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Saturday, February 16, 2008

Death and Taxes Not a Certainty in the Virtual World

by: Joydeep Dasmunshi, Associate Editor, MTTLR

Editor: This post is part of a short MTTLR Blog series on virtual worlds - Part one explores parallels between virtual property and real-world property. Part two (this post) examines the contract agreements that govern relationships between virtual world participants and creators. Part three (this post) considers taxation in virtual worlds.

Virtual worlds on the Internet have been getting a large amount of media attention over the past couple of years, due to the millions of users who have created "avatars" to interact with each other virtually. Many of these users are playing a type of large scale, interactive, computer game through their avatars, known as massively multiplayer online role-playing games, or "MMORPGs". World of Warcraft is one of the more popular MMORPGs, for example, in which "thousands of players adventure together in an enormous, persistent game world, forming friendships, slaying monsters, and engaging in epic quests that can span days or weeks."1 Other virtual worlds such as Second Life do not offer a gaming environment per se, but rather an interface in which users, through their avatars, can perform activities like going to concerts, attending lectures, creating and using objects, and even owning property. Second Life avatars are known as "residents" and the world even has its own currency, Linden Dollars, which can be exchanged for US Dollars at a fluctuating exchange rate 2

Image by Pathfinder Linden.
Used under a Creative Commons BY 2.0 license.
These virtual worlds are a big deal. In sheer numbers, there are millions of users in these virtual worlds: for example, World of Warcraft recently surpassed 10 million users 3, and Second Life has had over 20 million accounts registered (though many are inactive, duplicated, and not necessarily indicative of long-term consistent usage 4). Many of these users are doing things through their avatars that seem like they would be taxable activities in the real world, which raises the question: "Should there be taxes in virtual worlds?" This is a real issue, highlighted by the announcement that the Joint Economic Committee of Congress that it was looking into issues related to the economies of virtual realities. 5

While not many of us round up a group of friends to go slay a dragon in real life, one can make the case that discovering "loot" in an MMORPG is analogous to receiving a gift in real life. Or, more directly, receiving Linden Dollars (which are exchangeable for US Dollars) from another Resident in exchange for a virtual product seems awfully close to the definition of gross income in the Internal Revenue Code: "...all income from whatever source derived, including ... Gains derived from dealings in property"6.This isn't a unique question, it's just the first time that it has really been considered in the virtual world. When the IRS cracked down on "barter clubs" in the '70s, they ruled in 1980 that transactions involving "trade dollars" in virtual currency could be taxed, even though there was no actual money involved.7

In a recent article, Leandra Lederman considered many of these issues to reach differing conclusions depending on the type of virtual world, whether it was a MMORPG, World of Warcraft type world, or a Second Life type world8. One of the integral issues that this hinges on is whether or not the creations in these worlds are "property" or not. I won't go into that issue here, because the arguments on both sides have been presented in numerous forums, including, very recently, this blog9,10. But, in essence, Leandra argues, in the Second Life-type worlds, if Second Life residents are deemed to have property rights in their own creations, then sales of these items should be taxable11.

Personally, this makes sense to me on a basic level. It doesn't seem sensible that an individual should have to pay taxes just because of playing a game and killing orcs, but at some point, virtual world interactions go beyond the scope of games for fun, and start to look like real-world business transactions. When we've reached the stage where reputable companies like Microsoft and Verizon are hiring employees through "virtual interviews" in Second Life12, it seems perfectly natural that the government will want to get a cut of the action. As Dwight in the NBC show "The Office" responded when Jim asked him about his avatar, "Second Life is not a game."13

1 Blizzard Entertainment, World of Warcraft FAQ, (last visited Feb 4, 2008).
2 Linden Labs, Second Life LindeX Market Data, (last visited Feb 4, 2008).
3 Leigh Alexander, World Of Warcraft Hits 10 Million Subscribers, Gamasutra.com, Jan. 22, 2008.
4 Wikipedia.com, Second Life, (last visited Feb. 5, 2008).
5 J. Economic Comm., 109th Congress, Virtual Economies Need Clarification, Not More Taxes, Press Release #109-98 (Oct. 17, 2006).
6 I.R.C. § 61(a)(3) (2007).
7 Clay Risen, Taxing Virtual Economies, N.Y. Times, Dec. 10, 2006, §6 (Magazine), at 77.
8 Leandra Lederman, "Stranger than Fiction":Taxing Virtual Worlds, 82 N.Y.U.L. Rev. 1620 (2007).
9 Elizabeth Hertz, Virtual Property – Real-World Problem, The MTTLR Blog, Feb. 4 2008.
10 Erik Paulson, Virtual Property Protection: Continue the Experiment, The MTTLR Blog, Feb. 7, 2008.
11 Lederman, supra note 10, at 1658, 1670.
12 Hannah Seligson, Sight Unseen, New York Post Online Edition, (last visited Feb. 5, 2008).
13 The Office, Season 4: Local Ad (NBC television broadcast Oct. 25, 2007). Clip containing quote available at http://www.gametrailers.com/player/usermovies/149565.html (last visited Feb. 15, 2008).

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