The burgeoning world of prediction markets faces a significant tax quandary as the IRS has yet to offer any official guidance on how winnings and losses should be treated. Tax experts are exploring potential categorizations including gambling income, capital gains, and Section 1256 contracts, with the latter two generally offering more favorable outcomes.

Adding complexity are evolving contract types and ongoing jurisdictional battles between states and federal agencies like the CFTC, leaving traders and platforms seeking much-needed clarity.

Prediction Market Taxation Remains a Wild Card as IRS Stays Silent

As prediction markets surge in popularity, traders are grappling with a significant unanswered question: How will their winnings and losses be taxed? The Internal Revenue Service (IRS) has yet to provide any guidance, leaving participants and tax experts in a state of uncertainty.

Despite the year being well underway, the federal tax treatment for prediction market gains and losses remains unclear. This ambiguity creates confusion for users, with tax professionals observing conflicting advice being disseminated.

Prediction Market Taxation Remains a Wild Card as IRS Stays Silent — The Internal Revenue Service (IRS) has yet to issue guidance on the taxation of prediction markets.

Potential Tax Treatments Emerge

Tax experts suggest several potential classifications for income derived from prediction markets:

Gambling Income: This is one possibility, though it may come with less favorable tax implications, especially following recent legislative changes. A provision, potentially part of President Trump's "One Big Beautiful Bill Act," could cap gambling loss deductions at 90%, meaning even balanced wins and losses might result in taxable income. As noted by Nathan Goldman, a professor of accounting at North Carolina State University, "Sports gambling is actually in very bad tax treatment right now."
Capital Gains: Under this treatment, taxpayers with losses exceeding gains can offset ordinary income by up to $3,000 in realized losses. This is generally considered more advantageous than gambling income treatment.
Section 1256 Contracts: Futures contracts can be classified as Section 1256 contracts, which have a specific tax structure. This involves a 60/40 split: 60% of the capital gain is taxed at the lower long-term rate (0%, 15%, or 20%), while 40% is taxed at the higher short-term rate (as ordinary income, up to 37%). This split applies irrespective of how long the asset was held.

According to Ryan Schutz, a former IRS special agent and founder of First There Tax, "For the vast majority of people, the 1256 treatment or capital gain treatment would result in the least amount of tax."

The outcome of events like the World Cup final, often speculated on in prediction markets, is subject to tax uncertainty.

Unique Contracts, Unique Challenges

The emergence of new contract types, such as perpetual futures ("perps") introduced by platforms like Kalshi, adds another layer of complexity. These contracts, lacking expiration dates, may fall under different regulatory and tax frameworks than traditional event contracts. Schutz suggests that perpetuals might more closely resemble traditional financial contracts and potentially align with Section 1256 treatment.

George Salis, chief economist and senior tax policy director at Vertex, highlights the difficulty in creating a one-size-fits-all tax framework. "Some contracts may look more like sports wagering, while others may resemble financial or economic forecasting," he stated. "That range makes it harder to create one simple tax framework that applies cleanly across every type of contract."

State-Level Taxation and Jurisdictional Battles

States are keenly interested in the tax implications, as classifying prediction market contracts as gambling could generate significant revenue. Following the 2018 Supreme Court decision that empowered states to regulate sports gambling, many have imposed substantial taxes on online sports betting. However, the Commodity Futures Trading Commission (CFTC) asserts jurisdiction, viewing these event contracts as swaps.

North Carolina offers a unique approach, recognizing prediction markets under CFTC jurisdiction and imposing lower taxes on operators and sports betting sites compared to other states. This strategy may help the state avoid legal challenges from prediction market platforms.

Multiple states are engaged in legal disputes with prediction market platforms, arguing they operate illegal sports betting. The CFTC is actively involved, defending its claim of exclusive jurisdiction. A New York federal judge recently rejected Kalshi's attempt to prevent the state from applying its gambling laws to the platform's sports-related contracts.

These overlapping regulations and ongoing legal battles complicate the federal tax landscape. Experts are advocating for clear guidance from the IRS. Schutz expressed, "I would love to see IRS guidance. I think that would be the most definitive solution," while acknowledging the IRS might be hesitant to issue guidance that conflicts with the CFTC's position.

Both Kalshi and Polymarket provide users with a Form 1099 to report activity, though taxpayers are obligated to report earnings even without receiving a 1099. Neither the IRS nor the Department of Treasury responded to requests for comment from CNBC.