The Virtual World May Lead to Real World Tax Liability
Internet game players may soon be faced with the prospects of tax liability for their virtual winnings. The following except is from Daniel Terdiman, IRS taxation of online game virtual assets inevitable, CNetNews.com, Dec. 4, 2006:
If you are a hard-core player of virtual worlds like World of Warcraft, Second Life, EverQuest or There, IRS form 1099 may someday soon take on a new meaning for you.
That’s because game publishers may well in the not-too-distant future have to send the forms–which individuals receive when earning nonemployee income from companies or institutions–to virtual world players engaging in transactions for valuable items like Ultima Online castles, EverQuest weapons or Second Life currency, even when those players don’t convert the assets into cash.
New York Law School Prof. William LaPiana addressed the gift and estate tax issues at the State of Play/Terra Nova symposium:
LaPiana said that there is little question that the transfer of such assets could be taxable, since it is property. However, he did say that the taxes would accrue only if the total value of the estate’s assets, at the time of death, exceeded the limit set by the state in which the deceased had lived. In most cases, he said, that amount is $2 million, though some states, like New York and New Jersey, have lower limits.
There are not that many instances in which someone has that level of virtual assets, although the recent reports that Second Life land mogul Anshe Chung had amassed $1 million in virtual land and other holdings certainly suggest her heirs might have some interesting inheritance tax issues if she dies.
More problematic, LaPiana said, would be laws that require estate administrators to take on responsibility for the proper transfer of assets to beneficiaries. Because most virtual assets are locked behind password-protected accounts, it would be incumbent on the administrator to try to figure out how to get access to those accounts.
“Whoever is going to run your estate…has an absolute obligation to collect all your property and make sure that it goes to the (proper) people,” LaPiana said. “How do I make sure my trustee has access to this stuff after I die? These are all problems we’re going to have to face.”
Texas Tech Law Professor Bryan Camp then focused on income tax concerns. Prof. Camp is in the process of writing a law review article tentative entitled The Play’s The Thing: Taxation of Multiplayer Online Role-Playing Games. Here is an abridged version of the draft introduction of his article:
The central thesis of this article is that while player activity in online role-playing games undoubtedly produces measurable economic value to the player, game activity is neither taxable as matter of doctrine, nor should it be taxed as a matter of policy. Instead, the article argues that a “cash out” rule for taxation of game play income is the appropriate rule, both descriptively and normatively. Players whose added wealth consists solely in what I shall define as “units of play” should not be taxed unless and until they convert those units into cash or property that is something other than a unit of play. Conversely, players whose in-world wealth looks less like units of play and more like a medium of exchange can and should be taxed on in-world transactions. When play ceases, taxation begins. * * *
[Prof. Camp’s] article proceeds in three parts. Part I describes the relevant facts of online role-playing games. It introduces the two basic models of online gaming and describes how two types of game-related activity in each produce economic income to players. Part II reviews the basics of taxation, and the tax rules most likely relevant to game play, notably the rules regarding what constitutes income under section 61 and the treatment of disposition of property under section 1001. Part III then applies the tax rules to two types of game-related activity that produces economic income and suggests how and why the proper result should start as a cash-out rule and then what would cause that rule to change so that the shadow of tax will fall over in-world transactions involving only trade of virtual goods for virtual money.