taxes on second life income ?

in response to a hot line thread.
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some questions and observations

how would we pay taxes on sl income?

would any and all expenses incurred in world be deductible IE rentals, gifts given, tier fees, subscription fees and im sure there are many more.

would real life things be deductable the computer i use to play second life the desk i use to play second life, a portion of the rent/ mortgage i pay for my apartment or home and im sure there are many many more.

considering if all of these things were deductable my net income in second life would be a serious serious negative.

sales taxes were mentioned in the hot line post also. now as far as i know you only pay sales tax on purchases made to a company if said company has an office in your state when it comes to online purchases.
now even if i was to pay sales taxes to my state for purchases made from people living in my state how would i know who lives in my state and how would i charge them sales tax
with the current system sales taxes could never be collected.

also the poster in the hot line said they would report this to there state goverment and the federal goverment. so if you did that and the state and federal goverment came after some of us then we would be forced to prove our income to them and if we could not we would be subject to fins and penalties. even if we are not making any real income selling things in second life. the goverment would leave the burden of proof on us.

and i can tell you this! if this would happen you will See second life become a place for non us players.

also if linden labs decided to use the new money system to report income to the respective government agencies i can guarantee that no one in the states would ever use it.

I strongly suspect the driving factor behind the recent LL decision on money-changing was precisely to plug any liability on their end for failure to report.

I also suspect it is only a matter of time before GoM, IGE, or eBay are asked to report on confirmed (e.g., completed) transactions from their site.

It is a fact that the IRS considers ANY money received taxable (unless they say it's not -- which is kind of like some weird Mad Hatter/Alice Tea Party thing, but I won't go there) and they are aching, aching I tell you, to get their hands around a way to tax digital transactions.

So far, all they've really succeeded in doing is scaring some states (or waking them up to the sales tax they are missing) and running headfirst into the prohibition against regulating interstate commerce.

It won't always be this way. Trust me, when the day comes that the IRS decided to talk to you about your known income from virtual businesses, you want to at least have your own records. You won't like theirs... because they assume maximum profit. (chuckle)

To summarize -- even if you don't think you'll ever have to pay taxes for the money you make in Second Life, do yourself a favor and keep records.

Because this is all so new, if I were to make any income in SL I'd treat it as an extension of my RL business. Now because I have my real portfolio in SL and have been attempting to get my clients and others to advertise in SL, I already intend to deduct the subscription fee to SL (no different imo than deducting professional membership fees, materials fees, aso). Besides, as a designer I'm using it now as a kind of quick 3D sketch tool for some other ideas, so it is a part of my real design actitivity. Another way to look at it is that as a new technology, my time learning the tools and whatnot is part of my professional education... real world CAD training fees (for usually 3 days of training) far exceed SL's subscription fee for the year. That said, anyone who has their own business knows that the tax deductions received for expenses is actually a fairly small percentage of the cost. I won't recover my subscription fee, so it's not like I'm really getting away with anything even if the IRS said all my reasons were invalid (*but please enjoy the tax deductable country club golf outing, Congressman*).

Further, because real life clients would be paying US$'s for any services I rendered, there's no reason to charge SLers for these virtual goods to make money to compensate me for my time/effort - except for one big reason: fair business practices in SL. Consequently I'd be selling those goods at SL market prices; and if I were selling SL versions of their RL products, I would have to document any monies I made that were collected in Lindens and then removed via GOM (so long as they remain inside SL, I'd not bother reporting them). If/when I did that, it would be my Profit after I paid for anything in-world so I was thinking that by the time I convert those Lindens to real world currency, I basically have deductions removed (ala an IRS Form Schedule C). For others who didn't tie SL into their real business, I'd venture there are one of two options: a) set up a real business and do all that paperwork or b) claim income in the appropriate 1040 entry for what amounts to simple supplemental income.



I would divide what happens inworld from what you pay in RL dollars. So my above comment applies. However, if SL were my only activity, I might get more detailed in how I deal with inworld monies. Some might be strictly fun, some might be business-related. In that case, keeping track of money spent becomes a major activity in and of itself. Thing is, the IRS allows deductions for business entertainment (under certain circumstances and maybe inside SL as well, if we're going to get that detailed). That becomes a grey area, and depending on individual circumstance what is and is not claimed probably varies.



You might want to lose that word "play". If SL is an honest business activity, then regular deductions apply. But don't go thinking they amount to all that much. The first time I set up business, I had the idea I could buy all sorts of business things (I bought LOTS of design publications) and get my money back. I discovered how wrong I was come filing time.



Someone asked me why I don't start selling cars in SL and my answer was that the ROI just wasn't there (Return On Investment). However, there are professional training activities that also yield poor ROI. As virtual world commercie matures, the value in the intangibles (i.e. simply learning how to enter this market) make the overall ROI more compelling imo. Everyone running a business has made some kind of investment... most often the biggest nonrecoverable is Time. The hope of course is that at some point the books have less red ink in them.



You might want to research this. My state requires that I pay taxes on anything purchased out of state and used in state (Use Tax). So anything I order over the internet is subject to sales taxes and they explain how it works in the filing documentaion (which will answer your questions of "where?". Some/most of the companies I deal with out-of-state do not tack on Sales Tax. If they do, there's a formula I follow that is given by my state. If they don't, I pay my state's sales tax percentage. I suspect my state is not alone.



Documentation is an issue and is one reason I would use the conversion to real currency as the relevant "earnings" number. It's something easily documented - as are the fees paid to LL. Documenting in world activities becomes extraordinarily complex imo and would, in the end, have to match up to the monies converted through an exchange. I'm happy to avoid that.



I believe we can expect a very large influx of non-U.S. participants. I not only welcome them, I've been telling them to come.



Wrong. I would. But then again, I also feel I have a legitimate and uncontested right to bitch about how my tax dollars are spent. If I was not paying my taxes, I'd either not care how the government wastes tax dollars or I'd be a hypocrite if I did complain. I'm happy to bitch openly and honestly (and it doesn't really cost much to have that peace of mind)... and if the IRS ever comes knocking, I have the damned file boxes full of their documentation ready for inspection.

I think taxes should be 100% focused at the moment of Lindens turned to RL cash MINUS all RL expenses done in RL cash.


IE if you spend $500 usd a month and make the same cash out it should not be taxed.

As RL buisiness owner for the past 12 years, I can offer some insight & suggestions here that I think people should find helpful. Note, this is for US residents only. Other countries have their own laws & regulations. Perhaps some other people could talk about that.


Well, it's really pretty simple. As Robin pointed out, your SL earnings become income the moment you sell your L$ for US$. Beofer that happens, you have no income. Linden Dollars in and of themselves are worthless, so you could make millions inside SL and none of it is actually income until you sell those Linden Dollars for US dollars.

Technically you're in a service business, and your service is collecting Linden Dollars for people who want to pay you for your efforts. How you do it is irrelevant. You could be selling clothing, mugging avatars on the street, playing the gambling machines, whatever. The method doesn't matter. Your business exists to provide Linden Dollars to those who want to pay for the privilidge of taking them off your hands. That's it.

When you go to site like GOM to "sell" your Lindens, what you're really doing is hiring a subcontractor to help you find a buyer for your service. GOM facilitates the sale for you in the same way an independant broker might faciitate the sale of an apartment in New York City.


Inworld expenses are not "real" expenses since nothing inworld has any real world value. Giving someone a gift of an inworld item wouldn't count as a legitimate gift expense since nothing inworld has any inherent value, not even Linden Dollars. Remember you're in the RL business of providing the service of collecting L$ for people who pay you for that service. The $L themselves are not a product or a currency. Think of it like if someone were paying you to pinch hit for them in a baseball game because they're unwilling or unable to hit the ball themselves. Hitting the ball is monetarily worthless in and of itself. What is valuable is your service of hitting for someone else because he's willing to pay you to do it. Linden Dollars are just as worthless, but the service you provided by collecting them is valuable because someone somewhere is willing to pay you once you've done it.


Absolutely, as long as they're "real" expenses. Legitimate expenses would be any and all computer related items, the percentage of your rent or mortgage that your home office constitutes (easily calculated by square footage), any and all office supplies such as paper clips, pens, pencils, etc., SL tier fees paid in US$, in short anything you spend money on for the purpose of enabling you to take part in your SL business. Your computer itself is kind of a gray area. It can be considered either a one time expense for the year it was purchased, or it can be considered a business asset. If it's an asset, it's not 100% deductable in the first year, but the depreciation on it is deductable every year you use it until it loses enough value that it's not considered a worthwhile asset anymore. For example, say you bought it for your business last year and you paid $1800 for it. Now, this year it's only worth $1000. Your business just took an $800 loss.

Whether to declare an item as an expense or an asset is somewhat dependant on its value and its function; computes tend to fall into the inbetween spots in the rules (and those rules change all the time). It's best to consult an accountant, but tax software like Turbo Tax is usually pretty good at helping you make the right decisions as long as you actually read what it says on every step.



First of all, remember it's you're RL income that's important here, not your avatar's inworld income. Anyway, showing a negative is a good thing. It's a tax shelter for you. Let's say you make US$5000 this year selling your Linden Dollar collecting services, but you spend US$10,000 to do it when you calculate your expenses. You just took a business loss of US$5000, which is a completely legitimate deduction from your total taxable income. Since it's unlikely that SL is your primary source of income (you probably have a regular RL job), you're still doing fine. All that's happened is you're going to pay less taxes this year than you would have otherwise. Instead of giving the money to Uncle Sam, you spent it on your SL business, which is your right, and it's perfectly legal and legit.

The idea is to take full advantage of your constitutional right to pay as little in taxes as you can. You're still benefitting society since you're pumping money into the economy, but you're choosing where it initially goes instead of letting the government do it. That's all part of living in a free market society.



That varies from state to state, and it depends on the type of sale that's made. For example, in most states a mail order purchase (which is what the majority of online purchases are) are considered to be sales made in whatever state the seller happens to be located. If that particular state doesn't charge sales tax then the sales would be tax free. If it's a state that doesn't charge tax for out of state purchases, which many don't, then there's no tax, assuming you're not in that state.

However, if it's considered a retail purchase, then the sale is considered to be made wherever the purchaser bought it (usually determined by delivery address), and all local sales taxes apply. In my RL business, I'm a factory rep for a housewares company. Even though all products are shipped directly from the factory to the consumers, I'm still considered by the government to be a retailer and my company has to be registered as a retailer in all 50 states. I have to collect sales tax for every locality where a product is delivered, even if I've never been there. Thankfully, I'm a subcontractor and the company handles remitting the sales tax to all the local governments, but I'm still responsible for collecting it on every sale.

For your SL business, it's best to consult a local tax lawyer. Chances are you won't have to worry about sales tax, but as I said, the laws vary from state to state.


It's not really possible to know. As I said, consult a local tax attorney. The rules vary.


Collected, no, not unless the places that facilitate the sales (GOM, IGE, Anshe, etc.) start implimenting ways to do that. However, the fact that tax wasn't charged to the customer won't get you off the hook if it turns out it has to be paid. Worst case scenerio, you'd be responsible to pay that tax to the government. It's unlikely, but as I said, talk to a loca attorney to find out the regulations for your state.


Of course. Anyone can be audited at any time. That's one of the primary functions of the IRS, to make sure that people are paying the proper amount of tax, no more, no less. The real question here is what are you so afraid of? Why wouldn't you be able to prove it? Just keep receipts for everything you spend money on that relates to your business and you've got nothing to worry about. Just make sure all your reported expenses are legitimate. The things I mentioned above should give you a pretty good idea of what counts and what doesn't, but if you're not sure, consult an accountant. It's really no big deal. I know lots of peope who have been audited, and only one who got in any trouble, but that was just because he was stupid. I know a couple people who even got refunds after their audit since it turned out they had paid too much.

The important thing to remember here is that there's a big difference between tax evaision and tax avoidance. Tax evasion is the illegal practice of not reporting your full income. That's bad. That's what they busted Al Capone for. Tax avoidance is simply taking advantage of your constitutional right to pay as little in taxes as possible, and that's good. As long as everything you do is on the up and up, and as long as you keep records, you've got nothing to fear from the IRS, ever.


Not following you here. SL is already full of US and non-US people alike. How does proper income reporting change any of that? Are you saying people would leave the country if someone got in trouble for not running his or her business the right way? Come on, how do anyone else's business practices possibly affect yours?


First of all, I doubt that's what the new money exchange system will be for, but by all means LL should be providing end of year records for all transactions for each seller, as should the other exchange services. Why would no one in the states ever use it? I just showed you how your SL business can actually lower your taxes, but besides that, if you're running a business you should run it legitimately or not at all. Again, what are you so afraid of? Play by the rules, keep good records, and there's no problem. If you're unwilling to follow the rules, don't open a business. It's that simple.

thank you all
for your advice

what am i worried about? Chosen Few asked

I'm worried because unlike you that have posted here i know very little to nothing about business taxes. for me taxes are running turbo tax and plugging in some numbers and hitting enter and in a few weeks i get a refund. lol that's my extent of my knowledge of taxes.

my comment about only non us players was meant to sagest that because of the tax burden most us players would not bother to try and make money in game.
i know this is short sighted but i was half asleep this morning when i posted this originally.


its just seems like a very daunting task for some one who has never had to worry about there taxes in the past for now to actually think i would have to spend more time worrying about taxes when i already spend a great deal of time making things and selling them in various locations through out second life.
all i do is make clothes cause that's what i love to do i never even gave taxes a thought before i read the hot line post.

and the threat that this person would report us all scared me

Hmm, thank you for that very informative post, Chosen. Though, obviously, you're not trying to replace the advice of a qualified tax accountant familiar with individuals and their situations, it's great food for thought and a valuable perspective.

For example, though I remember this from my accounting classes, I didn't connect it:

Since I have to pay a monthly fee for my broadband connection, and since I need the broadband to conduct my SL business, I can consider the broadband a business expense and only report the amount of money I made less broadband expenses for the year -- that's a big chunk to take out. Also take out tier, premium membership fees... not bad. When I calculate my SL income this year, there'll be less for me to present for Uncle Sam to take a bite from! Thanks!

Thanks for your candid reply, Crucial. Maybe I can help put your mind at ease about a few things. First of all, don't be afraid of the IRS or feel that running your business transparently will be a burden. If all taxes have been to you in the past is "running Turbo Tax and plugging in some numbers," that's all it has to continue to be. That's all I do every year. Just follow the interview questions as normal, and when it asks you if you're running a business, say yes. From there it will ask you about your earnings and your expenses. Just plug the numbers in and do what it says. It's really pretty simple. If you're scared though, hire an accountant.

The bottom line is you really shouldn't be "worrying about taxes," as you put it, since taxes are just a part of the natural process of running a business. You don't WORRY about income tax when you get your paycheck from work, right? It's just something that happens. Well, there's no need to WORRY about self employment tax either. What you should be doing is realizing what a tremendous oportunity you have as a small business owner to lower your tax bracket. So many things you buy already can now be counted as business expenses, and all of that will lower your taxable income in the eyes of the government. Let me give you some examples:

Take someone out to dinner, mention the words "my Second Life business," save the recepit, and it's an entertainment expense.

Go on vacation, mention the words "my Second Life business," and it's a travel expense.

Make a long distance phone call, mention the words "my Second Life business," and it's business call.

Buy a box of CDR's; it's an office expense.

The idea is don't go out and buy things just because they can be write-offs, but if you're gonna buy something anyway, find a way to relate it to your business, and you can write it off. The power you have as a business owner in this country to control your own money so far exceeds that of the average working joe, it's not even funny.

Take a look at the 2005 Income Tax Schedule and let me give you an example of how SL can lower your taxes. Let's say you're making $40,000 a year working for the man. If you're single, you're gonna pay somewhere around $6500 this year in federal income tax. Now let's say you come up with enough expenses that you're able to show a $10,000 loss on your SL business. That put's your taxable income at $30,000 instead of $40,000. Now you only have to pay about $4000 in income tax instead of $6500. You just saved $2500!

Well, maybe you saved it. It all depends where those $10,000+ worth of business expenses came from. If you went on a spending spree just because you can, well then you obviously lost money. However, if you were smart and you found ways to tie expenses you'd incur anyway into your business, then you saved a fortune. As long as you have receipts for everything you spent and you have legitimate logic for how the things you paid for were related to your business, it's all legal and you've got nothing to worry about.

Now let's say the opposite happened, and your SL business shows a $10,000 profit. Well, you're gonna have to pay another $2500 in taxes on that. The short sighted reaction to that is to complain, "Holy crap, Batman, they're really sticking it to me. I owe $2500 now." Well, slow down, Boy Wonder. Okay, so you have to pay more taxes with your SL business than without, but keep in mind that's only because YOU MADE MONEY. Is paying $2500 to the gonvernment fun? Of course not, but remember, you still get to keep $7500 that you wouldn't have had without your business. Taxes are just a part of having an income. Higher income means higher taxes. You still get to keep most of what you earn though either way, so higher income minus higher taxes still means more in your pocket at the end of the day.

As long as your smart about your SL business, you'll ALWAYS come out ahead. A business run in SL is somewhat unique in that it has almost zero overhead. There's virtually no money you'll spend on it that you wouldn't spend anyway. You're gonna have rent or motgage with or without your SL business. You're gonna have an electric bill, a phone bill, an internet bill, etc. The only difference is now you can write off a significant portion of all of that, which will serve to lower your taxable income. The only possible way you'd raise your tax liability is if you make a lot of extra money, and what exactly would be wrong with that? Absolutely nothing. You win either way.


EDIT: Enabran's post appeared while I was writing this, so let me respond to a great point he made.Yes, thanks for reminding me to give a little disclaimer. I'm not a tax proffessional, and anyone reading this should consult a certified accountant and/or tax attorney if you're unsure about any specifics, or else do your own research. My purpose here is just to give you a general idea of what's possible. There are some great books on the subject if anyone's interested in learning. "Tax Deductions for Your Small Business" by J.K. Lasser is a great place to start.

Forgive me if this has already been mentioned but I believe you'd only have to pay taxes on any $L that you sold for $US. That is All! If you're going to claim internet connection, membership fees, and tier costs as a business deduction I'm sure you can, however it's not a simple formula of delete it from what you make. You can only claim a percentage for business costs. There are different spots on the tax form for income an deductions. Also by that frame of mind could you claim your plane ticket, hotel costs, and food on a trip to Vegas as business costs if you are declaring casino winnings as income? And I don't believe it would become a place for non US players only because many in the US don't make any money off SL and would probably still pay.

Some tax tips (brief)

Disclaimer: These will vary from state to state, so presenting them as general guidlines, not as statement of facts.

Basicaly there are three catagories SL income might come under.

1. Non-Taxable (less then 1000$ made in a year before business expenes deducted) if one falls under this catagory most likely they do not need to report.

2. Suplemental Income (One works a regular job and SL income was 1000 to 10000, check with state and feds for these amounts as they vary, these amounts from state i'm in.)

This group will have an easy go of it, just keep records of income and expenses. Add the income to Wages, Tips, Etc catagory of the 1040 forms at end of year, and if you itemize deductions, add the businnes expenses to there.

3. Business or Self Employement Income (over 10000 a year)

Basically if you earn over 10000 a year even if you have a full time job for other icome, it;s no longer suplemental. You either need to pay the high tier self employment tax on the SL income, or set up a legitimate business with seperate banking accounts, etc... and then Pay yourself an income from the business, cutting your own W2's at end of the year, and paying taxes to state and feds on a monthly or quarterly basis.

The later has higher up front costs, but will save a bundle on taxes in future years. Basicaly it requires a business licence (or registered business name with thier state) a Federal and State Tax ID for the business, and some back end work with IRS and SSA to find out what whitholding you need to do from month to month (or quarter to quarter) for the Fed Tax, State Tax, Local Tax, SS Tax and Medicare Tax.