You can find the full draft here.
The paper is by Leandra Lederman at Indiana University School of Law-Bloomington (Josh's colleague). The title is 'Stranger than Fiction': Taxing Virtual Worlds.
Abstract:
Virtual worlds, including massive multi-player on-line role-playing games (game worlds), such as City of Heroes, Everquest, and World of Warcraft, have become popular sources of entertainment. Game worlds provide scripted contexts for events such as quests. Other virtual worlds, such as Second Life, are unstructured virtual environments that lack specific goals but allow participants to socialize and engage virtually in such activities as shopping or attending a concert. Many of these worlds have become commodified, with millions of dollars of real-world trade in virtual items taking place every year. Most game worlds prohibit these real market transactions, but some worlds actually encourage it. Second Life, for example, grants participants intellectual property rights in their creations.
Although it seems intuitively the case that someone who accepts real money for the transfer of a virtual item should be taxed, what about the player who only accumulates items or virtual currency within a virtual world? Is valuable "loot" acquired in a game taxable, as a prize or award is? And is the profit in a purely in-game trade or sale for virtual currency taxable? This is an important set of questions, given the tax revenues at stake. Although the Internal Revenue Service has not yet attempted to tax transactions within virtual worlds, it is aware of the issue, and there is pressure on the government to determine how to resolve it, given that the economies of some virtual worlds are comparable to those of small countries. The Joint Economic Committee has announced that it is studying the issue.
Most people's intuition probably would be that accumulation of assets within a "game" should not be taxed even though the federal income tax applies even to non-cash accessions to wealth. This Article argues that federal income tax law and policy support that result. Loot "drops" in game worlds should not be treated as taxable prizes and awards, but rather should be treated like other property that requires effort to obtain, such as fish pulled from the ocean, which is taxed only upon sale. Moreover, in-game trades of virtual items should not be treated as taxable barter. If courts uphold game agreements that purport to provide players with a mere license to use the game, in-game trades do not constitute realization events and thus are not taxable. Otherwise, tax policy considerations suggest that Congress should provide nonrecognition for these exchanges.
By contrast, in virtual worlds that are intentionally commodified, such as Second Life, tax doctrine and policy counsel taxation of even in-world sales for virtual currency, regardless of whether the participant cashes out. However, as in game worlds, participants should not be taxed on purely in-world trades of non-currency items. This approach would allow entertainment value to go untaxed without creating a new tax shelter for virtual commerce.
Again, full draft here. I haven't had a chance to give it a close reading yet, but it's clear that Lederman's paper will make an important contribution to the ongoing virtual property discussion.
p.s. Though I haven't found an online version, I should mention that Kevin Saunders of MSU also has an interesting recent piece placed in the Villanova Law Review: Virtual Worlds-Real Courts, 52 Vill. L. Rev. 187 (2007). And there have been a slew of clever student Notes published recently on the virtual property question.
Since I paid for these items, and the tax is collected on the transaction, I should also be able to take the loss deduction that goes along with it, when I find out that the item I bought today is worth much less in the next upgrade cycle, and sell it then. So insted of investing in stock, I invest in game trinkets, so all of the accounting that goes into any real markeplace would be applicable to me as well, i.e. i bought 2 uber-widgets for 9 and 11 gold, and sold the one that I paid for 9 gold for 10 gold so my tax would be on the 1 gold profit that I made (or did I sell the 11 gold one and made a loss of 1 gold?).
Posted by: whomever | Mar 21, 2007 at 10:57
Fortunately for millions of WoW users, everything in the game is owned by Blizzard, and not by them. Says so in the EULA. We can't be taxed on stuff that ain't ours. End of story.
Posted by: Fearless | Mar 21, 2007 at 11:27
There is a question if is it legaly ok to ask for tax money for in-world transactions. But, there is also a question what virtual worlds will look like if tax is paid inside the world.
For example, if I, as a resident, am paying taxes based on my transactions in L$ then it is quite normal to expect that state that gets that mney will do its part of the deal. For real life taxes I pay I got legal, police and medical protection, education, and many other things. Shall we expect a goverment which gets the taxes to provide better stability of grid, to protect us from griefers (that would include virtual police and judical system)?
And which country is in charge for those taxes? If an European and player from Japan do transaction in a game owned by American corporation, who is in charge?
Posted by: dandellion | Mar 21, 2007 at 12:36
There are a lot of excruciating details around this issue. While it is true that not all taxable events are generated by realization, it is seldom that unrealized book values are marked-to-market and taxed before realization.
In the case of virtual world transactions, they could probably only create a tax event if their book values at the time possession is taken are known in dollar terms. It's technically possible to imagine a phat-lewt taxation regime; but I wouldn't lose sleep over that threat.
The bigger threat, IMO, comes from what ends up happening to the platforms that have convertible currencies. They're kind of screwed either way. If they have an independent currency, then it's unlikely transactions denominated in that currency could be taxed practically before realization (translation into dollars). But floating v-currencies may not survive long for a host of other reasons. If the v-currency is fixed, and thus denominated in dollars, then intragame transactions could easily be assessed for taxation.
Taxation of this sort would also erect an argument for virtual property rights and financial claims. Its' very difficult to imagine a system in which the "player" is liable for taxes generated from her financial gameplay activity but she is denied legal and financial claims on the property for which she pays taxes.
Posted by: randolfe_ | Mar 21, 2007 at 18:28
Government is always looking for new ways to get taxes from its citizens. I'll guarantee you at this very moment some public servants are kicking around this issue.
But if they do that, does that mean I can claim a deduction for the time, expenses, deprecition (wear and tear on swords), use of camping supplies, virtual health insurance while me and my band of merry adventures (a statutory partnership) head off to hunt for the foozle. For the taxes my government collects, I expect services in the virtual world too.
Do you ever stop and think that maybe this is getting too ridiculous?
Posted by: BJ | Mar 22, 2007 at 20:19
If they are going to tax me on my "profits" in Second Life, then they are going to take the deductions on the costs of doing business, just like in any other business. So in their quest to gain a sliver of my 50$/yr in sales -- if that -- they'll lose the 72$/yr premium account charges, the electricity to run my computer, the costs of the land to build my business (hey! Free islands!) and all the scripting, building, and furnishing I pay for.
Go ahead IRS... make the game free for me to play.
Posted by: shockwave yareach | Mar 26, 2007 at 17:44
and one more thing....
if I pay the taxes, I should become the legal citizen.
for that, UN should recognize SL as a state, and SL needs it passport. I am fine with being a citizen of SL. and you?
Posted by: dandellion | Mar 27, 2007 at 06:53
@BJ:
"Do you ever stop and think that maybe this is getting too ridiculous?"
Every day.
Taxing possessions in a virtual world? Might as well tax animated gifs on webpages.
Look, if you are one of the 116 people (less than .00232% of SL residents, I might add) who had a positive monthly cash flow in February 2007, then you should pay taxes the same way the neighborhood kid who cuts your lawn for $10 does. And unless you're a member of a select group of 5000 residents, that kid made more than you did anyway.
Posted by: Petey | Mar 27, 2007 at 21:10
when you work on ebay the prices on shipping are wrong you even make money on others why not pay taxes we all doooooooooooooooooooo
Posted by: betty | Jun 10, 2007 at 21:53