Virtual currencies can be used entirely within a virtual  economy, or can be used in lieu of a government-issued currency to  purchase goods and services in the real economy. Ann may have  earned taxable income from the sale of these virtual tools. Virtual Economies and Currencies Pose Various Tax Compliance Risks, but the Extent of Noncompliance Is Unknown

IRS, tax experts, academics, and others have identified various tax  compliance risks associated with virtual economies and currencies,  including underreporting, mischaracterization, and evasion. The tax compliance risks we identified for virtual economies  and currencies are described below. The unsophisticated taxpayer may not properly identify income  earned through virtual economies or currencies, such as virtual online  game assets exchanged for real word currency, as taxable income. Some taxpayers may use virtual economies and currencies  as a way to evade taxes. Because of the limited reliable data available on their size, it is difficult to  determine how significant virtual economy and currency markets may be  or how much tax revenue is at risk through their usage. Some experts  with whom we spoke indicated that there is potential for growth in the use  of virtual currencies. IRS Has Provided Some Guidance on Tax Reporting Requirements for Virtual Economies but Not for Virtual Currencies Used Outside of Virtual Economies

IRS has assessed the tax compliance risks from virtual economies and  virtual currencies used within those economies, and developed a plan to  address them in a manner consistent with internal control standards. However, in November 2009, based on EBEI having determined the  need, IRS posted information on its website on the tax consequences of  virtual economy transactions. IRS has not assessed the tax compliance risks of open-flow virtual  currencies developed and used outside of virtual economies. Likewise, IRS has not issued guidance specific to virtual currencies used  outside of virtual economies due to competing priorities and resource  constraints, and because the use of virtual currencies is a relatively  recent development that requires further consideration before guidance  can be issued, according to IRS’s Office of Chief Counsel and compliance  officials. By not  issuing guidance, IRS may be missing an opportunity to address these  compliance risks and minimize their impact and the potential for  noncompliance. Given the uncertain extent of noncompliance related to  virtual currency transactions, formal guidance, such as regulations,  revenue rulings, or revenue notices, may not be warranted at this time. According to officials from IRS’s Office of Chief Counsel, these types of  guidance require extensive review within IRS and the Department of the  Treasury and, in some cases, public comment, which add to the time and  cost of development. However, IRS may be able to develop informal  guidance, which, according to Chief Counsel officials, requires less  extensive agency review and can be based on other existing guidance. As such, IRS can develop informal guidance in a more timely and less  costly manner than formal guidance, according to the officials. An  example of such informal guidance is the information IRS provides to  taxpayers on its website on the tax consequences of virtual economy  transactions. Posting such information to its website would be consistent  with IRS’s strategy for preventing and minimizing taxpayers’  noncompliance by helping them understand and meet their tax  responsibilities, as outlined in IRS’s Taxpayer Assistance Blueprint. Recommendation for Executive Action

To mitigate the risk of noncompliance from virtual currencies, the  Commissioner of Internal Revenue should find relatively low-cost ways to  provide information to taxpayers, such as the web statement IRS  developed on virtual economies, on the basic tax reporting requirements  for transactions using virtual currencies developed and used outside  virtual economies.
Why GAO Did This Study

Recent years have seen the development of virtual economies, such as those within online role-playing games, through which individual participants can own and exchange virtual goods and services. Within some virtual economies, virtual currencies have been created as a medium of exchange for goods and services. Virtual property and currency can be exchanged for real goods, services, and currency, and virtual currencies have been developed outside of virtual economies as alternatives to government-issued currencies, such as dollars. These innovations raise questions about related tax requirements and potential challenges for IRS compliance efforts.
This report (1) describes the tax reporting requirements for virtual economies and currencies, (2) identifies the potential tax compliance risks of virtual economies and currencies, and (3) assesses how IRS has addressed the tax compliance risks of virtual economies and currencies.
To accomplish these objectives, GAO reviewed tax laws, IRS guidance and program documents, federal program internal control guidance, and interviewed IRS officials and knowledgeable experts on the topics.

What GAO Found

Transactions within virtual economies or using virtual currencies could produce taxable income in various ways, depending on the facts and circumstances of each transaction. For example, transactions within a "closed-flow" virtual currency system do not produce taxable income because a virtual currency can be used only to purchase virtual goods or services. An example of a closed-flow transaction is the purchase of items to use within an online game. In an "openflow" system, a taxpayer who receives virtual currency as payment for real goods or services may have earned taxable income since the virtual currency can be exchanged for real goods or services or readily exchanged for governmentissued currency, such as U.S. dollars.
Virtual economies and currencies pose various tax compliance risks, but the extent of actual tax noncompliance is unknown. Some identified risks include taxpayers not being aware that income earned through virtual economies or currencies is taxable or not knowing how to calculate such income. Because of the limited reliable data available on their size, it is difficult to determine how significant virtual economy and currency markets may be or how much tax revenue is at risk through their usage. Some experts with whom we spoke indicated a potential for growth in the use of virtual currencies.
Beginning in 2007, IRS assessed the tax compliance risks from virtual economies, and in 2009 posted information on its website on the tax consequences of virtual economy transactions. However, IRS has not provided taxpayers with information specific to virtual currencies because of other priorities, resource constraints, and the need to consider the use of these recently-developed currencies, according to IRS officials. By not issuing guidance, IRS may be missing an opportunity to address virtual currency tax compliance risks. Given the uncertain extent of noncompliance with virtual currency transactions, formal guidance, such as regulations, may not be warranted. According to IRS officials, formal guidance requires extensive review, which adds to development time and cost. However, IRS may be able to develop more timely and less costly informal guidance, which, according to IRS officials, requires less extensive review and can be based on other existing guidance. An example is the information IRS provides to taxpayers on its website on the tax consequences of virtual economy transactions. Posting such information would be consistent with IRS's strategy for preventing and minimizing taxpayers' noncompliance by helping them understand and meet their tax responsibilities.

What GAO Recommends

GAO recommends that IRS find relatively low-cost ways to provide information to taxpayers, such as on its website, on the basic tax reporting requirements for virtual currencies. In commenting on a draft of this report, IRS agreed with our recommendation.