Tobold's Blog
Monday, August 08, 2011
 
The Diablo III tax question

There are obvious dangers in getting your tax advice from a gaming blog instead from an expert, but Stabs has good advice on your tax liabilities from Diablo III RMT AH sales. He is completely right in stating that your taxes are your personal responsibility, not Blizzard's, and you should inform yourself whether you need to pay taxes on the money you make from selling Diablo III items for real money in the AH. It is quite likely that if you make serious money from this activity, you'll need to pay taxes on that.

The far more interesting question is whether you would have to pay taxes if you don't make any real money from Diablo III auction house sales. Basically it could be argued that if a virtual item is worth real money, gathering those virtual items is an income, and thus taxable. The horror scenario is that the legendary Sword of Uberness which is worth $1,000 on the AH drops for you, and you'd have to pay taxes on those $1,000 even if you never sold the sword.

Now I am not a lawyer, nor a tax accountant, but I find that scenario somewhat unlikely. For example there are Olympic medals for sale on EBay (I checked and saw a gold medal for sale for $15,000). Thus Olympic medals clearly have a monetary value if you'd chose to sell them. Nevertheless winners of Olympic medals aren't taxed on those medals as a form of income. They'd be taxed on the sales if they sold the medal, but not as long as the monetary value was hypothetical before any sale took place. Basically the question is at which point in time you actually made a taxable income, at the point where you gained the item you could sell, or at the point where you actually sold it. I'm pretty certain it is the latter. If you create a vase out of clay, you'd be taxed on selling it, not the moment you take the finished vase out of the oven.

Blizzard getting you in trouble by sending the list of the items and gold that dropped for you in Diablo III to the IRS is not going to happen. Blizzard getting you in trouble by sending a list of your real-money AH sales to the IRS is far more likely. And even there the trouble might only start the moment you cash out that real money. You might want to reconsider your plans of quitting your job and becoming a Diablo III item farmer. Or as Benjamin Franklin said: "in this world nothing can be said to be certain, except death and taxes".
Comments:
Thanks for the link, Mr T.

If anyone is unclear whether they need to declare it best bet is just to email their tax office. (Email, not phone so you have a record).
 
I, for what it's worth, AM a tax accountant in the UK.

I can say that a UK resident would only have to pay tax on AH profits if he/whe were trading in an organised manner with a view to making a profit. This will rule out most casual AH-ers and rule out tax on item drops. I think that in any case the UK tax authorities would be very unlikely to take a case unless the amount of tax at stake was large, because if they are going to tax you on your profits then logically they have to give you tax relief for your losses against your salary or other income, which they would not be keen on doing.

For VAT (UK sales tax) there is no requirement to charge VAT unless your annual turnover exceeds £70,000 or thereabouts.

This is a non-point.
 
This has been a topic in virtual world research for years (at least since 2006). Here's a paper by Leandra Lederman form IU Bloomington as it appeared in the NYU Law Review on the topic: http://hivenet.is/magnusson/hachan/Grein%20um%20WOW.pdf

The folks over at TerraNova have been blogging about it quite a bit as well. I don't see how Diablo III would be any different on this matter.

In short, report taxes when you're "cashing out". Even the IRS recommends it. http://www.irs.gov/businesses/small/article/0,,id=215593,00.html
 
Because item drop rate is somewhat fixed, a player erning potential is, in fact, directly related to the number of hours he/she plays.
So I think it would be fairer if players were taxed proportionally to the number of play hours logged on their computers. ;P
 
I don't see how Diablo III would be any different on this matter.

The difference between let's say WoW and Diablo III would be that RMT in WoW is not permitted, while it will be completely legit in D3. My WoW characters and gold are probably "worth something", but I can't cash out on that value in a legitimate way.
 
"The difference between let's say WoW and Diablo III would be that RMT in WoW is not permitted, while it will be completely legit in D3."

We've had virtual worlds with "legal" RMT for quite a while now. (Second Life,Entropia Universe, EVE in a way)

In addition to that, there is a difference between violating the ToS of a game and legality. I'm not sure if the fact that the ToS forbids RMT would make any difference in the view of the taxing authorities. I'm a layman though, so I might be completely wrong there.
 
IN particularly fun news, as we've already seen, this is going to be a country-by-country issue.

As Everblue says, it's a non-issue for the UK, for example. However, just because it's a non-issue for the tax system of the UK doesn't mean it's a non-issue in Germany, or Poland, or Argentina.

Having said that, on your last comment - if you are even vaguely considering starting any sort of business without having thought about tax, it might be a good idea to reconsider. This isn't a problem limited to Diablo!

- Hugh @ MMO Melting Pot
 
The far more interesting question is whether you would have to pay taxes if you don't make any real money from Diablo III auction house sales.

No, it's not interesting at all. It's settled law with all sorts of real world analogs.

Income realized from the sale of collectibles is taxed at the point you sell them, not the point at which you acquire them.

If you go down to the jumble shop and find a $10,000 antique and buy it for $10, you have not earned any money and you are not subject to income tax. It's when you sell it that you are taxed.

Among other things, there's no way the tax man could tell if you were going to sell that $10k antique retail and get the entire $10k or whether you were just going to sell it to an antique dealer for $5k (leaving him room to make a profit).

There's a variety of rules depending that vary by country, holding time and so forth that determine whether this is a short term gain taxed basically as income or a long term gain taxed under capital gains.

But it's very clear, you owe no income tax until you receive income from an item.
 
"But it's very clear, you owe no income tax until you receive income from an item."

What about people who go on game shows and win expensive cars or trips to Bermuda? I always thought they were taxed on their non-cash winnings, despite deriving no immediate income.
 
"I can say that a UK resident would only have to pay tax on AH profits if he/whe were trading in an organised manner with a view to making a profit. This will rule out most casual AH-ers and rule out tax on item drops.

This is a non-point."

Everblue, you're making a logical leap that really isn't justified. You're right about VAT, you're right that income tax only becomes an issue if you are deemed to be a trader.

But the Revenue's standard for what is a trader is going to be strenuously tested by this game.

They judge whether you're a trader or not based on a number of criteria that suggest you're like a business.
For example:
if you advertise (many casual players will spam chat if they have something to sell)

if you buy and resell for a profit (this is a normal game behaviour for many of us that we buy in gold and sell for a gold profit).

if you sell the item quickly (will very often be true).

There's no exact precedent for this system and it will give the Revenue something to think about. Here are their Am I a hobby or a business examples, some like the cushion maker are very close in spirit to what a Meph magic finder will be doing and are considered businesses. http://www.hmrc.gov.uk/guidance/selling/examples.htm

Here are the badges of trading used by HMRC. Some "casual" players using the real money AH will tick almost every box.
http://www.hmrc.gov.uk/guidance/selling/badges.htm
"It is not always easy to decide even using these ‘badges’ because a trade may exist even if only one or two of the indicators are present. "
http://www.hmrc.gov.uk/guidance/selling/income.htm

My point is we haven't seen anything quite like this before, nor has the Revenue and if many casual players make £20-50 per month it's possible HMRC might want a cut.

This is not a non-point.
 
According to the IRS (US), you need to make more than $9,350 to pay taxes. I doubt a Diablo 3 item farmer could make that much unless they are botting. However, I could definitely see someone making $1,000 or so supplemental income (in addition to their regular salary/wages) that would need to be filed.
 
Yeah, in theory you should report your profits. But, and this is a big but, I don't think there will be any.

I don't think there will be many Americans who can make a living doing this. Based on what's been said so far the drops are random and most will quickly become all but totally valueless. It will be very difficult to extract significant profits when you must pay to list an item, sell an item, and then give a % to the transaction company that actually turns it into hard money. Blizzard is designing the system so THEY can make a living off of it. Not so other people can.
 
What if you GIVE that sword away? I know a few years ago on the Oprah show there was a big issue of her giving people cars. She gave them cars for free but those cars were then taxed as income for the contestants.
 
According to the IRS (US), you need to make more than $9,350 to pay taxes.

So... anyone who buys Diablo 3 that also has a job. Or makes $180 a week.
 
Aw what the hell. I would just declare that income and get it over with. Even if I were taxed 30% (which I believe is about the maximum it can be), it's money made by having fun so I wouldn't mind a lot.

What I'm wondering is whether you have to pay taxes if you don't take the money out of Blizzard's system. What if you use that money to buy virtual items, other games, etc from Blizzard's own store?
 
What about deductions? Can I claim the costs of my gaming computer and internet connection as a business expense and get a tax refund? I guess you might have to prove somehow that you never used the computer for anything other than gold farming, or else you couldnt claim the full cost.
Interesting to think about anyway.
 
Something else to consider is that in some places an inventory tax is charged annually. I don't know the details, but it happens.

Fun times ahead!
 
Part of this that is really going to test the system is the fact that while everyone has a good idea of how you tax or don't tax physical items that have a clear ownership absolutely no one has an understanding of how you do the same with a virtual "item". The quotes on "item" are entirely necessary since in fact I can almost guarantee that the Blizzard EULA will make certain to state that any in-game item is in fact a part of the service you are buying... not an actual item with ownership attached to it. Further it is entirely unclear whether your "ownership" of the service your "item" represents has any real legal entitlements or is simply a fantasy market fiction created by a new Blizzard EULA for the sole purpose of allowing them to extract a percentage of profit on a controllable RMT system. I think it is hard to predict exactly how this will conflict/interact with any tax system without knowing the mechanics of the system in detail.

Really this system is not a player to player system with Blizzard providing the silent neutral market place. Blizzard wants you to see it as one but the fiction of what you "own" will soon show you the true nature of the beast here. This system is straight up RMT, pay to win. The only difference is that Blizzard is making someone actually farm an item before it is introduced in the market for sale. Rather than wave the magical programmers wand and create 10000 uber swords to sell they are allowing the RMT market to be driven entirely by the players themselves which is a clever way to avoid anyone closely examining their own involvement which should be noted is entirely in taking a percentage of the sale. If the market has a lot of cheap items through character farming it will generate profit on volume. If the market has expensive items through scarcity then they earn off the those willing to spend the most. And behind every sale and every drop they can control and change the scarcity and volumes at will without anyone knowing. Do you know whether they intend to balance for gameplay or RMT profits? How do you make the distinction going forward?

They are the silent partner to every farm and every sale without the straight up drama.
 
US tax law requires that every form of income be declared; however, they also choose when and how to enforce that requirement.

Except in some relatively rare cases, I expect that sales by individuals will be far below the give-a-crap threshold.
 
I'm curious about the distinction between online gambling and A cash AH. Isn't farming for a rare drop essentially like a slot machine?

Could the game be restricted in that case to adults?
 
This is an interesting discussion, but it's all moot for most people. Anyone who thinks they will make a substantial amount of money selling their drops hasn't realized that the Chinese farmers will be ALL OVER this game and anybody playing less than 16 hours a day has absolutely no chance to compete.
 
The horror scenario is that the legendary Sword of Uberness which is worth $1,000 on the AH drops for you, and you'd have to pay taxes on those $1,000 even if you never sold the sword.

I remember a baseball world series game not too long ago, where a game/series winning homerun ball was caught by a spectator. The moment this spectator caught the ball it was mentioned by the sports commentators that IRS Agents had ALREADY put a value on this ball, and this ball had X value(I dont remember the exact value, but it was in excess of $100,000.00), and that the spectator who caught the ball would be liable for taxes on this ball even if he never sold it.

Do people really think that the IRS isnt going to be watching the value of items in this game with this in mind? I think that it's highly likely that they will be.
 
@Harri

Anyone who thinks they will make a substantial amount of money selling their drops hasn't realized that the Chinese farmers will be ALL OVER this game and anybody playing less than 16 hours a day has absolutely no chance to compete.

Let's hope that Blizzard will not make the same mistake with D3 that it made with WoW where server co-location is concerned. The technology is in place NOW that can prevent the Chinese Farmers from being able to play on US servers. It will be interesting to see whether or not Blizzard chooses to employ it.
 
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