Tax Questions

This first post seems to confuse people into believing that my original question is still an issue. It is not. But the conversation is still about taxes.

Please refer to the last page to see where this conversation has gone since.

Where do you get the lindens to purchase stuff in Option A? Income from the business, once it's going, but don't you have startup costs?

Really, both these options boil down to Option B. To the tax man, your expenses are what you expend in US$. Your income is what you make in US$. All the thrashing around of lindens in between is meaningless.

I think it'd be a mistake to withdraw lindens from your in world business, merely in order to put them back into lindens in order to buy things for the business. There's a 3.5% withdrawal tax, for one thing.

True, you can offset your income with your expenses...you should probably run a couple of test cases to see if this reduces your tax bite enough to make the effort and expense worthwhile. But my feeling is that you're better off keeping the accounts in lindens as long as possible.

Disclaimer: I'm not an accountant, and I'm not even making a profit yet on my own SL business, so take everything I say for what it's worth...about L$2.

It's not a matter of taking money out just to put it back in. Option B only gives me the ability to deduct more expenses, although the income would also be greater.

Taking a deduction isn't exactly the same as using lindens and paying taxes only on whatever is left. Or is it when it comes to SE? Is the only difference more paperwork with Option B? I'm not new to paying taxes but I am new to paying SE taxes.

These arent' the only taxes I'm paying. My husband works full time and we file jointly.

I don't think you can declare it as hobby expense unless you show some kind of income. But I'm not a tax professional... so I'll refer you to one.

Seek a qualified tax expert in your state, fast.

Whatever you do, do *not* go off warm fuzzies you might hear in a forum like this.

I recall pages and pages of warm-fuzzy as related to SL gambling, then the hammer fell, and suddenly all the oh-so-don't-worry-about-it people vanished.

Same with VAT - bam, done, and very little room for dispute.

I certainly have opinions about your a) and b) but I won't even *begin* to touch upon it. Much matters - the state, do you have a business licence, are you a corporation or an individual, and exactly *how* you earned said money.

The US IRS won't look kindly on anyone it sees as skipping out on wage taxes (social security, medicare &c) either - if it decides (as it usually does) that income earned above a certain level was joblike, hoooo boy.

Unlike the common phrase "innocent before proven guilty" - this does not apply to the tax law. You prove you are innocent, if you can - failing that, they will assume the worst and bill accordingly.

Yeah, it's tough - there is for some an icky spot between clearly hobbyish 'piddling income' and 'business income' where you get all the nonsense of business filing and the cash you just made simply isn't worth the paperwork - if the tax prep itself didn't eat your income But that's the joy of dealing with business.

See a tax accountant asap, and I wish you the very best of luck.

Either im really tired or that is being made into a bigger mess then it needs to be. (All the different route options)

Firstly id say to get professional help so theres a less chance of making mistakes, but one thing I noticed is this is a new area and alot of tax people have no idea about virtual goods so you may have to explain some things to them.

Anyway here are my comments on this:

You`re making a profit right? So just keep a set amount of lindens in game to pay for your $10L texture uploads and any other products you want to buy. That has nothing to do with paying taxes. Its kept inworld. You are not going to want to buy $L with USD for inworld purchases then try to write it off on your taxes. Atleast I sure wouldn`t want to do that. If it were a business taking place in real life, sure, thats how you would HAVE to do it.

So anyway, cash out what you can. And for business expenses it would be your tier. Thats what I do. I DON`T purchase $L with real world money and say "Last week, I spent $10USD worth of money that went towards the business expense of uploading textures and buying a nice shirt for my ad, so im going to mark that off as a business expense to deduct when it comes to taxes" No, because I NEVER use USD for anything in this game but my tier fee. It seems to me you`d be adding extra unnecessary steps if you did it any other way. If youre making enough to cash out and have to pay taxes, then why not just use that inworld $L for your purchases and texture uploads and cash out the rest? Why would you even have a desire to use your RL $$$ to purchase fake game money?

Now, if you want to use USD to pay for $L to run an expensive ad, that would be another business expense you could deduct. But in my opinion id say to just only "spend" what youre making in SL, and cash out the unused portion. Try NOT to have to buy $L with USD. Pay taxes on the amount you cash out, minus your tier fee. Everything else stays in game and IMO to try and bring it into RL (Eg, by paying for $L with real world money so you can buy things INGAME for your business and trying to write that off) is making a mountain out of a molehole. Now, if you need to buy something in RL for your inworld business, like a graphic application, then you can write that off.

This is just what I personally do. I do have an accountant though as well. All I write off ever is my tier fees, and anything I purchased for my sl business in RL. Everything else stays in game and is never spoken of. If I do a classified ad, I do it with money earned in game, if i buy a pose for a product box, i do so with money earned in game. I cash everything else out and claim that. There is also a new helpful feature called "Account Statements" which logs all USD related to your account.

https://secure-web6.secondlife.com/account/statement.php

That is certainly something I want to prevent. Wasn't sure if Route A would put me in that situation.

I'm not trying to make it too complicated. I just wanted to make sure I wasn't about to get into trouble. Dealing with RL money vs. SL money is just confusing to most tax professionals. I started to explain one it and I think he needs a week or two to wrap his head around the concept, lol.

Thank you for your input though. I do appreciate it.

Yep, like i said, its a new area and alot of them have no clue. and in THAT, i wonder if they could even make mistakes. So, *you* have to know what you`re doing as well.

Thats why my suggestion was to not even use USD for $L purchases and have to go through the trouble of trying to write it off. Just use USD to pay your tier fee. Cash out what you can. Tell your tax guy what you made (the money you cashed out), and tell him what you lost (the tier fee). Simple.

That`s what I do personally. The $L i spend in game is of absolutely no matter, he doesn`t even need to know about that. It`s not "real" money. It`s not money I lost because I never cashed it out and spent it. Does that make sense?

Also, you more than likely need to be paying self employment tax .. medicare and SS.

But honestly i think its quite simple. When you start trying to explain to them about trading this fake money called lindens in for USD, they begin to get confused. They dont need to know about your inworld transactions, that part of it is just a "game" that can stay in game. I think all you have to do is tell them that you are using secondlife as a business platform, you sell things, and you have made X amount of USD, and you have spent X amount of usd towards your business. I`m assuming you have a registered business in your state...

you could try claiming items/services purchased via L$ profits as soft deductions, but I wouldn't recommend it. instead, only count income/expenses on what you litterally put into or take out of SL in cash dollars... this of course is a major pain since you'll be losing on every withdrawl to put money back in, but it's your only reliable paper trail.

everything that goes in, but can't come back out is an expense, everything that comes out but doesn't go back in is a profit.... if your profits exceed your costs (and we hope they do) then really all you need to record is your gross profit

as stated above, check with someone in the know, most cpa's will be able to give you more stringent book keeping advice on it to avoid any problems... and hey consulting them is a business expense =)

I am a tax preparer who prepared over 200 returns last year. I recommend you go to the IRS with your questions.

Start here: http://www.irs.gov/faqs/faq12-7.html

Are you making more than $600/year, after tier and Premium payment? If the answer is no, I wouldn't worry about it.

But I'm not a tax accountant, either, just someone who has had a one-man business before. If your really think this is a tax issue, the best bet is to get a professional opinion.

The way it works is if after a certain number of years in business ( I want to say 3) if you do not show a profit, then the business is declared a hobby and you can't deduct the expenses.

Yes, three years. You CAN still deduct the expenses of a hobby....but only up to the extent of the income from that hobby. (Therefore cannot show a loss as you might with a real business.)

I think a lot of you have missed the part where I did consult a tax professional. He didn't have a clue about what I was talking about.

Those that did know what they were talking about posted on this forum and I thank them. It was as simple as I had hoped.

Route A, that is, claim cash withdrawn as income and deduct tier fees (without worrying bout in-world expenses paid with lindens). The end.

Now here's a simple question that any tax professional can answer but since you guys are being so helpful .... is there a certain dollar amount that differentiates the SE income and "Hobby" income? I'm planning to file SE ... I'm just wondering.

It's more complicated than a simple dollar amount, which is why I posted the link to an IRS page that pertains to your situation.

A hobby airplane flyer might make $30,000 a year from flying people around in his airplane. But if his expenses from that "business" exceed his income three years in a row, it very likely would be classified as a "hobby" by the IRS, disallowing him from deducting the excess expense (and likely would be retroactive, forcing him to amend his previous three returns without those excess deductions...ie...increasing his tax liability).

But the neighbor who plows your driveway every winter might have an income from this business of $800. The IRS would consider this reportable self-employment income.

Neither route A nor B makes any difference there. The issue is you gotta pay those taxes in addition to regular income tax. You mentioned Schedule SE before so there you go; the additional self-employment tax is to pay for stuff like Social Security that is paid by the employer when you work for someone else.

EDIT: http://www.entrepreneur.com/encyclopedia/term/82618.html

The cash withdrawals certainly exceed tier and the yearly subscription fees.

Can you not deduct any expenses if the income is [later] considered a hobby?

Oh, here is another question for you guys who sell lindens on a regular basis ... I was reading on the SLX forum that they did their own witholdings (SLX was holding some 30% tax on withdrawals). But it was back in 04 and nothing has been posted since.

Have any of you had experience with this? If so, do they complete their witholdings every time a withdrawal is set for $600+ or once the total of withdrawals added up to $600?

EDIT: Never mind, I just got a response that they no longer do this. Phew... I'd much rather pay it myself.

But would like my other question addressed if you can .. is it impossible to claim any expense deduction if the income is later declared a hobby?

Hi Ghanie,

Option A does appear to be the way to go, I wouldn't count on all your tier and other fees being classed as allowable expense/deductions however.

As far as I know, to count as a deduduction/expense against business income you must show that the expense is in fact a true business expense.

An extreme example would be if you owned an island for your personal living and entertainment, but rented a small shop as your business premises.

Strictly speaking you would only be able to claim the rent on the shop as a business expense.

On the upside though, if you are making a decent amount of money from SL, your accountant should be able to show that at least a portion of your computing equipment and internet costs are business related.

This all boils down to how much real money you're making, what the associated tax liability is and whether the IRS can be bothered chasing it all down.

Good Luck

The "there" I was referring to was your concern about running afoul of Social Security and Medicare payments. I was simply letting you know that the Schedule SE takes care of that stuff, so if you are planning to file a Schedule SE along with your 1040 (and the Schedule SE is based on the Schedule C, so file that too) then those additional taxes are taken care of.

The only tier I have is for my shop. It would be very hard to classify that as a personal expense, hehe.

Do you guys claim the yearly fee for premium membership?

You don't have to pay ss or medicare on "unearned income", so don't be worrying too much about that one. I would believe that you only have to pay income taxes on any Lindens that you have cashed out into USD that has gone into your checking account. Any dedecution would be the amount of USD that you have purchased Lindens with. At least in my eyes, its in there, its spent. Kind of like you buy a gallon of paint to paint a rental and you only use 1/2 gallon. You still get to write off the whole thing before you use the second 1/2 gallon. So if they are one in the same or close it would be a wash -no taxes-..

I hope this makes sense. I have lived on "unearned income" for many years. At the present time I own my own business and I still don't have to pay SS or Medicare if I don't want to and I am incorporated. I don't have a clue about this one, but does LL send you a 1099 on money that has been cashed out? Dose anyone know?

I also suggest going directly to the IRS with your questions as 99% of tax preparers are going to need to research the question as well.

*Technically* you cannot deduct your tier fees unless you report your full income prior to the payment of the tier. For example: You make $1000 USD in December, this would be your "Gross". Your tier (assuming a sim) is $195. By the time you cash out - which the part where the IRS gets interested in you - your check is not for $1000 but for $805, this would be your "Net". Only if you report the full $1000 USD can you claim the $195 deduction for tier fees.

There are other deductions you can look at though: home office expense, computer system maintenance & upgrades, equipment depreciation, portion of your DSL costs & phone line costs. The closest comparison for tax purposes will be finding a preparer who has a client with income from eBay, they will at least have done some initial leg-work to figure out what is passing muster at the IRS these days.