IRS Clarifies Tax Treatment of Bitcoin and Other Convertible Currencies

[Andrews String]

The IRS issued on March 25, a notice (link) which describes how the IRS will apply U.S. tax principles to transactions involving virtual currency.  The GAO had previously issued a report (link) on virtual economies and currencies, calling for additional IRS guidance on the basic tax reporting requirements applicable to virtual currencies.

Reading through IRS's notice I have not clearly identify what exactly our transactions with linden lab stand for in order to determine how any earnings from second life would be treated regarding taxes in USA. I am not a US resident but live in Europe. However, in my country they have not even heard of second life so before asking an accountant in my country, I would first like to know what kind of income does IRS of USA consider second life earnings as.

So my question is whether someone's earnings selling for example virtual clothes in second life are subject to the self-employment tax in USA or what? Thoughts by anyone who either knows better or have understood better recent notice by IRS, would be deeply appreciated! Thank you in advance.

[Griffin Ceawlin]

In general, you can receive income in the form of money, property, or services. If you receive more income from the virtual world than you spend, you may be required to report the gain as taxable income.

http://www.irs.gov/Businesses/Small-Businesses-&-Self-Employed/Tax-Consequences-of-Virtual-World-Transactions

[Andrews String]

Thank you for answering here. I have already read most of this stuff but still my main question remains unanswered or at still I can not understand this matter myself. In other words, I have not realised what is my earnings as well as my activity in second life condidered as by U.S. law?

Let me explain..

I create virtual clothes. I sell them and earn linden dollars. I then sell my linden dollars through linen lab to other residents for real $USD. I totally understand this is a kind of income out of this activity that is taxable. IRS has recently named this income that comes from transactions with "convertible virtual currency". However, I am uncertain over how to characterize activity that gives me this income. Does selling virtual stuff put my self under the same category with an individual who sells real clothes? Or anything else applies?

[Cory Toll]

I would assume if my lindens stay inside SL I wouldn't have to pay any taxes.

 

I always thought that Linden Labs paying taxes would be enough since it's all their stuff and the money they send out to people is something other than "payment" since most of us don't actually work for them. They take fee's and such from us in multiple places. I'm not personally on the up and up about tax stuff so I don't know what I'm talking about. But I don't see why the government would have to dip their hands into our money if they've already taken some from LL as a bussiness that's holding our virtual businesses in which we have to pay land fees among other fees with the marketplace SL now owns and withdraw fees which may or may not cover the taxes that LL has to pay.

 

Maybe it would be more cut and dry if SL were an actual 3D internet that no one owned and people could actually own their servers and be hosts and all that jazz. I understand taxing bitcoin, or at least the concern that they think they should tax it along with those other currency. crypto currency or whatever.

[Drake1 Nightfire]

If you cash out from SL you have to claim that money. Plain and simple. Depending on the amouts would tell you what to classify it as.. Do you have to work outside of SL to pay your bills? If so then it would be "extra income." If SL pays for everything then you are self employed. I hope you can afford insurance.

[Andrews String]

Thank you for answering. What or who justifies wether you have or not to work outside sl to pay your bills? I mean, lets assume that my main job is outside sl. However, I also have an income from second life. In general what are the criteria that would make me self employed? 

[Griffin Ceawlin]

Who is Self-Employed?

Generally, you are self-employed if any of the following apply to you.

• You carry on a trade or business as a sole proprietor or an independent contractor.
• You are a member of a partnership that carries on a trade or business.
• You are otherwise in business for yourself (including a part-time business)

 

http://www.irs.gov/Individuals/Self-Employed

[Pamela Galli]

The IRS does not care much how you make your money.

 

Something tells me some people may get hit with a bill for back taxes.

[Parrish Ashbourne]

I've found a few articles recently that are saying that the IRS is now going to treat convertible currencies as capital gains?

http://www.forbes.com/sites/kellyphillipserb/2014/03/15/taxes-from-a-to-z-2014-h-is-for-holding-period/

http://www.forbes.com/sites/peterjreilly/2014/03/26/bitcoins-not-tax-fairy-dust-second-life-still-a-tax-haven/

 

[Andrews String]

Thank you for answering as well as providing this information. If someone takes a careful look through the last notice of IRS that is the title of my thread should read this: 

"For a more comprehensive description of convertible virtual currencies to date, see Financial Crimes Enforcement Network (FinCEN) Guidance on the Application of FinCEN’s Regulations to Persons Administering, Exchanging, or Using Virtual Currencies (FIN-2013-G001, March 18, 2013)" 

Relevant link FinCEN's guidance here

 

So my main question in this thread was not wether any earnings from second life are treated like a taxable income by the law. We all get they are! My question had to do with how finally this income is characterised by the law since different forms of income have different tax rates.

I really appreciate the fact that some people try to help providing various links by IRS or anything else that matters. But I think your answer Parish was the only one actually relevant to my question!

After all, is there anyone (that should actually be a lot) that has any income from second life to let us know what his/her income is treated like by the law? In other words what is his/her income is characterised as by tax authority and what is the tax rate?

(Answers like, this is a taxable income, go there and read, are not really relevant with this post since there is a recent notice of IRS that I call everyone her to read first!)

 

[Perrie Juran]

---

Andrews String wrote:

Thank you for answering as well as providing this information. If someone takes a careful look through the last

notice

of IRS that is the title of my thread should read this: 

"For a more comprehensive description of convertible virtual 

currencies to date, see Financial Crimes Enforcement Network (FinCEN) Guidance on 

the Application of FinCEN’s Regulations to Persons Administering, Exchanging, or 

Using Virtual Currencies (FIN-2013-G001, March 18, 2013)" 

Relevant link FinCEN's guidance

here

 

So my main question in this thread was not wether any earnings from second life are treated like a taxable income by the law. We all get they are! My question had to do with how finally this income is characterised by the law since different forms of income have different tax rates.

I really appreciate the fact that some people try to help providing various links by IRS or anything else that matters. But I think your answer Parish was the only one actually relevant to my question!

After all, is there anyone (that should actually be a lot) that has any income from second life to let us know what his/her income is treated like by the law? In other words what is his/her income is characterised as by tax authority and what is the tax rate?

(Answers like,

this is a taxable income, go there and read

, are not really relevant with this post since there is a recent notice of IRS that I call everyone her to read first!)

 

---

I read through that and one problem I see is I don't think the IRS has yet thought through every case scenario. 

In SL you've got two forms of income.  First is your income from the sale of goods and or services.  But then a second form possibly comes into play.  If you leave your $L on the Lindex hoping the value will go up.  At that point you are investing your $L. I hate to think the type of book keeping involved here.

The IRS letter did specifically state that a Bitcoin Miner is subject to Self Employment tax so they are not treating all activity as Capital Gains.

At least to me, for the IRS to say that your earnings from the sale of goods and or services is a capital gain seems to fly in the face of all logic.

What a fricking mess.

 

 

[Andrews String]

Thank you for answering!

After heaving read through linden lab's TOS, IRS's notice and FinCEN's relevant guidance, to me, the sale of virtual goods and services is not considered equivelant to the the sale of real goods and services! In addition, since any earnings that remain as L$ into Second Life are not money at all, the sale of virtual goods and services does not constitute a self-employment income that is subject to self-employment tax. Our earnings are considered as income only when we sell our L$ to other residents through the LIndex Exhchange, and we are even able to retain any L$ we have gathered before for more than a year. This last activity of exchanging or selling my L$ (that is considered by IRS as convertible virtual currency) is a taxable income but it is not any more a "sale of goods or services"..This is where the mess is for me, and what I really don't understand at all. That is why I thought opening this thread, but it seems no merchant with a taxable income replies, at least to let us know how is his/her income has been treated by the IRS till now. Imagine I don't even live in US..

[Perrie Juran]

---

Andrews String wrote:

Thank you for answering!

After heaving read through linden lab's TOS, IRS's notice and FinCEN's relevant guidance, to me, the sale of

virtual

goods and services is not considered equivelant to the the sale of

real

goods and services! In addition, since 

any earnings that remain as L$ into Second Life are not money at all, the sale of virtual goods and services does not constitute a self-employment income that is subject to self-employment tax. Our earnings are considered as income 

only 

when we sell our L$ to other residents through the LIndex Exhchange, and we are even able to retain any L$ we have gathered before for more than a year. This last activity of

exchanging or selling my L$

(that is considered by IRS as convertible virtual currency) is a taxable income but it is not any more a "sale of goods or services"..This is where the mess is for me, and what I

really 

don't understand at all. That is why I thought opening this thread, but it seems no merchant with a taxable income replies, at least to let us know how is his/her income has been treated by the IRS till now. Imagine I don't even live in US..

---

Curious question here.  Why does how it is treated in the U.S. matter to you?  Will it affect how you report it in your own Country?

I'm not an SL Merchant so can't answer as a Merchant.  Nor am I a Tax professional. 

[Andrews String]

In my country noboady cares nor have heard of second life..I would say here most updates on this matter start from USA and then other countries mostly follow up these updates. I am on way to write and send a relevant question to my country's tax authority. Since they dont know second life and even virtual currency dont seem to be in its priorities, I want to present this matter as more accurately as it could be. This is why I need to report how IRS of US treats relevant issues, since as I said evrything regarging this matter start here..I hope I have covered your curiocity By the way since your are not a merchant here, I appreciate even more your contribution!

[PaperB]

Im from South America, from a tiny country, and they havent heard much in my country about sl either.

But here is the thing, I can tell you for sure, my country IRS will know eventually that I got money from my paypal, and Im pretty sure they will in your country as well.

In my case for instance, the tax US IRS charge me is lower than the tax I would have to pay for the same work  income in my country. Despite the way you can see or not see the work you do here in sl, and despite this is virtual goods, you are working, and you are selling, what in my country at least its call a service. I work as a self employer making internet services. and thats what every merchant in sl is doing.

You arent selling real goods, but virtual goods are seen as an intangible, like softwares and correct me if im wrong, life ensurances. And youre getting real income out of it, that goes to your paypal account and finally to your hands. So you are getting a real income.

You can go and not pay taxes in your country you might get away with i, or you might encounter a huge bill a couple of years from now.

In my country, if I just grab the money from paypal and just start paying my bills, or using it on my credit cards to buy stuff, they eventually will know, that im getting extra money. At least here is like that, they can check your bank account status, they can see what stuff you pay and if youre not working in rl, or have another income beside this, they will eventually know, so I rather be assure and pay the taxes to IRS, that in my case is less money than if I pay them here, so to my country IRS, i figure out as a self employer that sells services to USA and within USA law and servers, pretty much like if im working there actually)

[Andrews String]

Thank you for answering! First of all, the right and responsible thing for every citizen of any country is to pay his bills. So do I! So my thoughts are not against that anyway! But since this is something new all the conversation that is happening with virtual currencies I try to figure out the principles that apply to them. That is this conversation about. By the way, you mentioned you pay taxxes to the US IRS because in your country tax costs would be more. Have your country tax treaty with US? In case it does (my country actually does), are you free to choose where to be taxed? And if so, what is the paperwork or any other process you had to do in order to do so? Any information on that would be really usefull for future reference. Thank you for your contribution!

[Parrish Ashbourne]

Found some more resources about vitural currencies in an artical at hypergridbusiness one has a large list of  international reffrenes

http://www.virtualcurrencyreport.com/files/2014/03/Virtual-Currencies_International-Chart.pdf

http://www.virtualcurrencyreport.com/

http://www.virtualcurrencyreport.com/2014/03/irs-clarifies-tax-treatment-of-bitcoin-and-other-convertible-currencies/

[PaperB]

My country dont have a tax deal with the US. Thats why, to avoid paying double taxes What i rather do is I pay US taxes and in my country I had to open a small bussines company for services. For this i pay a small fee a month. This is surelly different in every country. My advice is you go to your irs office and find out your best option. It might me the same as mine or might be different. The fact that you earn it in sl it doesnt matter, you could be selling your work elsewere on the net. What it does matter is you are making internet content and are getting pay by it, and getting your money from paypal. This is appart from the virtual currency issue really. Its just about the real money you are getting from paypal to your bank account or credit card or whatever you use to get it.

[Andrews String]

Thank you for the great sources!!! You have been quite helpfull!

@PaperB: Thank you for letting us know your situation in more details. I appreciate your answer!

[Steph Catseye]

Thank you Parrish for the interesting sources.

That been said these sources use words such as "likely" and probably etc..
They are no legal guides but they bring you up to speed.

Given the recent past of the US Government and their surveillance it is just a matter of time where your transaction history is becoming relevant for the IRS. I don't think they will burden themselves and have you pay taxes for each microtrnsaction but you will have to submit your entire Transaction history as proof for your win/loss calculation. Like I said it is a matter of time it is not happening now.

[LillyBeth Filth]

In answer to your question. It's really quite simple.

Virtual currency has zero value and is of no interest to the TAX authorities UNLESS you transfer it for real currency ie: sell it. 

So you can make as much L$ as you like and spend it all in SL and that's fine but if you start "cashing out" and that money is filtered through PayPal or any other online money transferring service there will be a record and you need to aware of it in case the tax man comes knocking.

As it happens, he already has on Linden Labs door. 

I would imagine a certain amount of "mass exodus" of people from SL when this poo hit the fan.

Years and years worth of unpaid taxes is enough to make anyone run for the Hills but I don't integrate with SL like I used to so I am clueless as to whether businesses have suddenly vanished.

Anyway my story...shortly after I posted in these forums some weeks back in relation to the tax forms etc.. a SL person contacted me asking me about how she should do ABC

She explained she did not "own a business"  in SL but that she DID cash out a lot. She went on to say her money came from "gifts" ... long story short she was an escort. And she laughed at the idea of "Taxing sex" and how she should increase her rates if she now has to pay tax.

Made me wonder if I was in the wrong profession! I had no idea escorts made THAT amount of money from "Cartoon sex" Jeez men are gullible! It could be a fat hairy bloke in a string vest for all the paying customer knows... why don't they just watch a porno of real people...? Anyway... I digress... 

Just wanted to share.. 

Edit:

I have come to realise my initial frustration to peoples "shock and outrage" that they have to pay TAX was a bit harsh.

I think it depends on what country you come from. Here in the UK you can't fart without being taxed so the concept was not alien to me and and I was not surprised when LL asked for the forms in fact, I am amazed this hasn't happened sooner as LL should have initiated this process considering the millions of RL dollars they have paid to people from all over the globe.

How much as the TAX dept lost over those years? 

The delay in pay outs is as a result of this TAX issue.. I would imagine their staff are stretched to capacity with questions and support tickets all relating to TAX forms.

 

 

 

 

[Pamela Galli]

---

Steph Catseye wrote:

Thank you Parrish for the interesting sources.

That been said these sources use words such as "likely" and probably etc..

They are no legal guides but they bring you up to speed.

 

Given the recent past of the US Government and their surveillance it is just a matter of time where your transaction history is becoming relevant for the IRS. I don't think they will burden themselves and have you pay taxes for each microtrnsaction but

you will have to submit your entire Transaction history as proof for your win/loss calculation.

Like I said it is a matter of time it is not happening now.

---

No. As others have pointed out, the IRS doesnt care what anyone does with their Lindens, just about what they do with the USD they get when they cash out.  The cash out IS your "win/loss calculation" (AKA "profit").