If you’re running a virtual goods business in, say, Second Life, you may soon find yourself on the radar of the Internal Revenue Service.
The Washington Post reports that Nina Olson, who serves as the U.S. Taxpayer Advocate, has recommended to the IRS that it take a closer look at the exchange of virtual goods in online worlds, which she estimates at $1 billion annually. From the WaPo:
[Olson] told the agency that it should "proactively address emerging issues such as those arising from virtual worlds." Her report said that about $1 billion in real dollars changed hands in computer-based environments during 2005. Additionally, more than 16 million people are said to have active subscriptions in these worlds, "many of which have their own virtual economies and currencies."
But Olson said the IRS hasn’t effectively been able to respond to taxpayer inquiries about how to report transactions associated with them. "Economic activities in virtual worlds may present an emerging area of tax noncompliance, in part because the IRS has not provided guidance about whether and how taxpayers should report such activities," said Olson’s report. She suggests that to improve voluntary tax compliance, the IRS issue guidance addressing how taxpayers should report economic activities in virtual worlds.
GP: It’s not entirely clear what Olson expects the IRS to gain from this line of inquiry. Anyone doing substantial business in a virtual world is already obligated by law to report their earnings, just like anyone running a real-world business. If a virtual goods vendor chooses to run his or her business "under the table," it would seem that they place themselves in legal peril.
UPDATE: New World Notes has a thoughtful analysis of how the IRS might look at the tax implications of Second Life transactions.