Virtual World Taxation: Theories of Income Taxation Applied to the Second Life Virtual Economy

Timothy J. Miano, George Mason University School of Law

Abstract

A virtual world is a computer simulated environment in which users interact with each other via graphical representations of themselves. Second Life is one such virtual world released by Linden Lab in 2003. One of the most important and interesting aspects of virtual worlds is the depth and sophistication of the economies that develop among the users. In fact, some virtual worlds, including Second Life, have currency exchanges where users can trade real-world currencies for virtual-world currency and vice versa. This means that the currency, goods, and services within the virtual-world marketplace have a corresponding real-world monetary value. The implication of this real-world valuation of virtual-world goods is that users can participate in the virtual-world activities for the purpose of creating real-world wealth. As such, there are implicit incentives within this system for users to participate in the activities that are wealth maximizing. This article explores the federal income tax consequences of the creation and expansion of Second Life—a virtual world where real people can engage in behavior constrained only by the time and efforts of those who wish to create the medium for a particular activity. Upon introducing the basic terminology and boundaries of Second Life and virtual worlds in general, it argues that the goods and services in Second Life possesses all of the same economic characteristic as real-world goods and services, and that it is improper to dismiss Second Life as no different than the video games that have, in part, given rise to the underlying technology. Having established that Second Life produces taxable income under the theoretical premises for § 61 of the Federal Income Tax Code, the article will analyze the activities in Second Life under the current tax law by examining whether the three primary operational limitations that currently exists in the tax code would exempt Second Life from taxation. Finally, this article concludes that under the current law the users of Second Life would properly be subject to some form of taxation for their in-world activities and briefly speculates at some policy reasons for why the government should delay taxing those activities despite the applicability of the tax law.