Prediction Market Traders Face Tax Limbo as IRS Stays Silent
The IRS has not issued guidance on taxing prediction market winnings, leaving traders facing potentially massive disparities in tax liabilities depending on whether contracts are classified as gambling or financial instruments.
With the year more than halfway over, the Internal Revenue Service has yet to issue guidance on the federal tax treatment of prediction market winnings and losses. The silence leaves traders guessing how their profits will be taxed, a critical variable for evaluating actual returns.
The tax bill for a trader could swing wildly depending on how the IRS ultimately classifies these contracts. Experts say winnings could be taxed as gambling income, standard capital gains, or under Section 1256 contracts. "Some contracts may look more like sports wagering, while others may resemble financial or economic forecasting," said George Salis, chief economist and senior tax policy director at Vertex.
The distinction carries severe financial consequences. Under President Donald Trump's "One Big Beautiful Bill Act," gambling loss deductions are capped at 90%. A trader who wins $100 and loses $100 would owe tax on $10. "Sports gambling is actually in very bad tax treatment right now," said Nathan Goldman, a professor of accounting at North Carolina State University.
Conversely, Section 1256 treatment offers significant advantages. It applies a 60/40 split, taxing 60% at lower long-term capital gains rates of up to 20% and 40% at higher short-term rates of up to 37%, regardless of holding period. "For the vast majority of people, the 1256 treatment or capital gain treatment would result in the least amount of tax," said Ryan Schutz, a former IRS special agent and founder of First There Tax.
The introduction of new products is adding to the confusion. In May, Kalshi launched perpetual futures, or "perps," which lack expiration dates. Schutz noted these might qualify for different, more favorable tax treatment than traditional event contracts. "When I first found out about the perpetuals, they felt more like a real financial contract... and that kind of tracks with the mechanics of 1256," he said.
The tax ambiguity stems from a broader jurisdictional clash between federal regulators and state governments. The Commodity Futures Trading Commission asserts prediction markets are swaps under its exclusive jurisdiction. However, multiple states are suing platforms, arguing they are illegal sports betting operations. Earlier this month, a New York federal judge rejected Kalshi's attempt to block state gambling laws from applying to its sports contracts.
States have a clear financial incentive to classify prediction markets as gambling. Since a 2018 Supreme Court ruling, states like New York and New Hampshire have levied taxes exceeding 50% on online sports betting. North Carolina took a different approach, imposing a 6% tax on prediction market operators compared to 23% on sports betting sites, partly to avoid courtroom battles. "Treating [contracts] as gambling income is more beneficial to [states], because that's a revenue driver," Schutz said.
The patchwork of state litigation is likely delaying federal action. "If states come in and they start enacting their own laws... that makes what Washington ultimately does a lot more challenging," Goldman said. For now, traders must navigate the conflicting rules alone. "I think the IRS might be hesitant to come out with guidance that conflicts with the CFTC position," Schutz added.
