Is the free ride over for successful businesses?

The difference between investment income versus business income has to do with how it was earned, and is largely separate from the question of when the transaction occurred.

If I'd bought a large quantity of L$ on 1/1/2008 and sold them all on 12/31/2008, that would be investment income. The profit came about because of the increase in value of the L$, and not because of any of my own efforts. It would be treated as short-term capital gain.

If, on the other hand, I applied my own skills to build a scripted object which I sold in-world, making lots of L$ in the process, that would be business income. The income came about because of my own labor, and I'd owe self-employment tax if the business showed a profit after deducting expenses.

that was pretty much where i was going with what i said..buying and selling lindens is investing and cashing out for profit..thats investment income.
but the thing i was getting at with created income is this..
can the IRS tax us on that if it is still in world or is it when it is sold??
does it have a value if it never were to leave at all?
i'm having a hard time seeing how they could until it came to the RL..

Can they? Most likely. Will they? Maybe, but probably not without first giving fair warning.

It has value because it is easily exchanged for USD, whether or not you choose to do so. Income is income, whether it's paid in USD, Euros, Yen, L$, or chickens.

So I have absolutely no sympathy for those who think that they can avoid taxes. If you receive L$ for work you do or things you design and sell in SL, that is income. If you cash out, or if you spend in-world on things not related to your business (things for your entertainment), then you owe tax.

If it is too small amount for the IRS to know about it, it is still your responsibility to report it on your tax return even if you could get by without reporting it. If you fail to report it, you are a crook.