One of the blogs I read now and then is Fargo’s Fileblog (part of Fileplanet/Gamespy). Last week Fargo wrote an article about Korea’s recent decision to add a specific value-added tax on RMT transactions for entities/individuals doing more than about $6500/year. I wanted to clarify a couple issues so sent in an email, which Fargo’s re-printed. I wouldn’t normally reprint a blog entry but since it’s my email anyway I thought I’d post the letter here. Perhaps someone can correct me somewhere, or perhaps it’ll just be useful to some of you in clarifying your thinking about taxation of virtual assets. Hope it’s helpful in any case, though I’ll take pains once again to mention that I’m not a lawyer or a tax pro of any sort.

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There are (at least) three separate issues here involving what can be/is taxed. I’m going to limit my commentary mainly to the US as I’m not intimately familiar with South Korea’s tax regime and the law surrounding it.

1. Anyone who lives in a country that taxes realized income is already taxed on RMT [Real Money Transactions]. That includes the US and I’m 99% sure it includes South Korea though I’d welcome contradiction from someone more intimately familiar with the ins and outs of taxation there. In the US, you already have to pay tax on all income you earn or capital gains you realize. It doesn’t matter if you earn it as a baker, a stockbroker, or a drug dealer. Regardless of the source of your income, the IRS wants its piece (your mileage as far as state taxes varies state by state, of course) and money is often easier to trace than any other type of evidence. It’s cliche to point it out, but Al Capone ultimately was busted for tax evasion, which is what anyone who isn’t reporting RMT income is engaged in. You called them ‘virtual profits’ in your post, but what people are generating is actual profit. Of course, along with reporting income one would want to consult a tax attorney to identify which costs are deductible from any income generated via RMT.

2. The South Korean tax is not the initiation of RMT taxation in South Korea. It’s a new tax on RMT, but RMT is already taxed as described in #1. I bring this up to reinforce the fact that South Korea’s new tax isn’t a sea change in tax policy over there. Instead, it’s the government placing a specific service tax on RMT, but I’m sure there are hundreds if not thousands of similar taxes applied, scattershot, to various industries.

3. The interesting/scary issue is how the IRS/Congress will eventually decide to treat gaining an asset in-game without selling it. Consider this question: if I’m playing WoW and gain 10 gold via playing the game, have I just gained something worth real-world money? There’s no disputing it’s worth real-world money insofar as I could go generate money by selling it on any number of sites. It has value. On the other hand, I’m playing WoW as a game and have no intention of ever cashing out that way (it’s against the EULA after all), so does it make sense to tax me on that? And on my mutant third hand, does it make sense/is it feasible for the IRS to distinguish based on the alleged intent of the person who gained an in-game asset? There is an issue here that complicate this question as well:

There is (as will hopefully be recognized by lawmakers) a big difference between a virtual world that tells you that you own stuff in-game (Second Life) and one that tells you that you do not (World of Warcraft). If Blizzard is right and it (not the player) “owns” the virtual gold, then one might be tempted to opine that it’s pretty clear that there’s no reason to consider your avatar’s gain of virtual gold as a taxable event. Conversely, Second Life has been telling people repeatedly that they own their stuff in Second Life (put to the lie a bit by their recent court filing in the Bragg vs. Linden case that I blogged about) for years, and if that is indeed true then it seems to me (as a non-lawyer) that gaining an asset in Second Life should be a reportable, taxable event whether you cash out or not. It’s an asset you own after all, and it has value, so you’ve experienced income if it’s worth more than whatever the IRS gift exemption is.

I wanted to directly address one of the questions in your post as well. You wrote, “Example: if you invested $200 into Second Life, and brought property that has grown to be worth $20,000 but still only exists online, would you have to report it as income?”

Almost certainly not now or in the future. Generally, we’re only taxed on realized capital gains. One glaring exception is property tax in any jurisdiction where the value of a piece of (land) property may be adjusted at times other than the sale of that property. Let’s just hope we can ensure legislators understand that there’s a big difference between virtual “land” (which is the equivalent of rented server time in Second Life rather than an object of any sort) and physical land, and that the same difference exists between virtual “objects” (which are really elaborate permission sets to access and, in very proscribed circumstances, alter data that sits in someone else’s database) and physical objects.

Now, having said that, if you bought $200 of “property” in Second Life and saw it grow to be worth $20k, then gave it to a friend, your friend would, at least in theory, potentially have to pay taxes on 20k worth of income, since he just got something worth 20k for nothing.

Again, I want to emphasize that I’m not a lawyer or a tax pro.