IRS May Push for Tax Compliance in Virtual Worlds

The IRS soon may keep a closer watch on the thousands, if not millions, of small firms and the self-employed that have sprouted up in virtual worlds.

The nation's taxpayer advocate, who recommends to the IRS how to improve the average consumer's tax-paying process, released her annual report Wednesday describing some of the most serious problems encountered by taxpayers as well as some issues that the IRS should proactively address.

Taxpayer advocate Nina Olson listed the usual perennial suspects -- telling the IRS it should simplify the tax code and improve its working with taxpayers experiencing financial difficulties, among many other things.

But she also told the agency that it should "proactively address emerging issues such as those arising from virtual worlds." Her report said that about $1 billion in real dollars changed hands in computer-based environments during 2005. Additionally, more than 16 million people are said to have active subscriptions in these worlds, "many of which have their own virtual economies and currencies."

But Olson said the IRS hasn't effectively been able to respond to taxpayer inquiries about how to report transactions associated with them. "Economic activities in virtual worlds may present an emerging area of tax noncompliance, in part because the IRS has not provided guidance about whether and how taxpayers should report such activities," said Olson's report. She suggests that to improve voluntary tax compliance, the IRS issue guidance addressing how taxpayers should report economic activities in virtual worlds.

By Sharon McLoone |  January 8, 2009; 12:00 PM ET Regulation Legislation , Tax Tips
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Voluntary tax compliance??! I'm sorry, tax payment is either mandatory or it is not, and I know of no one who would make a voluntary contribution to the US Treasury based on a percentage of revenues/income.

If the IRS can figure out away to ensure that virtual tycoons get real-world 1099-MISC's, then perhaps we can start talking about compliance and enforcement. Geez, can it really be that difficult to have that sit down with SecondLife and figure out a way to do it?

Posted by: chumbucket | January 8, 2009 12:57 PM

This is not just a US issue. In the UK (where I live), there is an obligation to declare income from all sources. I'd be surprised if this was not also true in the US.

Enforcement is the difficult bit, but is it so very different from other kinds of income?

Posted by: pikestaff | January 12, 2009 7:28 AM

This isn't just a US issue agreed. It's a universal 'grab grab grab the money' philosophy shared by most governments around the world.

If you think taxing 'virtual economies' is a good idea, then you better also try and tax every single exchange of goods between private citizens. Can you track my purchase of a book from a friend so that tax could be assessed? Can you track my giving $0.50 to the homeless guy on the street so that I get the deduction for giving to a charity? (or prove he isn't really homeless so I can charge him with fraud)

'Transactions/exchanges' occuring solely within the virtual world, are just that, virtual, with no intrinsic value. Once a virtual item or currency is exchanged for real value, it becomes possible to assess tax. Since converting virtual to real almost exclusively involves 3rd party payer systems like PayPal, its possible to track and assess income or sales tax based on jurisdictions and amounts. Since the IRS report specifically says that creating goods are not taxed until they are exchanged for money (i.e. farm crops), the virtual worlds are no different.

The point of all of this is there is no new 'issue' here. The assessment and tax is solely based on the real exchange of money. The virtual worlds themselves have nothing to do with it other than being a 'good' or 'service' being provided. Something that happens everyday in the real world.

Finally, a reason for the gov't to 'stay out' of virtual worlds. I can create relatively 'unlimited' amounts of goods in a virtual world, limited only by the time spent. If I can deduct losses on goods I've created, a fairly unlimited supply of 'tax deductions' has just been created. If the gov't wants to tax virtual worlds, they have to accept the fact that people will be using their $10 a month payment to create vast amounts of 'loss' by which to avoid paying real tax on their real life income.

Posted by: rpixley220 | January 12, 2009 11:50 AM

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