Virtual Worlds Could be Taxed

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Imagine Pac-Man coming home from a busy day eating dots and dodging ghosts. He greets Ms. Pac-Man with a kiss and pats the lesser-known Jr. Pac-Man on his little propellered beanie-adorned head, then he begins going though his mail. He’s shocked to discover he’s received a W-2 form — he earned a high score of 1,650,000 points in 2006, and he owes 15,000 Power Pellets in taxes to the United Federation of Ghosts.


This scenario might not be too outlandish in the future of gaming and virtual realities. At last month’s State of Play/Terra Nova Symposium in New York, researchers, scholars and thinkers debated the future of virtual worlds.


One of the symposium’s panels, “Tax and Finance,” considered the economics of virtual communities and the likelihood of whether such worlds ever could be effectively taxed by the federal government.


The conclusion the panel reached was that it’s inevitable — people already have been paying taxes on virtual items sold via eBay, and Congress began investigating the issue in 2006.


A report on the issue is expected to be submitted to Congress by the Joint Economic Committee (JEC) in the first quarter of this year. One of its authors is Dan Miller, senior economist for the JEC, online gamer and a participant in the State of Play/Terra Nova Symposium.


Under U.S. law, real income generated from the sale of virtual assets is subject to taxation, naturally. But as the federal government develops a better understanding of how the economies of virtual communities function, it might apply taxation within that space.


“It’s a question of ‘when,’ not ‘if,’” Miller said. “The key question is, ‘When do virtual economies become big enough and the dollar value becomes large enough that the IRS says ‘Wait a second, we want to pay attention to this.’?”


Miller’s consideration of the issue has involved first reading the research that is already available, then looking at it from a pure taxation angle, examining what previous IRS rulings, precedents and definitions apply to virtual transactions or would apply eventually.


“What is a taxable event?” Miller said. “How exactly does the IRS define a taxable event, and does a virtual transaction constitute a taxable event?”


Miller admitted that the entire idea of applying a tax to what is essentially a video game is somewhat absurd. In fact, that’s what drew his attention to the issue in the first place.


“To me, it seems unbelievable that somebody could incur some tax liability just from playing a game,” Miller said. “The more the virtual world is purely just a gaming or entertainment function, the harder it will be to introduce taxes to it. The more it seems to be a parallel to the real world, the easier it will be to introduce taxes to it.”


Of particular interest is the virtual world Second Life, a subscription-based program in which users can interact, create goods and services, and even buy and sell land.


Late last year, a woman named Anshe Chung made news when her Second Life avatar became the first virtual personality to amass a net worth of more than $1 million. That kind of number is bound to grab the attention of the IRS.


There are also sticky issues to consider, including how spouses or family members can gain access to an individual’s virtual assets if he or she dies. The debate might go beyond virtual taxation to even virtual wills and virtual estate planning.


From the JEC’s perspective, however, taxing virtual worlds is something it would like to avoid, favoring instead the support of free markets and the avoidance of burdensome taxes.


“Although we continue to research the issue, there does not appear to be a compelling case in favor of taxing virtual income,” said Rep. Jim Saxton, R-N.J., ranking member of the JEC. “In other words, what happens in the virtual world stays in the virtual world untaxed.”


At least for now, Miller said.


“Our motivation is to get out in front of the issue and help define it before the IRS starts issuing rulings because then it might be a much more difficult proposition to block or limit taxes,” he said.

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