, so fair warning!  Disclaimers, FTW!

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