Catch a Gideon

Do you owe taxes you don’t even know about?

December 20th, 2006 by digerati

You might owe taxes on virtual assets.

In 2001 economists estimated the “virtual economy”’s GDP at $135 million. That is virtual assets that exist in no way what-so-ever outside the internet. Earlier this year, Julian Dibbell asked the question, “are my virtual assets taxable?” He then proceeded to sell his Ultima Online virtual assets on eBay and then reported the real income to the IRS.

He earned a claimed $11,000 from the sales, but then went a step further, asking IRS employees if he also owed taxes on his virtual gold and castles. Keep in mind these items only existed in the online world. He got no definite answer. Many are now making significant income selling off virtual assets. Congress recently decided to take a real look at the taxablity of virtual assets.

The issue is a complicated one. The problem as thought by economists, is that the virtual assets now have a real world value. As soon as Dibbell first auctioned virtual assets, they gained an exchange rate with real dollars. Prior to that point, virtual gold could be exchanged for virtual castles, but there was no relation to the real world.

Of course, this is an easy translation if you exchange x amount of gold for y dollars. This is much harder if you sell your virtual Hamptons estate for y dollars. Who is to say what a Hamptons estate is worth, especially one where you can’t feel the breeze flowing through your hair.

In theory, anything that can be exchanged for dollars can be taxed in dollars. I don’t particularly see a problem with the idea of taxing the sale of things that result in dollars. You sell anything on eBay, you should pay income tax on it (and possibly other taxes). But there are some interesting problems.

Problem number 1: Estate taxes. So let’s say you are really good at these games and you die. If these virtual assets are taxable, technically your family would have to pay estate taxes on the virtual assets. If you had acquired, say, millions in virtual assets, your family could suddenly be in the hole. Worse, none of those assets are liquid or even movable in the same sense as any real assets.

Problem number 2: stolen items. I’m not up on my video games recently, so I’ll use an example that doesn’t quite work. Let’s say you can acquire assets in a game similar to Grand Theft Auto. Currently, the IRS requires you to pay income tax on any stolen assets (see IRS tax code part 525). So every time you steal an increasingly expensive vehicle, you’d have to pay income taxes on its real world value. This was addressed in the 1980s when the IRS realized the barter economy had grown to epic proportions. Technically if you trade services with someone, the difference in the value of those services is taxable. These differences are probably rarely reported.
Problem number 3: what’s a real world exchange rate anyway. Since most virtual assets are sold on eBay, who is to say what an asset is worth? A million tons of gold bullion could be worth $10 thousands today, and only $500 tomorrow. Game makers or managers would have to set their exchange rates, similar to how many countries will pin their currency to the dollar or euro. That essentially gives these game controllers the financial powers of a small country.

Problem number 4: deductions. So if they can tax virtual assets, why can’t I donate them to charity and get tax benefits? I doubt the Red Cross can make much use of a Second World Ferrari, but if it saves me $10k off mytax bill this year, you’ll bet I’d donate it. This would undoubtedly be exploited, probably illegally since it would be almost impossible to track anything.
This month the Congressional Joint Economic Committee (JEC) is looking at the issues regarding virtual taxation, which seems viable, though may be entirely against common sense. The report is due out in early 2008.

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