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Profits earned in online communities must now be reported to the IRS.

Second Life has become a second life to many current and hopeful entrepreneurs. Second Life is thriving and many people are dancing to the beat of a virtual income. Entrepreneurs have flocked to Second Life - a computer-based 3-D virtual world where users create a second life all online in pursuit of making real money. The Second Life residents can buy and sell goods for Linden dollars, an in-world currency that can be converted into real U.S. dollars.

I've talked to a couple of Lifers that claim that Second Life pays their apartment rent. Anshe Chung claims to be the first virtual world millionaire made entirely from Second Life.

However, eCommerce reality is getting a virtual wake up as the reality of the tax man and tax reporting has come knocking. Under current tax law, it's clear that earnings in real U.S. dollars generated within virtual realities are reportable to the IRS. If a Second Life real estate mogul cashes out of her Second Life in-world property portfolio, she's liable to pay income tax on any profit that's been exchanged into real dollars, just as an ebay seller is responsible for reporting income generated from an online sale.

On the other hand, the tax law is shadowy when it comes to virtual money where money is part of the game and has created its own currency. The big Life question: Is a transaction that occurs only in Linden dollars and doesn't involve any real-world, currency exchange taxable?

The logical answer would seem to be no, but questions like that have the tax community animated about the issue. Taxable exchanges have gained enough buzz that it has attracted the interest of the Joint Economic Committee of Congress. As virtual worlds gain popularity, they're studying issues related to the economies of virtual realities such as Second Life and World of Warcraft, (online role-playing games).

The results of the study are due to be released before the end of the month - and suggest that ""s long as virtual activity stays within the virtual economy, it shouldn't be taxable," said Christopher Frenze, executive director of the JEC, which conducts policy research on economic issues facing Congress

Many people are arguing that even the profits that are generated and stay within the virtual world are taxable. "As soon as you start looking at what's going on in these worlds, they look a lot like real economic transactions," said Bryan Camp, a professor at Texas Tech University School of Law.

"Even if profit isn't realized in real dollars, there's still an exchange of items of economic value. In the real world, if someone trades goods or services without the exchange of real money - also known as bartering - that's a taxable event," Camp noted.

With all of the attention drawn to Second Life and the thousands of Linden dollars that can be made the IRS eventually will have to respond to the debatable situation. "I think it's on the IRS's radar screen in a way it was not six months ago," Camp said.

Dan Miller, senior economist for the Joint Economic Committee became interested in the issue when he began exploring some of the virtual worlds in his free time. He says he has an open mind about how real world tax authorities should interact with virtual economies.

"We are starting with a blank slate and going through the various dimensions of virtual economies, and seeing where they might intersect with public policy," he said. Miller hopes to have a rough draft of his report done by the end of the year, although he admitted that some of his colleagues may need some convincing.

A CNN Money article on Second Life income stated that an IRS spokesman offered the following comment via e-mail: "Any time someone wins a tangible prize or award, the value is reportable as taxable income. An accumulation of points would not result in tax consequences, but redeeming or selling them for money, goods, or services would."

Second Life operator Linden Lab doesn't seem overly concerned about potential tax regulations on virtual economies, at least not yet.

"I found that talking about this issue with some of the other economists on the committee, they are not really familiar with what a virtual economy is. The idea of Second Life or World of Warcraft or some of these other synthetic universes, [is something] they have trouble wrapping their head(s) around. So there's an educational hurdle to overcome here," Miller said.

However, there are some on Capitol Hill who won't require much explanation.

"I can almost guarantee that there are some members of Congress spending time in Second Life or World of Warcraft," Miller said.


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