Bitcoin, the rapidly growing electronic currency, recently caused the Government Accountability Office to issue a report, urging the IRS to provide more guidance on this new “ cryptocurrency .” There’s even less state-specific guidance on the issue of income or sales taxation of bitcoin transactions.
The emergence of these virtual economies will likely put additional pressure on the states to derive tax revenue from transactions that are conducted independently of state, local, or international borders. A major question is whether states can update their pre-digital tax regimes in a way that is constitutional as well as equitable to businesses and consumers.
The issue of electronic currency taxation becomes even more complex when considering the subset of virtual currency that can only be used to acquire items and services within a specific online game.
While there are ways to earn in-game currency by performing actions within the electronic universe, some games allow players to purchase in-game currency using real-life money, like in the popular Zynga game “ Farmville .” In many cases, however, currency that is not otherwise purchased with real-life money is obtainable on the “black market,” as entrepreneurial gamers auction off in-game currency, which they will eventually transfer to the player using in-game mechanisms.
For example, in the massively multiplayer online role-playing game (MMORPG) “ World of Warcraft,” which boasts the most players of any MMORPG with over 8 million subscribers around the world, virtual currency and in-game items can be mailed between users. This has led to a practice called “gold farming,” in which players acquire in-game currency through legitimate interactions within the game, but then conduct a third-party exchange outside of the virtual world, where the seller exchanges in-game currency for real-life money. Gold farming is so successful that some people holdfull-time jobs engaging in the practice. While gold farming may technically be legal under U.S. law, it is explicitly banned by World of Warcraft’s terms of service.
Guidance on the tax treatment for the exchange of in-game currency into real-life money is scarce. The IRS has briefly addressed the existence of in-game currency in “ Tax Consequences of Virtual World Transactions ,” posted on its website. Beyond noting that gains from virtual dealings may be reportable, the IRS does not offer any real instructions for gamers, but merely sends them towards topics “similar to activities in online gaming worlds” such as online auctions, bartering, and electronic business.
The recent report from the Government Accountability Office, “ Virtual Economies and Currencies ,” mostly deals with concerns over “open flow” system transactions in which virtual currency and U.S.dollars can be freely exchanged, like through bitcoin. Another example of this type of system is “ Second Life ,” an online world which also provides a legitimate market for the conversion of in-game “linden” dollars to U.S. dollars, called the “ LindeX exchange .” Games such as World of Warcraft, however, in which exchange of in-game currency with real-world dollars is not allowed, fall into a sort of hybrid system that the report only addresses briefly.
Guidance surrounding the sales of electronic “goods” within game environments is also scarce. From a state sales tax standpoint, should these in-game purchases be characterized as the purchase of tangible personal property, which is generally taxable, or a service, which is generally exempt? In other words, when I sell the sword that I earned after hours of arduous tasks, am I selling tangible personal property, or a service? And if I am selling tangible personal property, where should I source the sale—to the location of purchase or the location of the server?
Obviously in-game currency has created a series of problems that can’t be solved by a nine-sentence blurb on the IRS website. The GAO report urges the IRS to issue more specific guidance to taxpayers who engage in the use of electronic currency. Whether the IRS will focus on bitcoin or turn its eye to in-game currency is yet to be seen.
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