The rapidly expanding landscape of prediction markets has introduced a significant layer of financial complexity for traders: the conspicuous absence of definitive guidance from the Internal Revenue Service (IRS) regarding the taxation of their winnings and losses. As of mid-2026, the federal tax agency has yet to issue clear directives, leaving market participants, platforms, and tax professionals in a state of considerable confusion and regulatory limbo. This regulatory vacuum is particularly pressing as the year progresses, compelling individuals to navigate an intricate web of potential tax classifications, each with dramatically different implications for their bottom line.
Background: The Rise of Prediction Markets and Their Unique Structure
Prediction markets are online platforms where users can trade contracts based on the outcome of future events. These events can range from political elections and economic indicators to scientific discoveries and even the results of sporting contests. Unlike traditional betting, prediction markets often frame these events as tradable assets, allowing users to buy or sell contracts that pay out based on whether a specific outcome occurs. For example, a contract predicting "Team A wins World Cup" might trade at $0.70, implying a 70% probability. If Team A wins, the contract settles at $1.00; if not, it settles at $0.00. The appeal lies in their ability to aggregate information and potentially forecast outcomes more accurately than traditional polls or expert opinions, leading to their growing popularity among a diverse user base.
Platforms such as Kalshi and Polymarket have emerged as prominent players in this space, offering a wide array of "event contracts." The core functionality involves users speculating on binary outcomes, buying "yes" or "no" contracts, with payouts determined by the accuracy of their prediction. While these markets provide a novel way for individuals to engage with current events and economic forecasting, their classification for tax purposes remains contentious. Are they akin to traditional gambling, a form of speculative investment, or a new class of financial instrument? The answer to this question holds significant financial consequences for millions of potential participants.
The IRS’s Omission: A Void in Federal Tax Guidance
The prevailing sentiment among tax experts and prediction market participants is one of frustration over the IRS’s prolonged silence. Ryan Schutz, a former IRS special agent and founder of First There Tax, articulated this widespread confusion, stating, "I think it’s extremely confusing for the users of prediction markets because they’re getting a lot of [conflicting] guidance." This conflicting guidance often originates from various sources, including online forums, financial advisors interpreting existing laws, and even the platforms themselves, none of which carry the authoritative weight of an IRS pronouncement.
Historically, the IRS has, albeit sometimes belatedly, issued guidance on new financial instruments and evolving economic activities. For instance, it took several years for the agency to provide comprehensive guidance on cryptocurrencies, another novel asset class that presented unique taxation challenges. The delay in addressing prediction markets, which have seen a surge in trading volume and public profile, is particularly concerning given the significant financial sums involved and the implications for compliance. Without clear rules, taxpayers are left to make educated guesses, increasing their risk of incorrect filings, potential audits, and penalties. The lack of clarity also hinders the mainstream adoption and institutional investment in prediction markets, as large financial entities typically require robust regulatory frameworks before committing capital.
Navigating the Labyrinth of Potential Tax Classifications
Tax experts have identified three primary categories under which prediction market winnings could potentially be classified, each carrying distinct tax liabilities: gambling income, capital gains, or treatment under a Section 1256 contract. The choice of classification is not merely an academic exercise; it dictates the applicable tax rates, the ability to deduct losses, and the overall tax burden on traders.
Gambling Income: A Less Favorable Framework
If prediction market winnings are categorized as gambling income, they face what many experts describe as "very bad tax treatment," particularly following legislative changes. Under former President Donald Trump’s "One Big Beautiful Bill Act," a provision was introduced that applies a 90% cap on gambling loss deductions. This significantly alters the tax landscape for gamblers. Previously, a taxpayer who won $100 and lost $100 would effectively have zero taxable income from gambling. However, under this new framework, the same taxpayer would only be able to deduct $90 of their losses, resulting in $10 of taxable winnings despite breaking even overall.
Nathan Goldman, a professor of accounting at North Carolina State University, highlighted the punitive nature of this provision for sports gambling, a category many states and critics argue prediction markets resemble. The implication is clear: even successful traders in prediction markets, if classified as gambling, could find their profits substantially eroded by taxes, and even those who lose money might still face a tax liability if their gross winnings exceed their deductible losses. This framework serves as a strong disincentive for traders hoping to offset their gains fully with corresponding losses.
Capital Gains: A More Balanced Approach
Alternatively, if prediction market contracts are treated as capital assets, their profits and losses would fall under the capital gains tax regime. This treatment is generally more favorable than the gambling income classification. Under capital gains rules, taxpayers who experience losses that exceed their gains can use up to $3,000 in realized losses to offset ordinary income (such as wages or salaries) in a given tax year. Any remaining capital losses can typically be carried forward to offset future capital gains or ordinary income.
Capital gains are also differentiated by holding period: short-term capital gains (assets held for one year or less) are taxed at ordinary income rates, which can be as high as 37%, while long-term capital gains (assets held for more than one year) benefit from preferential rates of 0%, 15%, or 20%, depending on the taxpayer’s income bracket. This distinction, however, introduces another layer of complexity for prediction market contracts, which often have short durations.
Section 1256 Contracts: The Preferred Tax Haven
The most attractive tax treatment for the "vast majority of people," according to Schutz, would be if prediction market contracts are deemed Section 1256 contracts. This designation applies to certain regulated futures contracts, foreign currency contracts, and options. The primary benefit of Section 1256 treatment is a statutory 60/40 split: 60% of any capital gain or loss is treated as long-term, and 40% is treated as short-term, regardless of how long the asset was actually held.
This means that even if a prediction market contract is held for only a few days, 60% of the gain would still qualify for the lower long-term capital gains rates (0%, 15%, or 20%), while only 40% would be subject to the higher ordinary income rates (up to 37%). This "mark-to-market" system also simplifies reporting, as positions are treated as if they were sold at fair market value at the end of the tax year. The clear advantage of Section 1256 status makes it the most sought-after classification for prediction market traders, offering significant tax efficiencies compared to the other two options.
The Emergence of Perpetual Futures: Further Complicating Classification
The complexity of classifying prediction market contracts has been further exacerbated by innovation within the industry. In May 2026, the prediction market platform Kalshi introduced perpetual futures, or "perps." Unlike traditional event contracts that have a defined expiration date (e.g., the date of an election or a sporting event), perps have no expiration dates. This fundamental difference introduces a new dimension to the tax classification debate.
Ryan Schutz noted that perps do not follow the same structure as traditional event contracts, suggesting that different tax guidelines might apply. "I could definitely see an argument of someone saying that event contracts could have a different categorization than perpetuals," he observed. He further elaborated, "When I first found out about the perpetuals, they felt more like a real financial contract because they don’t have a specific end date and that kind of tracks with the mechanics of 1256." This observation implies that perpetual futures might have a stronger claim to Section 1256 treatment due to their resemblance to traditional financial derivatives.
However, the diverse nature of event contracts themselves presents a significant challenge for any single tax framework. George Salis, chief economist and senior tax policy director at Vertex, highlighted this difficulty: "Some contracts may look more like sports wagering, while others may resemble financial or economic forecasting. That range makes it harder to create one simple tax framework that applies cleanly across every type of contract." This diversity underscores the need for granular guidance from the IRS, potentially even creating sub-categories of prediction market contracts for tax purposes.
The Federal-State Clash: A Battle for Jurisdiction and Revenue
Beyond the federal tax ambiguities, prediction markets are caught in a broader jurisdictional battle between federal agencies and state governments. The Commodity Futures Trading Commission (CFTC) asserts its authority over prediction markets, contending that the platforms’ event contracts are structured as "swaps" and therefore fall under its regulatory purview as derivatives. This assertion aligns with the idea that these contracts are financial instruments rather than pure gambling.
However, many states vehemently disagree. Following a landmark 2018 Supreme Court decision that empowered states to regulate sports gambling, numerous states have begun to view prediction market contracts, particularly those related to sports outcomes, as illegal sports betting operations. This stance is largely driven by a desire to protect consumers, prevent illegal gambling, and, crucially, to generate significant tax revenue. States like Oregon, New York, and New Hampshire, for instance, have implemented substantial taxes, with some reaching at least a 50% tax on online sports betting sites. For states, treating prediction market contracts as gambling income is a more attractive option, as Schutz pointed out, because "that’s a revenue driver." This creates a direct conflict with the CFTC’s assertion of jurisdiction and the industry’s preference for a financial instrument classification.
North Carolina’s Strategic Distinction
Amidst this federal-state conflict, North Carolina has taken a notably different approach. Unlike other states that directly challenge prediction markets as illegal gambling, North Carolina has recognized prediction markets as operating under the CFTC’s jurisdiction. This strategic move is reflected in its tax structure: the state imposes a 6% tax on prediction market operators, significantly lower than the 23% tax it levies on sports betting sites.
This nuanced approach could be a calculated legal maneuver. Nathan Goldman suggested that North Carolina’s decision to implement a lower tax number for prediction markets might be an attempt to mitigate potential legal challenges. "I think North Carolina is pretty much saying, ‘Maybe if we go in with a lower number, we won’t have as big of a fight in the courtroom over whether we’re allowed to impose this,’" Goldman explained. By aligning with the CFTC’s view, at least partially, North Carolina may be trying to avoid getting sued by prediction market platforms that claim federal preemption over state gambling laws. This highlights the delicate balance states are attempting to strike between asserting regulatory authority and avoiding costly legal battles.
Legal Confrontations: Prediction Markets in the Crosshairs
The jurisdictional dispute has predictably spilled into the legal arena, with multiple states initiating legal proceedings against prediction market platforms. These lawsuits typically argue that the platforms are operating illegal sports betting services, circumventing state gambling laws. The CFTC has actively engaged in this fray, intervening in some cases to defend what it claims is its exclusive jurisdiction over event contracts, further complicating the legal landscape.
A recent development underscores the challenges faced by prediction market platforms: a New York federal judge earlier in 2026 rejected Kalshi’s request to prevent New York from implementing its state gambling laws on the platform’s sports-related event contracts. This ruling represents a significant setback for platforms seeking to operate uniformly across states under federal regulatory umbrella. The judge’s decision indicates a willingness by the judiciary to allow states to apply their existing gambling statutes, at least for certain types of contracts.
These converging legal actions and differing interpretations from federal and state authorities create a chaotic environment. "If states come in and they start enacting their own laws, we have these converging laws all over the place and that makes what Washington ultimately does a lot more challenging," Goldman noted. The fragmented legal landscape makes it incredibly difficult for the IRS or any federal agency to craft a cohesive and universally applicable tax framework. Any federal guidance would need to carefully navigate these established state positions and ongoing legal precedents.
Platform Responsibility and User Obligations
Despite the overarching regulatory uncertainty, prediction market platforms do take some steps to assist their users. Both Kalshi and Polymarket, for example, provide users with a Form 1099 to report their trading activity. A Form 1099-MISC (Miscellaneous Income) or 1099-K (Payment Card and Third Party Network Transactions) is typically issued by platforms that process payments or facilitate transactions exceeding certain thresholds. While this documentation is helpful, it does not absolve taxpayers of their ultimate responsibility. Taxpayers are legally obligated to report all their earnings, regardless of whether they receive a Form 1099.
However, the platforms have largely refrained from offering explicit tax guidance to their users, a stance that is understandable given the legal ambiguities and the potential for liability. When approached for comment, neither Kalshi nor Polymarket directly addressed the role they play in ensuring users have a better understanding of their tax obligations. This silence underscores the industry’s precarious position, caught between a desire to innovate and the need to comply with an undefined regulatory framework. The ultimate burden of interpreting complex tax law and accurately reporting income from prediction markets thus falls squarely on the individual trader, often without the necessary authoritative clarity.
The Urgent Call for Clarity: Implications for Industry and Taxpayers
The absence of a clear roadmap for taxing prediction markets is a critical issue demanding immediate attention from federal authorities. Tax experts are united in their call for definitive IRS guidance. "I would love to see IRS guidance. I think that would be the most definitive solution," said Schutz. Such guidance would provide much-needed certainty, enabling traders to comply confidently, platforms to operate with greater clarity, and the government to collect appropriate revenue.
However, Schutz also acknowledged a potential hurdle: "I think the IRS might be hesitant to come out with guidance that conflicts with the CFTC position." The intricate dance between the IRS and other federal agencies, particularly the CFTC with its asserted jurisdiction, suggests that any guidance would require inter-agency coordination and a harmonized federal approach. This complexity likely contributes to the delay, as the IRS may be waiting for broader regulatory consensus or judicial clarification on the fundamental nature of prediction market contracts.
The broader implications of this prolonged uncertainty are significant. For the prediction market industry, a lack of clear tax rules can stifle innovation, deter investment, and impede mainstream adoption. Potential users may shy away from platforms if they are unsure of their tax liabilities, or if they perceive the risk of non-compliance to be too high. For taxpayers, the ambiguity creates undue stress, potential financial penalties, and a disproportionate burden of navigating an undefined legal landscape. It also creates an uneven playing field, where some traders might unknowingly or knowingly misclassify their income, leading to inequitable tax outcomes.
Conclusion: An Evolving Landscape Demanding Definitive Action
The burgeoning prediction market industry stands at a critical juncture, poised for significant growth but hampered by regulatory ambiguity, particularly concerning taxation. The IRS’s continued silence on how to treat winnings from these platforms has created a complex and confusing environment, forcing traders and platforms to grapple with conflicting interpretations and potential classifications ranging from unfavorable gambling income to the more advantageous Section 1256 contracts.
This federal inaction is compounded by an ongoing jurisdictional battle where the CFTC asserts control over prediction markets as financial instruments, while numerous states seek to categorize them as gambling for revenue generation and consumer protection. Legal skirmishes, such as the recent ruling in New York against Kalshi, highlight the deep divisions and the lack of a cohesive national strategy. As prediction market contracts continue to evolve, with innovations like perpetual futures adding further layers of complexity, the need for definitive federal guidance becomes ever more urgent. Without a clear and comprehensive tax framework, the industry’s potential will remain constrained, and millions of participants will continue to operate in a tax limbo, underscoring the pressing demand for the IRS and other federal agencies to provide a definitive roadmap for this evolving financial landscape.
Disclosure: CNBC and Kalshi have a commercial relationship that includes customer acquisition and a minority investment.
