I’m currently working on an academic paper which discusses the what is a virtual economy, whether those activities should be taxed, a how should they should be taxed. My current thoughts are leaning toward characterizing the realization events which give rise to tax liability as occurring when the income is withdrawn from Second Life, by converting the income form Linden dollars to real US dollars. I feel any other way would be unfair, because Second Life is owned and controlled by Linden Labs. Linden Labs could go bankrupt and take the income of their residents with them, and it would be unfair to tax individuals on money which they didn’t have full possession. Also, once the income leaves the virtual economy it gives the government something to attach, if need be, to satisfy any tax liability.

After all, the rights the users of Second Life and other MMOGs enjoy are a function of their Terms of Service agreements they enter into with the online game providers. As such, those rights are subject to that agreement, which include clause that allow Linden Labs to delete a users account for any reason, and in the event of dispute arising under the agreement, an arbitration clause.

So, in short, let the money leave the game before we worry about taxing it.

NEW YORK–If you are a hardcore player of virtual worlds like World of Warcraft, Second Life, or EverQuest II, IRS form 1099 may soon take on a new meaning for you.

That’s because game publishers may well in the not-too-distant future have to send the forms–which individuals receive when earning nonemployee income from companies or institutions–to virtual-world players engaging in transactions for valuable items like Ultima Online castles, EverQuest weapons, or Second Life currency, even when those players don’t convert the assets into cash.

Most governments are only beginning to become aware of the substantial economic activity in online games, but the games’ rapid growth and the substantial value of the many virtual assets changing hands in them is almost certain to bring them into the popular consciousness.

“Given growth rates of 10 to 15 percent a month, the question is when, not if, Congress and IRS start paying attention to these issues,” said Dan Miller, a senior economist with the Congress’ Joint Economic Committee, who is also a fan of virtual worlds. “So it is incumbent on us to set the terms and the debate so we have a shaped tax policy toward virtual worlds and virtual economies in a favorable way.”

Miller’s comments came during a Saturday panel called “Tax and Finance” at the State of Play/Terra Nova symposium, the fourth annual gathering at New York Law School of academics, lawyers, and other scholars to talk about the legal, social, and economic issues surrounding virtual worlds.

The panel was formed in the context of recent questions–first raised by author Julian Dibbel in his book Play Money and in an article he wrote earlier in Legal Affairs magazine–about whether the transfer of virtual assets, or players’ acquisition of virtual loot by, for example, killing monsters, creates taxable events.

“If you haven’t misspent hours battling an Arctic Ogre Lord near an Ice Dungeon or been equally profligate spending time reading the published works of the Internal Revenue Service,” Dibbell’s article began, “you probably haven’t wondered whether the United States government will someday tax your virtual winnings from games played over the Internet. The real question is: Why hasn’t it happened already?”

And while Miller’s committee began examining these issues in October, his comments Saturday suggested there could be wider future congressional oversight and a revised IRS tax policy. That’s in spite of the fact that Miller said his committee, and Congress in general, is not out to gouge virtual-world players.

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3. New World Notes: THE SECOND LIFE OF JUDGE RICHARD A. POSNER

So if Liden labs had not granted all it’s user’s property rights to there virtual goods then, the IRS’s argument that they should be able to tax them would be weakened.

Years from now, it may be that “Second Life” could be as prominent on bar exams as contract law. This isn’t a prediction of a New Age approach to torts. “Second Life” is an online role-playing game with dynamics that could draw U.S. law into virtual worlds. The game created a lot of buzz at the recent State of Play II: Reloaded conference, co-sponsored by New York Law School and Yale Law School.The game’s developer, San Francisco-based Linden Lab, rocked last year’s conference by granting players intellectual property rights to their virtual creations. Most game developers, such as Electronic Arts Inc. and NCsoft Corp., insist that all tools and characters created in digital worlds belong exclusively to the company. “Second Life” players, in contrast, do own the characters and objects they construct. Players can also use the game’s scripting language to write computer code that alters what their creations can do.

The line between virtual worlds and reality is already hazy for online games, such as “Ultima Online” and “EverQuest.” Players trade $880 million worth of virtual goods each year using third-party Web sites or Internet cafes that match buyers and sellers, according to Stephen Salyer, the president of IGE Ltd., an online currency and property trading site. Participants use credit cards and the electronic payment system PayPal. Typically, the buyer requests a meeting time in the game’s virtual bazaar, notifying IGE of his character name. Similarly, eBay currently counts more than 10,000 virtual items for sale.

Developers such as Sony Online Entertainment Inc., which owns “EverQuest,” ban trades using real money. General Counsel Andrew Zaffron cites concerns about spoiling the collaborative spirit among players, dealing with customer complaints when sales go awry, and disrupting Sony’s ability to fine-tune and refresh game content. But IGE’s Salyer says such arguments are mostly a “head-fake,” noting that many developers deny the real-dollar connection to avoid disputes if real-world property law ever applies to virtual goods.

Linden Lab’s “Second Life,” in contrast, embraces a more fluid border. Linden founder and chief executive Philip Rosedale argues that a virtual world with property rights and real income opportunities stimulates sophisticated online communities. One player, for example, earns real money creating intricate virtual airplanes and selling planes, flight time and sky-diving lessons to other characters. Then again, that income might just bolster a real-life court claim in the unfortunate event of a digital heist.

“Second Life” might further blur legal lines with its adoption of devices such as rents on virtual land. Once players buy parcels, they must pay Linden’s monthly land-use fees. Translatable into U.S. dollars, such fees could further weaken the idea that players build, buy and sell just for fun, says Alan Behr, counsel at Alston & Bird and head of the firm’s electronic entertainment task force.

Cory Ondrejka, vice president of product development, acknowledges that the game’s property and economic policies could eventually support virtual property claims in real courts. But he argues that other gaming companies are in denial.

Linden Lab also insulates itself from real-world liability over created property with a user license agreement that mimics those of Internet service providers, says Ondrejka. An entrepreneur who develops a new virtual car model, for example, might have a copyright claim against an automobile buyer who makes unauthorized virtual duplicates. But Linden would avoid liability as a hosting service protected under the Digital Millennium Copyright Act.

U.S. case law to date doesn’t provide a good road map for potential litigation stemming from these disputes, says Behr. But some foreign courts have begun to accept the notion of virtual property. Last December a Beijing court ordered the restitution of one player’s stolen virtual weapons. Given that the United States takes a much stronger stance on the idea of property than the People’s Republic, it’s not hard to imagine such claims reaching American shores — and soon.

Nice place. What are the taxes?

Related posts:

1. IRS taxation of game assets inevitable.
2. New World Notes: THE SECOND LIFE OF JUDGE RICHARD A. POSNER
3. Fantasy Life, Real Law