Sorry, You Can't Escape Taxes In the Metaverse

Yes, intangible assets earn tangible tax burdens, including on sales of digital assets. 

And just when so many thought they could leave all their earthly troubles behind. JL 

Kyle Orland reports in ars technica:

The 2018 Supreme Court decision South Dakota v. Wayfair, Inc., Et Al established that states and localities could charge sales tax for products sold by online companies that don't have a physical presence in that state. Aside from possible local sales tax exposure, cryptocurrencies can be taxed as income or capital gains when they're earned, sold, or converted to another form. NFTs could be taxed as collectibles, attracting a top capital gains tax rate of 28% in the US. And the IRS is starting to crack down on enforcement for crypto-based earnings thanks to a provision in last year's bipartisan infrastructure bill.Second Life, the long-lived online metaverse that still attracts nearly a million monthly active users, has announced it will start charging US users local sales tax on many in-game purchases for the first time since its launch in 2003. That could be a significant drag on the online universe's robust in-game economy and serve as a warning for other nascent metaverse efforts hoping to sell virtual goods to US residents.

In announcing the move Monday, Second Life developer Linden Labs cited the 2018 Supreme Court decision South Dakota v. Wayfair, Inc., Et Al. That decision established that states and localities could charge sales tax even for products sold by online companies that don't have a physical presence in that state. Following that decision, Linden Labs says it has "done our best to shield our residents from these taxes as long as possible, but we are no longer able to absorb them."

As such, starting March 31, Second Life users will be billed for local taxes on recurring billings such as subscriptions and land fees. Linden Labs will continue to absorb any taxes charged on one-time purchases like name changes and purchases of L$ in-game currency. But those costs will be passed on to users "at some point in the future" Linden Labs writes.

"This is news we don’t enjoy sharing, but for the health of the business and of Second Life, we can no longer continue absorbing these tax burdens," Linden Labs writes. "Thank you for your understanding and your continued support of Second Life."

Declare the pennies on your eyes

Specific sales tax rates can vary widely from state to state, and many localities charge additional sales taxes on top of that. Residents in four states—Delaware, Montana, New Hampshire, and Oregon—pay no sales tax at all, while seven cities—including Seattle, Chicago, Los Angeles, and Oakland, California—charge residents over 10 percent in combined state and local sales taxes on every purchase.

Those taxes could have a significant impact on Second Life's US customers, who account for nearly half of the user base, according to SimilarWeb estimates for visits to SecondLife.com. All told, Second Life still generates roughly $600 million in economic activity each year and pays users over $80.4 million annually in real-world cash, according to a September report from VentureBeat.

While US users have long had to pay income taxes on any real-world money pulled out of the Second Life economy, the additional sales tax fees could be a significant drag for many users month to month. "I have to think this will have a huge impact on the Second Life economy and the community culture as a whole," longtime Second Life observer and journalist Wagner James Au writes.

One user on the Second Life community forums, Teresa Firelight, detailed how local California taxes will add about $20 a month to their current $202 of monthly investments in Second Life regions and land parcels. That increase could force them to cut back on spending for alternate avatars (or "alts"), which each come with their own taxable $8.25 monthly premium subscription. "Plus there is the annoyance factor... being annoyed at a tax may make me want to cut back my premium alts even more as they expire," Firelight writes.

Enlarge / This virtual tropical island may look a lot like a real-world tax haven, but don't be fooled...

Linden Labs

While the new cost could come as a shock to US Second Life users, those in Europe have been paying value-added tax rates of up to 17 to 27 percent on Second Life purchases since 2007.

FURTHER READING

Second Life “land” dispute moves offline to federal courtroom

Griping about taxes isn't new to Second Life, either. Early in the game's history, Linden Labs tried to create a complicated tax system that automatically deducted more in-world L$ from users that built more in-world objects (thus using up more of Linden Labs' server resources). That led to an organized in-universe tax revolt, which in turn led Linden Labs to change to its current system of charging users directly for land via a monthly fee.

Linden Labs' experience could serve as a cautionary tale as other major companies all rush to launch their own metaverse offerings. That includes companies using so-called "Web3" technologies like cryptocurrencies and NFTs to power their virtual economies.

Aside from possible local sales tax exposure, cryptocurrencies can be taxed as income or capital gains when they're earned, sold, or converted to another form. NFTs, meanwhile, could likely be taxed as collectibles, attracting a top capital gains tax rate of 28 percent in the US. And the IRS is starting to crack down on enforcement for crypto-based earnings thanks to a provision in last year's bipartisan infrastructure bill.