SL income and US taxes

Hi all,
I was just curious if anyone knew how much you'd have to make on SL to have to report it on your taxes?

I'm new to having to do my own tax related things and I don't want to spend all my cash only to find out that I had to pay tax on it.

This is only a vague recollection but I think it's like you don't have to pay tax if your income is less than $1000. But it has nothing to do with where that income is coming from, so like if you have a main income and make a few hundred on the side then you have to include that side income as part of your income.

Ahhh. Ok cool. I need to declare then.

What if you never cash out of the game? Would the IRS consider SL as like a stock?

Well don't take my word for it, make sure to ask a tax professional. I'm just saying what I seem to recall.

The taxable event is when you cash out - you haven't received any USD until you do so. Considering that SL is arguably a "game" for tax purposes, you'd probably declare your SL income as "winnings", which you'd have to present on U.S. Tax form 1040, line 21.

Of course, the advice to consult with a tax preparer with experience in this area is still sound. Free advice is usually worth what you pay for it.

Note that this answer is speculation.

Since SL transactions consist of transferring IP rights between two individuals using an "IOU" or "chit" to keep track of economic value transferred, there is strong support for the argument that the taxable event occurs when you take possession of L$, rather than when they are converted into cash. See the IRS rules on barter income for more information.

I can see the merits of this argument - though, one of the key phrases might be 'take possession of'.

We don't even possess our avatars, or anything on the grid with the exception of our intellectual property. Which we own anyway - no one can write a law to take our intellectual property away from us automatically.

So... do we ever really possess $L?

This is a fundamental point that should be addressed. The service terms say no, if I recall correctly... but service terms say many things. I wish there were better ways to 'test' all of these issues without a conflict in the court system.

well i found this:
"The rapid emergence of virtual economies has outstripped current tax law in many areas, but there are some clear-cut guidelines that already apply. For example, people who cash out of virtual economies by converting their assets into real-world currencies are required to report their incomes to the IRS and other national tax authorities, depending on where they live in the real world."
From: http://secondlife.reuters.com/stories/2006/10/15/us-congress-launchs-probe-into-virtual-economies/

I report every wooden nickel I receive on my taxes, why not Lindens? If I have to declare income derived from activity on SL, can I write off as an investment loss money that I've spent on SL? It's only "fair".

I think it basicly comes down to actual value. You earn 1000$L, then since you CAN cash that out, it is of value. Like if someone gives you a car. Its not cash but it can be exchanged (sold) for cash, thus it has to be considered as if it were money. Just look at what happened with Opra. She gave a brand new free car to everyone in one of her Audiences, and many had to sell the car to pay the taxes ON the car.

As for the differance between a car being a phisical object vs $L being virtual, keep in mind also that you have to pay taxes on money you make via stocks etc. I don't think SL would qualify as a tax shelter

I agree with the statement about income below 1000$ you don't have to pay taxes. Infact I had one year that I didn't make 1000$US that year, and while I still had to file, istead of a return, I got a letter confirming I don't owe them and they don't owe me. But ya, that 1000$US per year threshold is cumulative of all income.

And keep in mind that it's NET income that you report. The money you spend to be in Second Life is an expense, so I believe you could legitimately deduct it from your profits. (I am not a lawyer, however.)

You could not deduct your expenses from your SL business unless you, in fact, report your SL business as self-employment. This would require itemizing and filing Schedule C to list your income and expenses for your business.

This would not be considered "gaming" income, because that refers to gambling winnings and lotteries, etc...

If your "business" in SL does not maintain profitability (income greater than expenses) for 3 of the last 5 years, then it is not considered a business at all... just a hobby. And you cannot deduct your expenses for hobbies. The income from hobbies still must be reported and is still taxable.

I don't believe the L/USD exchanges report the transactions to the IRS, so it is also doubtful anyone would know what you should report as income but you.

It's my Understanding that you are required to report All your Income from all sources whether one dollar, or ten thousand, But there is a Minimum amount you must reach Before Taxes are calculated against it. That is how i recall the US Tax Laws (Though i Emigrated long before i ever had to Pay any there) and i Know that is how it is in Canada. I Left France (Martinique) when i was extremely young, so i can't tell you how it works there.

Angel.

The counterargument is that legally L$ have no value, and if some people are willing to pay for them, that's purely their own affair. For example, if you pick up a piece of scrap paper from the sidewalk, and I walk up to you and say "Oh my god! I'll pay you US$10000 for that!" (and I'm serious), then that alone does not mean you have to pay tax on the US$10000 if you keep the scrap.

It's my Understanding that you are required to report All your Income from all sources whether one dollar, or ten thousand, But there is a Minimum amount you must reach Before Taxes are calculated against it. That is how i recall the US Tax Laws (Though i Emigrated long before i ever had to Pay any there) and i Know that is how it is in Canada. I Left France (Martinique) when i was extremely young, so i can't tell you how it works there.

Angel.

First, It's not 1000, it's like 600 bucks**EDIT: my spouse said it was $6000, just to show the discrepancy here). Like the person said who responded to your real question, make sure to properly do your research. You don't necessarily need a tax professional for something like this. This particular answer is right in the tax book, possibly right on the tax form itself.


Second, ignore the people posting here that feel because you created a prim, and could sell that prim, it has value, and you should be taxed on it. If you spend a day chopping wood in your backyard, you don't pay tax on that firewood until you actually sell it. Use a bit of common sense in this regard.
Any cash you make from SL or selling anything in any other game(legally or not) simply goes under 'other income'. You don't need any special forms, etc. It's right on the most basic of the tax forms.


This only applies to L$ that you exchange into cash. No, you don't declare all of your L$ that you have on your character because it does NOT have value until you exchange it into real money. LL could easily close the game tomorrow (not that they are) and all of that money you just paid in taxes on your imaginary money would be your loss.


Something else I wanted to mention; even though you can't use L$ as a tax deduction, it makes sense to keep track of what you've put into the game, and deduct that from what you've taken out, (before declaring that 10 dollars you had them send to your bank account last week) as profit. What is left over is actually profit, and at that point you pay taxes on it.

EDITne more edit since I found someone commenting on L$ and stocks. Stocks have very specific rules as far as what you pay on. Just because you own stock, doesn't mean you pay taxes on it. You pay when you cash out or you pay on dividends (monthly or yearly interest paid to you by the company who's stock you have) earned. There are also rules about if you simply getting dividends in the form of more stock instead of receiving a check in the mail. You'd also have to pay if you trade stocks for something IRL. L$ have no value outside of the game and you'd be hard pressed to trade someone L$ for a car(unless you know other SL players). This transaction, however, would be taxable by the value of the car according to your local DMV. The real difference between L$ and Stocks is stocks are tied to something tangible, such as a business, the assets of that business. L$ are tied to whatever LL decides to use that day as a measuring stick (the number of ants on a donut left outside for 1 hour, the launched distance of a burnt out hard drive, etc).

What I heard from a friend (an accountaint, but not a tax accountaint) is while it's in SL it's just points in a video game and when you cash out you are making money from selling those points. The links do say "Buy" and "Sell". Again, I'm not saying that's the official law, but it makes sence to me.

You have just effectively demonstrated that SL users should pay tax on L$ when they are received, rather than when they are cashed out.

It is possible to buy a video card through SL Boutique using L$ only. It is possible to exchange services (i.e. graphic design, programming, etc.) using L$ as payment. An exchange of this sort would be taxable if transacted in US$ (or, indeed, if exchanged purely as a service-for-service transaction), therefore it should also be taxable if transacted in L$, particularly given that the US dollar value of the L$ transaction can be determined each day using LL's own currency exchange.

Nope, there is *no* reason L$ should not be taxed as income when they are obtained.

The IRS actually has a help line where you can call to get answers to questions like this. The difference between its answer and the answers here is that (provided you GET THE NAME AND BADGE NUMBER OF THE PERSON GIVING THE INFORMATION AND KEEP IT ON FILE WITH YOUR TAX INFORMATION) if the answer is WRONG you can assert that, since the Government gave you incorrect information, it can't hold it against you. At the very least, it would defeat any claim for interest and penalties (which can get very ugly, very fast).

The number is: 800-829-1040.

When the income becomes taxable is a question on which officials within the tax community cannot yet agree. The reasons for this are complicated tax garbage that really is more an intellectual excercise than a practical one, lol.

The best solution is to consult a tax professional (like a CPA), and ask the same question if you income is worth the investment in the advice. If you prepare your own taxes via TurboTax, you can buy audit defense protection for about $40, which means, if you comply with the terms of the policy, they will hire an accountant to represent you if the IRS comes a calling.

Right now, the best approach is probably to track the money you put it, and the money you take out, and keep track of the Lindens you earn and reinvest (think of it as money you would reinvest in a real business). It's a ton of record keeping, but you will be sooooo happy to have it if the IRS comes a calling.

If you make $1 from SL you have to report it. I would judge by money you withdraw. You will probably have to keep up with this as LL probably doesn't have to send out 1099s yet (That's a form that reports "other income.".

No you can clame that its a game, just like you cant be taxed on other games currency.

You only need to declare when you withdraw it from second life as an income. But if you do that, just remember what you paid into second life to offset. Ie your subscription.

I spent $800 on sl and made $30 so I have ages to go till I break even.

I was reading somewhere about us goverment charging a tax when you withdraw money, if they do that Ill be annoyed, because they havn't accounted for what ive put in.

It has to be said that in reality, how do you actually prove that you paid someone therefore actual expenditure against earnings? What about VAT (in the UK and Europe this applies)? Does import/export duties apply?

When we set up our ingame business, one of the first things we did was to make an alt character, which is used soley forthe purposes of, when people pay us for services, and we then purchesed a ATM system and issued cards to all members of the group. Whenever a transaction is made, either payment recieved or purchase made with the ATM card, we recieve an email direct to our company email address. We then log in to the alt and make out a notecard giving details of who paid, or what the payment was for. Each month, we go to the second life website and download the transactions spreadsheet and save that to the relevant folder on the hard disc, a copy being made to our internet server for safe keeping. The spreadsheet is than annotated to show to whom or from whom the transactions are made. All ingame notecards are then copied and put into the folder on the PC and copied to the webserver.
This provides us with a payment transaction report supported by ingame copies of transaction details to provide an audit trail.

We believe that taxes (maybe even VAT) will only be applicable if/when we exchange L$'s for hard currency through our paypal accounts. On the basis, that the L$'s used/left ingame represent no acutal real life colateral until it is withdrawn/exchanges for actual money or goods that can be used within international boundaries. After all, if.. SL was to close tomorrow, anything remotely tangible is non-recoverable and therefore no benefit in kind can be extracted that would attract taxes. Actual transactions made in game would therefore become mute because the only tangible element you could be taxed upon, is what you can retrieve to exchange.

Just my ramblings

Your logic is impeccable - however, as flawless as your logic is, you have come to the incorrect conclusion because your initial assumptions are completely wrong.

Whether you agree to exchange game points for services is entirely your business. It does not mean that the Lindens have any inherent value, and they specifically do not. It says so in the Terms of Service you agree to when you log on. The taxable moment is when the game points are exchanged for real currency. Before that, they are simply a method for keeping score within the simulation. Under no possible legal definition can they be considered currency.

In your example, the taxable moment is not the purchase of the real world goods from within SL using Lindens. The taxable moment is the point at which those Lindens are converted to United States Currency by the company selling the goods. At that point the company has received money. Before that, they have an incremented number of game points, nothing more.

The test of a currency is not whether someone is willing to exchange the markers for goods or services. That falls into the the definition of a barter exchange, not a monetary exchange. Barter is still taxable, of course, but in the real world, not in the virtual one. There is no taxable transaction in a world that does not technically exist.

Think about this for a moment- if Lindens were actually currency, it would be possible to successfully sue Linden Labs for nonperformance, based on loss of Lindens. The threat of an online service being buried in thousands of frivolous law suits based on loss of points in an online simulation, predicated on their supposed actual value as currency, would grind the company providing that service to a standstill. The very proof that the Linden has no direct intrinsic value is the fact that Second Life exists.

This only applies to persons or businesses subject to US income taxes:

There's only one problem with the argument as stated above: the IRS could care less what LL calls Lindens. Whether they are a license, a game chip, or a figment of our imagination according to the TOS, what matters is whether they are "income" within the meaning of 26 U.S.C. §61. The TOS is worthless in that analysis as it has no force of law.

You can argue that, due to the fact that LL could take all the Lindens away tomorrow that the value of the Linden is not "fixed" until it is withdrawn. A contingent asset isn't income. However, if you choose to leave your value in LL to avoid tax, and LL remains a going concern (in other words, stays in business), you might lose that one as well.

I really like the record keeping AWM Mars recommends. That's the type of detail you really need. Here's the shocker: The IRS doesn't bear the burden of proving deductions (i.e. what you put into SL). YOU DO. The IRS only has to prove the "income" as they define the term, and they get to subpoena all your financial records from you to do it.

Bottom line: the TOS doesn't help you, and if you aren't keeping records, you really are playing what's called the audit lottery. Some win, some lose but it's definately a gamble.

26 U.S.C §61 does speak very generally about various sources of income. However, the key word here is "income". It's not income until you convert the Lindens into an actual currency or other real goods in the case of barter. Your point hinges on the interpretation of simulated goods as having the same property of intrinsic value as the real thing, which, of course, they don't. Since Linden Labs declares the actual digital information required to display representations of these virtual objects as their sole physical property in the Terms of Service, by agreeing to the ToS, you agree that you do not own any of the items in SL. Therefore, no actual sale can take place, because you have waived any rights to that property that might potentially exist. Since no sale can occur, there is no taxable moment within the simulation.

The ToS actually does protect you extremely well against taxation on game points, because it defines the game points as having no direct value in any real world economy (and of course it cannot be argued that the United States Government, nor any other sovereign government, recognizes the Linden as legal tender), and because it is impossible to perform any sort of sales transaction within SL because it is impossible to receive any material goods in exchange for any actual currency that might be exchanged between the potential participants. You are protected twice over against taxation of receipt of Lindens as currency.

The only taxable point is the conversion of game points into a cash prize for playing. At that point you have converted your game tokens into a currency recognized by the real world government, and you may now be taxed on these monies as income.

Because the Internal Revenue Service does not deal in any currencies except the ones officially sanctioned and recognized by the United States Government, no other interpretation of these facts is possible.

Incorrect.

Conversion to real goods is not required for a barter transaction to be taxable. If I cut your grass in exchange for you cleaning my house, no goods have changed hands, yet the transaction is taxable for each of us at the fair market value of the services rendered.

Exchange of services for L$ is absolutely no different from this, other than the fact that tokens are used to denominate the value of the services exchanged, thereby making it *easier* to determine taxes due on the barter transaction.