Are Virtual Game Economies Now Taxable? The IRS Clarifies Reporting Requirements for Virtual Currencies in Online Gaming

By Mitchell Kopelman and Maggie Crow

The taxability of virtual currency has been a hot topic for the IRS recently. In October 2019, the IRS issued several Questions and Answers (now expanded to 45 topics and counting), which provided the first guidance since 2014 on the taxability for virtual currency transactions. Most notably, the IRS launched the first reporting requirement for virtual currencies by requiring taxpayers to disclose on Schedule 1 of Form 1040 whether they “received, sold, sent, exchanged, or otherwise acquired any financial interest in any virtual currency.” With this announcement, the IRS stated that the new guidelines also applied to “convertible” virtual currency, specifically referencing Bitcoin, Ether, and even V-bucks, which are a virtual currency unique to the popular online video game Fortnite, in the original language on the IRS website.

Red flags and questions

This wording immediately set off red flags among the taxpayers and preparers.

• Would all transactions in the virtual economies of video games now be taxable?
• Will children and preteens across the country now be taxed on their virtual success in World of Warcraft?
• Are Grand Theft Auto enthusiasts racking up tax liabilities with each investment in a virtual hot rod?
• What about more ambiguous currencies, like the gold and gems players use to advance in popular games like Smite from Hi-Rez Studios?

Clarification from the IRS

The IRS heard these concerns and appeared to see the error in their ways. On Feb. 14, 2020, the IRS issued a clarification on virtual currency transactions within online gaming environments, specifically stating that taxpayers are not required to report any virtual currency transactions that occur and remain within an online game environment. They also removed all references to gaming-related virtual currencies from their site, leaving only Bitcoin as an example of a “convertible” virtual currency.

In their statement, the IRS also clarified that, while some of these virtual currencies in online gaming may technically be convertible, they often never leave the game environment itself. Players simply earn, trade, and spend their currency in the game environment through in-game purchases, like customizing a character or advancing the gameplay. While these currencies are crucial to players’ existence in the game, they are distinct to the game itself and are not convertible or transferable for U.S. Dollars or for currency in unrelated games. As long as the virtual currency is not converted to a non-virtual state, then the taxpayer should not indicate these transactions on their tax returns. However, if a player is involved in an online game where the virtual currency is convertible into a non-virtual form, then that transaction might still be taxable.

In some cases, gaming companies that have developed more than one game allow their communities to move tokens between games.  Gaming companies have also been working on plans to create tokens that can be used offline.  This exists already, and several game developers are looking to capitalize on this using blockchain technologies. As this kind of technological evolution continues in the gaming world, the IRS will have to continue to evolve as well; this latest guidance will undoubtedly not be the last.

Guidance for game developers

Are you a game development company or otherwise involved in online gaming with virtual currency? Still confused by the new reporting requirements? The professionals at Aprio are constantly evaluating the new guidance and are prepared to help you stay informed with relevant new tax laws. Contact Mitchell Kopelman for more information about gaming companies and/or virtual currency at mitchell.kopelman@aprio.com.