Paying taxes on Second Life profits

One thing I get asked a lot when I'm speaking on panels, or just talking to folks about entrepreneurship in Second Life, is whether it's necessary to pay taxes on income earned in the virtual world.

In a word: Yes. It may seem to some like a game, but as far as your government is concerned--be it the U.S. Internal Revenue Service, the Canada Revenue Agency or any other--money you make as an entrepreneur in Second Life or any other virtual world or online game is fully taxable.

Of course, unless you're an employee of Linden Lab or the Electric Sheep or some such company, any money you make is self-employment income, and should be dealt with as such.

So, for example, in the U.S., that means that you would have to file a Schedule C Profit or Loss from Business (Sole Proprietor) form to go along with your 1099; In Canada, self-employment income from Second Life is reported on lines 135 to 143 of the T1 General Return.

It's too bad, I know, that you have to pay taxes on this income, especially when in many cases, you could hide all of it in Linden dollars. And sure, you could probably get away with it, since Linden Lab isn't reporting your earnings to any government--at least not yet. But, better safe than sorry, I think.

There is one other thing worth mentioning here, however.

Some small-scale Second Life entrepreneurs have found it possible to side-step the taxation issue by doing under US$500 worth of work for each individual client. That's because, as I understand it, it's not necessary to report income unless you've made more than US$500 in a year from a client. As with any tax-related advice, don't take it as gospel unless you've consulted an accountant.

You can find a more complete discussion of this and many other business practicalities in Chapter 2 of my book, The Entrepreneur's Guide to Second Life, which will be in stores by Nov. 5, but which you can pre-order right now.