A Taxpayer May Wonder

Two weeks ago, the U.S. Internal Revenue Service's "taxpayer advocate," Nancy Nina Olson, announced the release of her office's annual report to Congress, a yearly federal ritual whose long and impeccable streak of unnewsworthiness was broken this year by the inclusion of an item that actually made headlines. IRS May Push for Tax Compliance in Virtual Worlds, was the Washington Post's. IRS Official Recommends Policy on Virtual World Transactions, echoed the gamers at Kotaku, and IRS Report Recommends Self-Reporting Virtual World Income, added Second Life watcher Wagner James Au at New World Notes. The stories all correctly related the basic fact of the matter: In a detailed, 13-page passage, the report urged the IRS to "proactively address emerging issues... arising from virtual worlds." And if the stories all nonetheless failed, each in its own way, to relate the real news of the matter, that's understandable, because the news here is subtle: What this report delivers, in effect, is nothing more and nothing less than official recognition that the question of virtual-goods taxation is actually, like, a question.

Believe me, this will come as news to many. Having worried this question in public for over five years now, I can attest that a lot of people have a hard time accepting that existing IRS regulations and practices, followed to their logical conclusions, could even conceivably require taxation of purely virtual income -- of the minerals you mine from asteroids in EVE Online, of the Azerothian gold you earn trading enchanting materials in World of Warcraft's auction houses. Many will nod their heads as if appreciating the complexities while at the same time -- and incidentally not unlike the Washington Post story on the Olson report -- offering little evidence that they have any meaningful idea what's being talked about. Others will make the mistake, as Kotaku's write-up did, of thinking that the issue at hand is the far less ambiguous, far less controversial, and far less interesting one of taxing real-money income from the sale of virtual goods.

But even those who recognize the true surreality of the issue will often as not prefer to believe that the IRS could only, in the end, come down on the side of common sense. And even when the multiple and mutually contradictory IRS rulings that might apply to virtual goods are laid out as clearly and as thoroughly as the taxpayer advocate has just done, they will choose to ignore the contradictions and see only the rulings that fall in with their sense of the sensible. This seems in any case to be what Au did in singling out as the report's "key point" a finding that arguably equates virtual property with deck chairs on a cruise ship -- each one "owned" perhaps by a particular passenger for the duration of the cruise but only in the most provisional and ultimately untaxable of ways.

And while I agree that's a potentially productive point, what seems ultimately to be "key" in this report is not any one, decisive argument -- whether for or against the taxation of virtual goods as such -- but a warmly inconclusive phrase that recurs at various points throughout it: "A taxpayer may wonder." As in, "A taxpayer may wonder if creating virtual items or setting out to obtain them is similar enough to farming and harvesting crops that such acquisitions are not taxable," or "a taxpayer may wonder if the acquisition and sale of virtual property for virtual dollars is nontaxable because it is similar to winning a hand of poker before leaving the table or cashing out."

A taxpayer may wonder about all these frankly nutty analogies and scenarios, in other words, without having also to wonder whether it is he himself -- and not the tax system -- that is a little nuts for entertaining them. Needless to say, this sort of permission to question the sanity of a basic economic institution would have been a lot more useful if it had been broadly handed out a few years earlier and if the institution in question were the banking system.

But I'll take it. And thank you, Nancy Nina Olson.

Comments

[SLHamlet]

1.

Julian Dibbell's being modest here, deigning to mention that Olsen's report specifically cites... Julian Dibbell:

"In 2005, for example, when a taxpayer asked the IRS how to report the acquisition, exchange, and sale of virtual property, IRS employees gave him
two different answers and one advised him to submit a private letter ruling request.58 The
taxpayer later published a book describing the situation, as well as his discussion with the
IRS."

[Footnote: "See Julian Dibbell, Play Money, or, How I Quit My Day Job and Made Millions Trading Virtual Loot, 303-311 (2006) (describing discussions with one IRS employee at a Taxpayer Assistance Center and his conclusion that in-game transactions involving virtual property are not taxable, and a follow up call to an IRS business assistance line where the IRS employee expressed the opinion that such transactions are taxable, but recommended that the taxpayer obtain a private letter ruling, for a fee, to get a more authoritative answer)."]

[Don]

2.

fyi, it's Nina not Nancy

[Julian Dibbell]

3.

@Don: Doh! Fixed.

[Chris]

4.

In most virtual worlds, the user is a party to a contract that specifies that they don't own "their" virtual property and may not sell it.

This seems to pose obstacles for the aspiring taxman, unless they intend to consider all the virtual property the *server owner's* property and tax it that way.

Or, in other words, how do you tax a transaction in which something which I don't own and can't sell and which has no value is "traded" for something else I don't own and can't sell and which also has no value? Does it even make sense to call that a transaction at all?

Maybe a virtual transaction is no closer to a transaction than a virtual tiger is to a tiger, and trying to tax the former is as silly as trying to cage the latter.

[Thomas Malaby]

5.

The only fly in that theory's ointment, Chris, is that so very often the law proceeds (develops, changes) more in accord with the changing expectations and practices of the actors than in some strict accordance with one standing interpretation of existing law and practice. While the EULAs and TOSs may specify that lack of ownership, and that may of course win the day legally, it is by no means guaranteed. (Shall we bring up frequent flyer miles again?)

The law, it seems to me, may consider (for example) how different it is to have deck chairs on a cruise ship which are "owned" but not really, and to have virtual goods whose form and accumulation are directly tied to the user's effort in the world over time.

Beyond that, from the point of view of tax law it is, after all, the income that matters, not the ownership (if I understand my legal academic colleagues correctly).

[Adam Hyland]

6.

To tack on to the point made above, tax law is specifically developed in an adversarial fashion toward local agreements written to gloss over value in transactions. I don't have play money in front of me, but I believe that Julian noted some similar arrangements in meatspace companies (riverboat casinos comes to mind).

Also... :)

When the time comes for public comment on rules changes and the IRS intimates that they have to chose between taxing the VW owner and taxing users, Blizzard et al. will run so fast from that provision in the EULA/TOS that it will leave smoke rings a la Wiley E. Coyote.

[Bryan Camp]

7.

Hi all,

Like a bad recurring dream, here I haunt these pages again.

Thomas reads his academic colleagues in taxation correctly. It's increase in wealth (income) that counts, not ownership. The concept of "ownership" simply adds a (huge) layer of complexity on the basic problem of how to measure and tax increases in wealth.

A couple of recent pieces on virtual currency (one by Ted Seto from Loyola Los Angeles and another by one of his students, Steve Chung) give you a glimpse of the awful possibilities.

Regard, -bryan camp

[Tripp]

8.

Hasn't it only been a matter of time for this to come to pass? Maybe there's a chance the government will decide that the potential revenue is not cost efficient to pursue, but I have to wonder if the IRS won't eventually catch up with the culture and at least TRY to gather revenue here.

[Scott Merrick]

9.

Hello all,

Just wanted to let you know your blog has been chosen as a nominee for ISTE Island's "Blog-o-the-Month" at the Blogger's Hut. See the website I note with this comment for more information and a SLurl, which I refrain from posting here. However, if you wish to use the link or anything else to encourage folks to get their avatars on into SL to vote for your excellent work, please don't hesitate to do so! Cheers!

[Prokofy Neva]

10.

Julian Dibbell is once again sensationalizing and misrepresenting these issues merely to get hits and incite everyone to gasp and debate furiously.

But..No actual IRS tax official has said *anything* other than that upon cashout to real US dollars, then you report your "game gold" as taxable income. Full stop. There aren't any complexities, layers, nuances, or anything else of the sort. That's it. That's ALL they are saying anywhere. IRS experts and Congressional tax experts have given talks in SL; various experts and lawyers have looked at this; and they are all saying a very simple thing: cash out, then pay. Not while you play.

There are no G-men looking to try to tax your mining of ore in WoW or Eve if it doesn't result in *cashout in dollars*. It's silly to claim otherwise.

Please point to an actual, existing, real written communication from the IRS, and not speculation by sensationalizing "experts," and you'll have a story.

What's ESPECIALLY annoying here is that Dibbell is trying to say "man really does bite dog" on a story that in fact isn't saying anything like that. Press on the links and read them through.

There aren't any awful possibilities, stop fretting. Your faux alarm here is merely meant to make games seem more magical than they are.

[dmyers]

11.

TN comments remain MIA yet Prok gets through!

The turvy is the topsy!

Cats are sleeping with dogs!

[Additional Income Online]

12.

This will take the fun out of it. It is kind of weird how people think it is a real, or alternate existence. Will there be virtual doctors, lawyers, etc.

[MZ]

13.

Can anybody give me a Definition of Taxpayer that marries Internal Revenue Code with restrains of the United States Constitution? (in plain English)
I've been looking for few months and can't find. The only plain English results that pup out are from what IRS calls "tax protesters" community. I want to have in front of me a LAW that will make me confident that been a law obeying citizen for over thirty years of my life and paying my taxes was a right thing to do. Freedom is not free - somehow we have to insure funding for institutions of freedom. But I see nothing wrong with citizens trying to make sure that what is been done is done according to the Law of the Land so that we pay our shares in the way it was meant to be. I know that there are some of you who are tax experts and possibly working for IRS. So anybody who knows, help me, please - in plane English of course.

[Omer]

14.

I'd hate to see taxes in Virtual worlds, Heck we play them to AVOID real life issues, and throwing taxes in our faces would hurt that illusion.