METANOMICS: ACCOUNTANTS IN SECOND LIFE

MARCH 31, 2008

ROBERT BLOOMFIELD: Hello, everybody, and welcome to Metanomics and a session

today on accountants in Second Life. It feels like we were just here, given that we had a

special show last Friday. Today’s show has the usual, I guess, ivory tower perspective that

we take every week, looking at Metaverse issues from a fairly academic perspective. But

we’re also going to talk a bit about some of the raw practicalities for business people in

Second Life. So I apologize in advance for the provincial American focus, but tax day here is

only 15 days away. If it makes anyone feel better, I, for one, haven’t taken a single step

toward filing, so you know what they say: Those who can’t, do teach. So I’m glad to have

some professional onboard today so they can weigh on what the tax implications are for

people who are doing work and business in Second Life.

I’d like to thank United Business Media’s Think Services Metaverse Group for letting

Metanomics hold this event at CMP and, as always, thank our sponsors SAP, Cisco

Systems, Generali Group, Saxo Bank, Kelly Services and Sun Microsystems. Special

thanks to my own institution, Cornell’s Johnson Graduate School of Management, for

supporting me in this series. And to SLCN for filming and distributing these weekly

discussions. I’d also like to say hi to all of those who are watching from Rockliffe University,

which is one of our event partners. If you don’t know, Rockliffe provides a core curriculum to

Second Life residents. The core curriculum is technically based courses on the fundaments

of prims and in scripting. And those introductory classes are free of charge so definitely

worth checking out. And they also provide space for conferences and events. And, of

course, they get together every Monday for Metanomics. So those of you that find CMP too

crowded or you want to hang with a crowd of Rockliffe University folks, you can find them

and watch Metanomics there.

We’ve got some great sessions coming up. Next week, on the seventh, we’ve got a bunch

of experimental economists coming in to talk about how they’re using Virtual Worlds for

experimentation. On Monday, April 14th, Cory Ondrejka, former chief technology officer of

Linden Lab, and Wagner James Au, the former resident journalist and reporter, will be with

us to discuss the history and the future of Linden Lab. On the 21st, Mitch Wagner, from

Information Week, and Steve Prentiss, from Gartner, will be joining us. And on the 28th,

we’re going to be in another World, Sophia’s Garden, with their director, Karen Herzog. This

is a Virtual World platform set up for families with serious ill children to communicate with

one another, with friends, and with their medical providers. This is an interesting platform

that’s based on the technology Quaq, and Quaq’s CEO, Greg Nuyens, will also be joining

us.

We are always looking for new guests, and we would love to hear your suggestions.

Self-nominations are certainly welcome. So if you or someone you love has created a

Virtual World or is conducting business or research related to Virtual Worlds or is involved in

public policy regarding Virtual Worlds, just let me know, and we’ll see what we can do.

Before I introduce our guests, I have one more important announcement. I know that the

timing of our show doesn’t work for everybody, especially those who are in the U.S., who

have Real Life obligations during the workday. This is particularly ironic for a show like

today’s, which is directed toward a U.S. audience that often is running virtual businesses as

a moonlighting job. So I’m pleased to announce that SLCN is going to have a special

rebroadcast of every Metanomics show, and that will be on Tuesdays at 3:00 P.M. Second

Life time, on Muse Isle. Those of you who aren’t able to attend our live show, you might be

wondering, “Why not just watch it whenever I want to on SLCN or just listen to the audio on

my iPod.” So I’m going to answer this in two words, and the first word is backchat.

If you watch it alone, you can’t talk with other people, and you can’t expand on the

conversation. So I think there’s going to be a pretty healthy crowd at Muse Isle, who will

have a lot to discuss. Tomorrow I’m guessing it will be a lot of small business owners who

want to talk more about accounting and taxation of their businesses. And that brings us to

the second word, which is serendipity. Christian Renaud announced in his first posting on

Cisco’s Virtual Worlds blog that Virtual Worlds are places, and one of the benefits of being

in a place is that you never know who you’re going to meet. So come join JenzZa Misfit and

Bevan Whitfield on Muse Isle and talk about the show, and meet some new people you

might not have met otherwise. So again, that’s 3:00 P.M. Second Life time every Tuesday

on Muse Isle.

Okay. Let’s see. I see that Chili Carson says she has lost sound. So Yxes, if you can

address that, let’s try to get this going as quickly as possible, and IM me when we are done.

You can find more information about Metanomics at our website metanomics.net, and you

can also follow us on Facebook or Twitter. If you haven’t done so already, this is a great

time to join the Metanomics Group in Second Life so you can join in the Metanomics

backchat, which is already up and running.

Okay. Let’s see. Chili, you can hear me?

ARLENE CIROULA: I can hear you now. I did lose you there for about a minute.

ROBERT BLOOMFIELD: Okay. Well, I didn’t say anything interesting anyway so that’s

probably quite all right. Okay. So let me introduce our guests, and we start here with

Chili Carson known in Real Life as Arlene Ciroula. She’s the chief operating officer of the

Maryland accounting firm Katz, Abosch, Windesheim, Gershman & Freedman. Arlene has

taken the interesting step with KAWG&F creating and launching the world’s first virtual

accounting office in Second Life. She works with Bean Wollongong, aka Byron Patrick, who

serves as the IT director for KAWG&F, and has worked closely with Arlene in setting up

their Second Life practice and working with clients. Byron is a licensed CPA. He’s also a

certified information technology professional, which is a certification from the AICPA, the

American Institute of Certified Public Accountants. So he bridges that gap between business

and technology.

We also have Rocky Maddaloni, Tom Hood, who is the CEO and executive director of the

Maryland Association of CPAs, and he also founded the Second Life Association of CPAs,

SLACPA. Now we had also hoped to have Professor Bryan Camp with us. He’s a professor

of law at Texas Tech School of Law and is chairing the Committee on Individual and Family

Taxation for the American Bar Association’s Tax Section. He can’t be here today,

unfortunately, but I did have some pretty extensive back and forth with him on some of

these tax issues, and so I’m going to try to do justice to his view on some of the tax topics.

So this is going to be loosely a two-part show. In the first part, we’re going to talk with Arlene

and Tom and Byron about what they are all doing in Second Life. And the second half of the

show, we’re going to move on to talk about specific problems in the taxation of Second Life

businesses.

So Arlene and Byron, let’s start with you. Welcome, both of you, to Metanomics. I first saw

coverage of your accounting business on CNET, in a story by Daniel Terdiman, and I guess

that was in August of ’06. My first question here is--you two must have some sort of tag

team affiliation. Arlene, can you talk about how you two are splitting duties in your Second

Life practice?

ARLENE CIROULA: Absolutely. And, you’re right, it is a tag team. What happens generally

is, someone will approach me in-world via IM, and then I’ll spend a little time talking to the

person about what they’re looking to do, the project scope and so forth. And not all of those

inquiries are really accounting related. Sometimes it’s an entrepreneur that’s looking for help

with a business plan or wants to talk out about an idea that they have. But if it takes a turn

where it looks like there’s going to be some real accounting and tax work to be done, then

Byron, being a CPA as well as having the technology certifications, he will step in and

actually work through the nitty-gritty and the nuts and the bolts, with the potential

opportunity.

ROBERT BLOOMFIELD: I have one question. I struggled through the whole introduction

saying things like Katz, Abosch, Windesheim, Gershman & Freedman or KAWG&F. What

do you guys call yourself?

ARLENE CIROULA: We do go by KAWG&F.

ROBERT BLOOMFIELD: Still a mouthful. You’ve got lots of partners there, huh.

BYRON PATRICK: Understatement.

ROBERT BLOOMFIELD: So can you give us a sense of the size of your Second Life

practice, roughly how many, whether you think of it in terms of chargeable hours or how

many businesses you’ve interacted with? Just give us a sense of--

ARLENE CIROULA: Well, we really look at this--you know, it’s evolving. It’s been about a

lot of R&D for us. This is a brand new technology. It’s a brand new way of interacting, so we

don’t put a lot of our normal statistical analysis around this practice. And, in fact, what we

really do is when we’re approached, we look for opportunities that we feel are interesting

that will further our understanding of working in this environment. So it’s not like my regular

accounting practice where I can give you all kinds of ways of analyzing and slicing and

dicing the customer base. I can describe to you the kinds of things we’ve been involved with

and why we took those engagements and get better.

ROBERT BLOOMFIELD: I know that, in so many businesses, there’s the Real Life price

and the Second Life price, which is usually substantially less. Would you say that’s the

same with you right now?

ARLENE CIROULA: Oh, absolutely. Absolutely. There are very few businesses in Second

Life at this point that where our fees would make sense for them. So again, we’ve looked for

interesting projects where it’s going to further our understanding and have priced it

accordingly.

ROBERT BLOOMFIELD: So can you pick one of these? I know, as we discussed before

the show, you would rather not name names. But can you tell us a little about what one of

these projects that struck you as something that would be interesting and educational for

you?

ARLENE CIROULA: Yeah, actually. And it’s one that Byron’s been working on off and on

for a while. It’s a content builder-designer. And this particular individual has a number of

businesses that they’re trying to get off the ground. I don’t know that this person, five years

ago, would have ever thought of themselves as running their own business, so they need a

lot of help just with basics. And typically, unfortunately, people get into being a business

owner here either by accident or maybe by design, but it was more of an entrepreneurial

flash, and they get out of the gate without really putting in good recordkeeping practices.

And then, at some point, they realize they have a business on their hands where they need

to be doing a little more controlling. And that’s generally where people will come to us.

Byron can tell you a little bit more about what happens when somebody comes to us in that

condition.

ROBERT BLOOMFIELD: Yeah, Byron, take it away.

BYRON PATRICK: Well, effectively, once you kind of come into those conditions, it’s not

much more different than things we see in Real Life with respect to people getting into a

business and not necessarily with accounting systems at the forefront of their priorities. So

it’s effectively just an education of getting them informed as to understanding what’s

important to keep track of and how to easily get into maintaining systems which will allow us

to make the business decisions based on some accounting information that they can have.

ROBERT BLOOMFIELD: I know that if you have a business of the type that has a lot of

Linden transactions, for example, someone who has a clothing business. We had

Raven Pennyfeather, from RFyre, on Metanomics back in the fall, and she talked about the

massive data that she would get from Linden Lab, that records all of the transactions and

tells them who gave what to whom. So do you tell your clients to rely on that data and make

that part of their recordkeeping, or do they need to find other means?

BYRON PATRICK: It’s definitely information that they should keep track of, but we don’t

use that necessarily to rely on the business accounting components. From our perspective,

it’s the accounting information that they need to keep track of, to keep track of their income

taxes and basically the money they’re putting into Second Life and the money they’re taking

out of Second Life. The transactions within Second Life really is a function of making good

business decisions, so they should be aware of it. But, from a recordkeeping perspective,

the important stuff when it comes tax time is really the U.S. cash that’s going in and coming

out of the business.

ROBERT BLOOMFIELD: Okay. So I don’t want to jump ahead too quickly to the tax rules,

although you did foreshadow what I believe is going to be the consensus of the panel, which

is that taxes really are going to be driven by that cash-in and cash-out and what happens

in-world is pretty much not going to have direct tax implications. But we’ll get much more

into that in the second part of the show.

Going back to the type of practice that you’re running now in Second Life, one question I

had: There are all of these stock exchanges and banks and firms that are listed on stock

exchanges. Have you dealt with any of the firms that are either tapping the Second Life

financial markets or are actually trying to run them?

ARLENE CIROULA: Well, it’s interesting you bring that up because we had quite the

experience with that last year. We had someone that approached us sometime in the

summer about participating in a project that they were launching, and they wanted to do it

as an IPO, and they wanted to raise about 30 percent of their initial capital through that

initiative.

ROBERT BLOOMFIELD: And by IPO, you mean an IPO on one of the Second Life

exchanges?

ARLENE CIROULA: Yes, Beyers, that’s correct. They wanted us to participate on a couple

of different levels. They wanted the firm to be their, quote, CFO for the incubator and take a

portion of the net income in exchange. And let’s not even get into whether that’s something

we can do, but that’s what they asked for. And then they also wanted us to do some other

audit work. As they began to parade various exchanges in front of me, I kept rejecting them

because some of those stock exchanges at the time, the financial information they were

preparing on themselves didn’t even make sense, between accounting mistakes and math

errors. So I was eventually dis-invited to participate. I think I was asking too many questions,

and subsequently the gentleman behind it ended up being one of the scandals of last

summer, who ran off with a whole bunch of people’s money. So that was a situation where I

think we probably learned more from something we didn’t involve ourselves in rather than

something that we did. On one hand, I’m glad we stepped away from that. On the other

hand, I confess I was a little sad when Linden Lab said no more stock exchanges, no more

interest-bearing vehicles and so forth because I felt that there was some interesting and

creative experimentation going on that now we don’t get to see what could have happened.

ROBERT BLOOMFIELD: I know that Dave Altig, from the Atlanta Fed, is actually doing a

study of the bankers who left and the bankers who remained. And a number of those

bankers who remained actually are just revising what it is that they’re doing. And, instead of

offering sort of flat interest, they’re doing profit sharing arrangements. So you might have

those opportunities. These people are still around, although I think it definitely put a big

damper on the activity, and, I guess, given your concerns--so you’re disappointed. But do

you think Linden Lab did the right thing?

ARLENE CIROULA: That sort of leads into another topic, and I mentioned this before. I’d

be very curious to see what their top three strategic initiatives are over the next 12 to 24

months because so much of what they do seems reactive. And that particular case they

seemed to be reacting [AUDIO GLITCH]

ROBERT BLOOMFIELD: So actually this brings us to our next guest Tom Hood, who has

brought the Maryland Association of CPAs into Second Life and also has started up the

Second Life Association of CPAs. So first, Tom, welcome to Metanomics.

TOM HOOD: Thank you, Beyers.

ROBERT BLOOMFIELD: Now you had a great event on your sim, I think it’s CPA Island, a

little while back. You actually had John Zdanowski, the CFO of Linden Lab. Let’s see, he

was giving a speech in Real World to Real World CFOs, but we had that streamed in to your

Sim, and we actually had an opportunity to ask him questions. One of the questions that I

think I asked was something about the in-world banking and financial markets, and he sort

of poo-pooed the whole thing and said, “Well, we really don’t think that the in-world

economy is a huge issue that needs to be thought about all that much.” I was wondering

what your take was on that.

TOM HOOD: Well, I think he was kind of alluding to the fact that they had pretty much dealt

with the crisis, I guess. But I think, on the other hand, he had a couple slides showing

exactly how fast that economy, in fact, in Second Life is growing even subsequent to that

banking crisis. So it’s definitely a real growing economy, I think, as are some of the other

Virtual Worlds that are certainly with significant critical mass. World of Warcraft I can’t

imagine how much money must run through that in any given time. So I think this whole

virtual economy thing is a significant and growing item, and the tax authorities around the

world probably are already beginning to investigate and try to figure out what they should do

about this stuff.

ROBERT BLOOMFIELD: And can you talk a little bit about what your plans are, your

organization’s plans are, in Second Life?

TOM HOOD: Well, I think actually the part of the credit for us getting into Second Life is

sitting right next to me here on my left. Bean and Chili were certainly a big part of our

inspiration, being a Maryland firm, as we started to look into Second Life. And actually the

reason we started was part of our job in the Association World for CPAs is to connect

students and prospective students to the accounting profession and ultimately to getting

their CPA licenses. And we thought that Second Life was an opportunity to begin to look at

and reach this gaming generation. So that’s what really led us to kind of begin doing it. And

knowing that we had a CPA firm already in there that made us say, “Wow! We should

definitely be looking at this.”

So that’s what got us kind of started. We started a little house, like most people do. Rented

property and just started playing around how to couple of like meet-ups. And then that led

us to buy our own island, and we now have two islands. And KAWG&F has their main office

on CPA Island.

And then the rest of our plans now are to, one, we built an accounting education pavilion,

which is designed to kind of talk about the career, kind of a 3D walk through an accounting

career. And then we’re giving away kiosks to accounting educators to put their schools--your

school’s in there, Beyers, and we got about ten others now that have started. And basically

put a little website link and some basic information so that the theory would be a resident

coming in who might get interested in an accounting career could walk into the exhibit hall

and see a bunch of colleges that they could find real live web links to. So that’s kind of

phase one.

And then phase two is our meeting areas. We’ve got a major conference center and, as you

said, we held the CFO event with Zee Linden or John Zdanowski. And, prior to that, we had

another mixed reality event that included accounting educators. And actually one of the

accounting educators in the audience, Robins Hermano is doing some neat stuff at the

University of Central Florida, so he did a presentation in Second Life to our educators

conference in Real Life. And that actually worked pretty well. So having events, kind of

building a community of folks who are interested about CPAs in the Second Life world is

really what kind of prompted us to kind of do all that. So the notion of attracting the younger

folks, students and accounting educators and then having a place to meet and talk about

this. We would say wherever there’s an economy, you know you need CPAs. So that’s kind

of what we see.

ROBERT BLOOMFIELD: That makes sense to me. Now let me ask you: There are so

many lawyers who are looking at Virtual Worlds, Virtual World law. They have conferences.

They’ve been in Second Life. They write on blogs like Terra Nova. Ben Duranske has

Virtually Blind. Lawyers seem to be all over Virtual Worlds. Accountants? Not so much. Do

you have a guess as to why that is?

TOM HOOD: Well, I think two things. The law around internet and intellectual property is

certainly a well established discipline so that was probably a natural fit for some of the

lawyers in that domain. And secondly, CPAs tend to be a little more conservative, and so it’s

taken CPAs a little longer to get comfortable and begin to get in here. That’s why I think you

see probably the most that we’ve met are the accounting educators. Quite a few of your

colleagues, Beyers, seem to be the pathfinders in here. And we found a few other CPAs. In

fact, some CPAs or their counterparts from around the world are actually finding us, and a

few of those have started to weigh in and join up. So we’re starting to find them from kind of

all corners of the globe.

ROBERT BLOOMFIELD: Okay. Great. Well, let’s show those lawyers what accountants

can do and make some progress on some of the issues that accountants worry about.

Before we do that, you talked about the economy, where there’s an economy we need

CPAs. And I think CPAs also tend to be in a pretty good position to assess what’s

happening in economies, whether times are strong and weak and so on. So I’m wondering

actually, I guess, Arlene and Byron, you’re probably in the best position to assess this. I

mean every once in a while you hear people talk about whether times are good or bad.

There are some statistics showing that Second Life’s economy continues to grow, but there

are certainly many anecdotal stories that suggest there is some sort of recession or

flattening. And there are some data, for example, premium accounts tend to be flattening.

And so I’m wondering what you take is on the strength, right now, of Second Life’s

economy.

ARLENE CIROULA: Well, I think that we still have a situation here where we have a few

people that are doing very nicely in Second Life, and then a lot of people that are just kind of

scratching along. I think that some of the technological problems and some of Linden Lab’s

decisions play into what happens. For example, this whole recent furor over the use of the

logo now. You’ve got people that are changing their mind about wanting to be in Second

Life because of that. And the lack of stability of the platform definitely makes it hard for

people to run businesses at times. So I think those kinds of things they certainly hurt the

little businesses a lot, and I think that this is an economy of a lot of little businesses. And,

again, that gets back to I would really like to see what Linden Lab’s direction is over the next

12 to 24 months because it would help businesses to guide themselves better.

ROBERT BLOOMFIELD: Yeah, well, they talk about, certainly in the Real World,

businesses wanting stability in regulation. You want the tax law to be predictable, you want

the accounting rules to be predictable so that you can make long-term investments. I think I

agree with you they’re, right now, simply not very predictable, what it is that Linden Lab is

going to do. Are they going to ban stock exchanges next? Are they going to impose other

restrictions on what people thought that they owned and could do, whether it’s banking or

brand, I think that’s an excellent observation. Byron or Tom, do you have anything to add to

that?

BYRON PATRICK: I think Arlene said everything I have to say.

TOM HOOD: Beyers, this is Tom. I saw a question earlier that I think Dancer had asked.

The notion of this taxation of Virtual Worlds and, in fact, anything else in the U.S. is a bigger

and growing issue. As budgets are tough in the different states, states are all kind of

reaching out or, in some cases, overreaching to find ways of taxing income from lots of

sources. And I think one of the questions was, “What if you’re working temporarily in another

state, is that income taxable?” The answer is, it depends on the different states you’d be

coming from and going into. There is a federal law that the CPAs, in fact, are working on to

try to standardize, if you will, or put at least an exemption--I think It's called a 60-day

exemption--so that at least for 60 days you could do temporary work without worrying about

that. But that point makes the point of the kind of complexity and uncertainty around taxing

in a Virtual World. And I’m sure on the European and other parts of the world, that could be

another one of those, again, growing problems. Where there’s money and potential tax

revenue, there’s going to be people trying to figure out where you’re getting it. So that’s the

only part I wanted to add to that.

ROBERT BLOOMFIELD: Great! So let’s jump into taxes. Probably the right place to start is

just to remind our listeners of what I think of the IRS’s version of “heads, we win; tails, you

lose” in taxation, which is that anything a taxpayer receives of value is going to be gross

income, unless there’s an exception that says otherwise in the code or the regulations. And

then the flip side of that is nothing you spend, none of the resources that you consume are

deductible unless it says specifically in the tax code or regulations otherwise. So that’s sort

of where we start with, and so I think the question is then: What’s the most aggressive

position that you could take when you’re filing a return? And here I think it makes sense to

talk about--I mean, let’s start with personal returns. So an individual has a proprietorship.

They’re just filing a Schedule C as part of the--they’re not going out and creating a

corporation and all that. So what’s the most aggressive position they could take? And I

would think it would be this, that as soon as they buy Lindens to do stuff in-world, they take

a deduction. And they don’t recognize any gross income until they cash out. So the

alternative would be that, when you buy these Lindens, you have to capitalize them. You

have to recognize them as assets, so you can’t deduct them right away. Instead you have to

wait until that asset gets used up or time passes depending on what type of asset it is,

there’ll be different rules. And then, again, the less advantageous position on the income

side would be that, as soon as you get Lindens, you treat them as gross income.

So I’d like to start with the gross income side. How is it that taxpayers would be able to

justify not recognizing any income from their Second Life business until they cash out their

Lindens and get U.S. dollars? And I guess maybe, Byron, we can let you start with this one.

BYRON PATRICK: Sure. Well, I think the main component is there’s noting guaranteeing

that my Linden dollars are going to be worth something tomorrow. So I can accumulate

hundreds of thousands of Linden dollars, sit in here in Second Life and buy all the virtual

goods I want. But if things change tomorrow and I can no longer log into Second Life, and

Linden Lab no longer exists, I no longer really have anything of value. So I think that alone

could be a position that anything accumulated in here is nothing but baseball cards until you

cash it out.

ROBERT BLOOMFIELD: Couldn’t I make a similar argument and say, “Well, someone paid

me in gold or IBM stock,” and who knows what gold or IBM stock will be worth tomorrow.

BYRON PATRICK: Well, I think, at a minimum, gold and IBM stock is something that’s

recognized by the U.S. government as something of value that can be transacted, and it’s

governed in some way. The Second Life Linden, not so much.

ROBERT BLOOMFIELD: I guess my question is: We can always take aggressive positions

with the IRS and say something is not income and delay the recognition of that income. And

we can have a rock solid case where it’s written specifically into the code, or it can be

somewhat that we believe we can justify it, but it might not actually go through. Or you can

say at least this is a position worth taking. I forget the terminology, but I know that when you

take particularly aggressive tax positions, you actually have to state on your return, with a

separate attachment, you have to notify the IRS you’re taking that position. So how solid is

the ground, do you think, for arguing that you can put off recognizing income until you get

U.S. dollars?

BYRON PATRICK: I think it’s a function of how you treat it because clearly if you’re

accumulating an exorbitant amount of Lindens--it’s a function of behavior. Then certainly, it

appears that you may be trying to avoid some sort of tax implications. My recommendation

with the people we work with is: Look at your transactions. Try to do a monthly

reconciliation. Keep 20,000 Lindens in Second Life. At the end of the month, if you have

40,000 Lindens, you can cash out. You’ve made money. If you’re down to 10,000 Lindens,

well, you need to feed the pig and put some money back in. With that monthly reconciliation,

you’re effectively staying at an even keel, and you’re not preventing taxable acts as well as

not taking additional expenses that maybe you’re not due. So it’s a function of behavior. If

you’re accumulating a lot of Lindens, sure, you may be trying to beat the system. And if

you’re trying to keep an even keel, then I think you have solid grounds that you’re not trying

to create any type of tax avoidance.

ROBERT BLOOMFIELD: I mean I know that there are many businesses that are really

building up very large Linden balances, and so potentially we’re talking about a significant

dollar amount of tax liability that would be in question. So my question to you, Byron, is: First

of all, would you recommend that people state on their return that they are taking the

position that the Lindens are not taxable until they’re turned into cash? And then the second

question is: Would it matter whether they are keeping all that money in Lindens because

they think they need that much in Lindens for their operations? That it’s a business decision

as opposed to simply being intended to delay tax incidents.

BYRON PATRICK: No, I wouldn’t necessarily recommend stating on your return--I mean I

haven’t seen anybody trying to avoid $100,000 of taxable income out of Second Life either.

So with respect to the magnitude, it’s very small exposure, any position you take with most

of the Second Life income. I wouldn’t put it out there because I don’t believe it’s that

aggressive of a position that could be that questionable. Second, it’s hard to say with

respect to how people are operating and what’s a reasonable level of Linden’s to keep in or

pull out. I think it really comes down to the volume of business you’re doing and the way

you’re operating your business.

ROBERT BLOOMFIELD: Tom or Arlene, do you have anything to add to this treatment of

gross income?

TOM HOOD: Beyers, this is Tom. I think I would say I agree with Byron. One of the things

that makes it a little unique is that it’s kind of almost a derivative notion, in terms of Linden.

Linden dollars are, for the most part, only going to come out as long as Linden Lab is there.

So again, it gets back to the uncertainty of what this transaction really is. So I think, for the

most part, you are pretty safe. However, as Byron said, if the nature is this is how you do

business and make money, then you might be looked at differently from the IRS perspective

because that whole notion of behavior, if this is a major material part of your income and it’s

a significant amount of dollars running through those transactions, that certainly gets the

IRS’s attention.

ROBERT BLOOMFIELD: And, Arlene, anything to add?

ARLENE CIROULA: I think Byron kind of touched on this. Beyond just the tax

considerations, there’s also the risk consideration. And I see on the back channel people

saying you don’t know if your Linden dollar’s going to be there when you log in sometimes.

And so I think you have to figure, “What’s my risk? I’m going to leave enough money in

there to operate properly, but not so much that, if something happens, I get wiped out.”

ROBERT BLOOMFIELD: So we have a question I see here from Quanta Torok: Would

Second Life transactions be covered under IRS regulations concerning barter instead of

cash income? So why wouldn’t the barter rules apply to Lindens?

BYRON PATRICK: They possibly could.

ARLENE CIROULA: I have read that they do. Certain people think that they do. I have read

that. But there is--

ROBERT BLOOMFIELD: Oh, go ahead.

ARLENE CIROULA: Okay. Go ahead.

ROBERT BLOOMFIELD: Well, I was going to say mostly I’ve talked with lawyers and read

the writings of lawyers. And my impression is, they are often taking the view, I mean, they’re

focusing on what the law could be or what the absolutely correct interpretation of existing

law is. I’ve been out of practice a long time. I was a tax accountant at KPMG Peat Marwick,

in a former life, a long time ago, so maybe I’m just out of touch with practice. But my

impression of accounting and the way they view the tax law is, it’s really a question of

whether you can justify a position and whether you’re willing to live with the risk that, if

there’s an audit, that you’re overturned. I mean I understand that the barter rules could well

apply, but, to me, it seems like there’s a strong enough position for saying, “Look. Lindens

are highly restricted by the terms of service of Linden Lab. We barely even own them. And

so we don’t believe it’s appropriate to have them taxed.” Am I capturing the spirit of the way

accountants treat tax preparation correctly?

ARLENE CIROULA: Yes. We’re still waiting to see a little guidance. I know the Joint

Economic Committee has been looking at this for a while. There’s been a little gossip

around that maybe the IRS is going to look at this, but we haven’t seen anything really yet.

So it’s all theoretical now.

ROBERT BLOOMFIELD: I hope I’m not sounding too crass, but my view is, if there’s not

guidance, then you’re doing the right thing by your client to identify the most aggressive

positions that you can reasonably justify. And, if you’re getting to the point where it’s hard to

justify them but possible, you may need to attach a note to your return. But it doesn’t seem

like you guys really believe we’re at that point so you could probably justify taking a number

of these positions.

Let’s see. Let’s move on actually to the other side. I think that we feel reasonably

comfortable with delaying recognition of gross income until you actually get cash. But now

what about the flip side, when you take thousands of dollars out of your U.S. bank account

to buy Lindens, which you then use to do whatever. You’re hiring people. You’re hiring

scripters. You’re renting land. Can you justify deducting that right away? So, Byron, you

want to take first stab again?

BYRON PATRICK: Sure. Can you justify deducting it right away? Yes and no. On

December 31st if I put $10,000 into my Linden account so that I can represent a $10,000

expense to offset any income I have at the end of the year, maybe not so much. But if it’s a

regular transaction, but, again, we’re not over- or under-stating how much money is sitting

within Second Life, within the LindeX, then, sure, absolutely. If I need to put $10,000 every

couple months into Second Life to maintain my business and keep it up and running, then,

sure, I think that’s a fair way of doing business.

ROBERT BLOOMFIELD: I guess I’m wondering about the case where I’m hiring people or

buying other people’s products in Second Life, paying them with Lindens in order to create a

build. So we’re creating a building and terra-formed land and maybe the type of chair that

I’m sitting in that had to be scripted to make me move in various ways. Those are often the

types of expenses that we’d actually have to capitalize rather than expense right away, and

I’m wondering if that’s different in Second Life.

BYRON PATRICK: I don’t see it as any different. Well, I’m sorry. That’s not true. I see it as

completely different. The transactions going on in Second Life I’m not buying real bricks.

This is not physical property that the tax law has specifically listed as capitalizable assets.

Right now I guess there could be an argument if you call it, software, but it’s something else

[AUDIO GLITCH] my perspective, I’m not even worried about the individual transactions if

I’m buying [bricks?] for my workers or virtual chairs for the building. It’s all Second Life

service expenses for performing my business and generating income.

ARLENE CIROULA: But, Byron, as a capitalization issue, doesn’t that correspond to--we

could correlate it to making software and, therefore, it wouldn’t need to be capitalized?

BYRON PATRICK: Sure, if you’re developing software, then that’s exactly the approach

you could take.

ROBERT BLOOMFIELD: I mean I look around at the build that we’re in right now. This

couldn’t have been a trivial matter to seam the four Sims together and have all these chairs.

I know that they’ve spent a lot of time making it look nice and being very functional for UBM

Think Services’ activities.

And so if we say that all that money spent was actually to build software, then, under the

Uniform Capitalization Section 163 Rules, that’s going to be internally developed software,

so it would be immediately expensable. Right? I mean I have that right?

ARLENE CIROULA: Yeah, that’s what it looks like.

ROBERT BLOOMFIELD: Right. And so then I guess we have the question of let’s say I buy

U.S. $10,000 worth of Lindens, and so I do--all those Lindens, and I’m actually going to be

paying that money maybe only half of it this year and half of it next year. So actually let me

say this again just so it’s clear. I give up $10,000 of cash this year, and I spend half the

Lindens I get by paying builders this year and half next year. Is that a $10,000 deduction or

a $5,000 deduction in this year?

BYRON PATRICK: Being consistent with the way we’re approaching it, that’s a $10,000

expense this year, as long as you are going to use that. The risk in doing that is, okay, you

take the $10,000 expense this year, and next year we’re recognizing income when we pull it

out. But, if we decide we have too many Lindens in there and then pull out $4,000 worth of

those Lindens, guess what? That’s taxable we’ve now pulled out. So it’s going to show up. It

may go out in one year and come back in the next year. At some point, the tax man’s going

to get his hands on it.

ROBERT BLOOMFIELD: I see a comment by LifeFactory Writer saying, “Not that any of

these expenses amount to much in real currency, but it’s a test of principle in new tax laws

in the new age of virtual business.”

I wonder if that’s true. I mean I know that, on my show, I’ve already had and am planning to

have in the future a number of people who are making real serious money. I hope they’re

getting good advice. So there’s an interesting ivory tower aspect here. But, boy, I think for

some people this is real money.

BYRON PATRICK: No question.

ROBERT BLOOMFIELD: So let’s see. There’s another issue. Actually, there are a bunch of

issues that are coming up. Some of them came up when I talked with Bryan Camp of Texas

Tech Law School, and then I see a bunch of them coming up in the Metanomics backchat.

So first, let me mention Bryan’s concern, which is that he was a little concerned that hobby

rules might come into play for a lot of Second Life residents. And, in particular, he was

suggesting that, if you took the fairly aggressive position that we seem to believe is at least

reasonably justifiable, that when you buy the Lindens, you deduct the U.S. money, and then

you wait until the last second when you actually get cash, and that’s when you have income.

And he says, “Well, you have to make sure that the deductions don’t exceed the income

because the IRS is likely to say, ‘Well, this is just a hobby.’” Arlene or Byron, do you think

that’s a realistic concern?

ARLENE CIROULA: Yeah.

BYRON PATRICK: Oh, yeah. Absolutely. I think it’s a real risk. The thing about hobby

losses, again it actually comes back to behavior. If you do get questioned, how are you

treating this as a business? Are you just running it out of your joint personal checking

account with your husband or wife? Or have you, in fact, set up a separate business

account to keep track of these transactions? Do you have Quick Books or Peachtree and

actually running this effectively as a business? Or is this something where you’re getting in

and tinkering around? And, if you’re running it as a legitimate business, if you have losses,

then you have the rights to those losses.

ROBERT BLOOMFIELD: We don’t want to get too technical, and I suppose actually this is

a perfect time for me to say actually, on all of your behalves as well as mine, that you really

need a professional to work with you on your particular tax position for your particular

circumstances, and please don’t rely on our advice as providing you with a legal justification

for whatever positions you choose to take. We love that you’re listening and watching

Metanomics, but don’t use us as your official tax advisors. Does that work for all you guys?

BYRON PATRICK: [CROSSTALK]

ARLENE CIROULA: It does. I mean what we’re bringing up here should just sort of alert

people to things to look for and consider and explore, as you say for their particular

circumstances.

ROBERT BLOOMFIELD: Now that said, can one of you just quickly summarize? So Byron

talked about the rules for hobby loss that your intent has to be business, separate record

keeping and so on is extremely helpful if not necessary to make it not be a hobby? What

else is important?

BYRON PATRICK: Well, one of the things that they do look at is that they look for some

years of profits. Typically, kind of the benchmark rule is three years of--you need to make

money three out of the past five years. Granted there may not be a long history right now,

but going forward at some point you do need to show some profits.

ROBERT BLOOMFIELD: Okay. So now I’m seeing a bunch of questions in chat, and we’ll

see how many of these we can get to. One question is, this is from Star Magmi(?), if I’m

pronouncing that correctly: How do Linden dollars transformed into U.S. dollars for Second

Life residents living outside the U.S., how do those get taxed? Are you guys dealing with

international law at all?

ARLENE CIROULA: No.

ROBERT BLOOMFIELD: No. Okay. So anyone willing to take a stab at that issue?

BYRON PATRICK: I think it’s a local issue depending on what country you’re in.

ROBERT BLOOMFIELD: Yeah. Sorry about that, Star. I was afraid of this, but tax law is so

specific. We haven’t even started talking about state taxes in the U.S., but it really matters

where you are.

Let me ask though a U.S. tax question, which is: Do you have any concerns about

jurisdiction? If you’re running a Second Life business, would you just view that as being

entirely 100 percent business where you reside? Or do you think that there are other

jurisdictions that might come into play here?

BYRON PATRICK: I think it’s undefined. I definitely have a concern, and I don’t even know

where to begin with respect to jurisdictions and where transactions may or may not be

happening. For the time being, the rule of thumb is wherever you are is where the business

happens. But there could certainly be, down the road, some questions.

ROBERT BLOOMFIELD: Yeah. Linden Lab has servers in California, Texas and the UK.

And your clients could be in any number of places. But you would still probably say--unless

you know of some particularly salient fact otherwise, with a real strong foreign connection,

you’d probably just say view it as the business as where you park your butt in the chair?

BYRON PATRICK: Yeah, I would.

ROBERT BLOOMFIELD: Okay. Let’s see. I guess another issue that we have here is on

things like clothing. So if you buy business suits and lots of clothing for your Second Life

business, what do you think, deductible?

BYRON PATRICK: Sure. I think it falls under a lot of what we’ve already been talking about.

The individual transactions I’m not so worried about within Second Life. It’s more the ins and

outs of U.S. currency.

TOM HOOD: This is Tom.

ROBERT BLOOMFIELD: Oh, yeah. Tom?

TOM HOOD: I would add that we’ve seen some changes in the IRS now starting to go in to

investigate the use of Blackberries and cell phones and even texting, this whole debate of

personal versus business use. So I think Byron’s right. Your general rule would be when you

buy Lindens, then that cash--but if you’re going to allocate it, there’s a significant personal

use component. You’re better, if you keep the right records, to document and prove

business use case, then you’ll be protected in the event they start to really look into how

much time are you spending in personal use versus business use, and are the clothes

business or personal, that kind of stuff. So I think, to the extent you’re seriously in the

business, the key is documentation, so try to keep the records that support what you’re

spending and then use that as an allocation as the worst case. And the best case would be

take the cash deduction when you buy the Lindens.

ARLENE CIROULA: And as a practical matter, if you really wanted to make it clean, you

could have your avatar dedicated to your business, and then you could create an alt for

non-business uses.

TOM HOOD: That’s a great idea.

ROBERT BLOOMFIELD: So, Arlene, have you recommended that type of structure to any

of your clients?

ARLENE CIROULA: To myself. Because going into the whole issue of branding for the firm

too. I mean Chili Carson is with KAWG&F, and that has a certain meaning. And, if I want to

interact in Second Life in a more entertainment capacity, I wouldn’t do that as Chili Carson.

That’s a way of keeping it clean.

ROBERT BLOOMFIELD: Now T.J. Asp asks: Do people [AUDIO GLITCH] buy alts need

Social Security numbers too? I assume that that is tongue in cheek. The answer to that

would have to be absolutely not. But I do wonder. It raises in my mind a question about

Linden Lab’s role in reporting to the IRS. I mean, at this point, as I understand it, Linden Lab

does not issue 1099s to the IRS on behalf of people who are taking a lot of cash out,

cashing out their Lindens into dollars. And I don’t think they have any plans currently to do

that. But do you think the IRS could ultimately insist on that?

ARLENE CIROULA: We heard Zee Linden talk about that a couple of weeks ago, and they

really believe that they can stand behind the way eBay is being treated. And, who knows? If

the IRS decides to reach inside and push them to do that, who knows.

ROBERT BLOOMFIELD: It actually surprises me, frankly, that eBay does not do this. I’m

not exactly sure, given that some people are getting so much cash from--it would be

relatively easy to arrange. I’m wondering exactly why they aren’t reporting this, though I see

that T.J. Asp adds in Linden Lab doesn’t actually do the paying, hence no 1099. And that’s

true. They often do not actually pay out the cash. Other people may well be buying that. Is

that the right explanation on that one?

ARLENE CIROULA: Yeah.

BYRON PATRICK: Yeah, that’s right.

ROBERT BLOOMFIELD: Okay. So we’ve gone over because we started a little late and

had a technical glitch, but I think we really covered a great deal of ground. Do you think

there are any big issues that people should really know about either your accounting

businesses, Arlene and Byron, or Tom? Actually, let me let Arlene and Byron go first about

how people should be thinking about the accounting and the taxation of their businesses.

Anything you want to add?

ARLENE CIROULA: Well, there’s two pieces. As Byron alluded to earlier, we’ve talked a lot

about taxation today, and where we’ve been heading with people is, when you put the

money in and when you take it out, that’s when we’re going to be concerned as to whether

that’s a taxable event. But, in terms of tracking what you’re actually doing in Second Life,

that’s more about monitoring how you’re running your business and formulating your

strategy. There are some tools to help you do that. But those are two different

considerations.

ROBERT BLOOMFIELD: Can I ask, maybe you don’t want to say, but for people who are

considering professional accounting services from you, about how much do you charge?

ARLENE CIROULA: We have really priced it according to the person, the business owner,

the project and the opportunity and how interesting it is to us. And I will also tell you that one

thing that’s really important is, we insist upon complete transparency. We have to know who

we’re dealing with. And so sometimes people that want to be anonymous because this is a

place where you can be anonymous, that would eliminate us being able to work with them.

ROBERT BLOOMFIELD: Okay. So you want to know their Social Security number.

ARLENE CIROULA: Yeah. We have to know who they are. We won’t take clients where

there’s no transparency.

ROBERT BLOOMFIELD: Okay. Tom, anything you want to add, either about your thoughts

on people who are running virtual businesses or about your activities with the Maryland and

Second Life Associations of CPAs?

TOM HOOD: Well, no, I think Chili and Byron covered it well in terms of the tax and

accounting issues. The one thing, I guess the next most exciting event is June 17th and

18th. We’re going to run the Accounting and Business Expo in Real Life in Baltimore,

Maryland, and in Second Life on CPA Island. So folks will be invited to come back to that.

You’d have to join the Second Life Association of CPAs in Second Life, and we’ll be

featuring the CFO of Linden Lab back for a kind of update session there. And then we hope

to offer the first Continuing Education in Second Life. So we’re excited about that event.

ROBERT BLOOMFIELD: Now do you need to be a CPA to join the Second Life group

SLACPA?

TOM HOOD: No. Actually it’s really about people interested in the CPA community, so we

haven’t put any membership criteria on that, other than to kind of keep it so that we at least

know who’s coming in to CPA Island.

ROBERT BLOOMFIELD: And as long as we’re doing disclaimers today, I assume someone

who is a member of SLACPA is--that does not indicate any sort of professional certification

or capability [AUDIO GLITCH]

TOM HOOD: That’s correct. We have not put the CPA exam in Second Life yet, but that

might be a good idea.

ROBERT BLOOMFIELD: Well, I wish you luck with what you’re doing, and it’s been

fascinating to have all three of you on the show. So thank you very much for joining us. I

would like to thank our audience for being patient during our brief technical problems.

Those of you who want to discuss these issues further, do keep in mind that tomorrow,

Tuesday, 3:00 P.M. Second Life time on Muse Isle, there will be another broadcast of this

show. So it’ll just be a rebroadcast of this show. And my guess is there will be a lot of people

sharing interests, so if you know of someone who is running or is planning to run a Second

Life virtual business, and they’re trying to think about the accounting and taxation issues,

invite them to join us on Muse Isle. So thank you, my guests Chili Carson, Bean Wollongong

and Rocky Maddaloni in Second Life. I hope we’ll see you back on the show sometime.

ALL: Thanks for having us, Beyers.

ROBERT BLOOMFIELD: Bye bye all.

ALL: Bye bye.

Document: cor1014.doc Transcribed by: http://www.hiredhand.com Second Life Avatar: Transcriptionist Writer