Prediction Markets Are Becoming a Tax Issue—Here's Why That Matters

Prediction markets have grown rapidly over the past few years, attracting investors, cryptocurrency enthusiasts, and high-net-worth individuals looking for new ways to participate in financial markets. Platforms such as Kalshi have introduced many investors to a different type of trading—one that allows participants to buy and sell contracts based on the likelihood that future events will occur.

While much of the attention has focused on how these markets operate, an equally important issue is beginning to emerge: taxes.

Recent action by North Carolina suggests that state governments are starting to develop tax frameworks specifically for prediction markets. Although the new law applies to prediction-market operators—not individual traders—it represents a much broader trend. Federal and state regulators increasingly view prediction markets as a permanent part of the financial landscape, and that means tax rules, reporting requirements, and compliance expectations are likely to continue evolving.

If you actively trade prediction contracts, now is the time to begin paying attention.

Prediction markets allow participants to trade contracts tied to the outcome of future events. Instead of buying stock in a company or investing in a mutual fund, traders purchase contracts that increase or decrease in value depending on whether a particular event occurs.

Examples include contracts based on questions such as:

• Will the Federal Reserve raise interest rates this year?
  
  
• Will inflation exceed a certain percentage?
  
  
• Will Congress pass a particular piece of legislation?
  
  
• Will a specific economic indicator reach a stated level?

Although these markets may resemble sports betting at first glance, there is an important legal distinction.

Many prediction-market platforms operate under the oversight of the Commodity Futures Trading Commission (CFTC), the federal agency responsible for regulating U.S. derivatives markets. Rather than treating these platforms as traditional sportsbooks, the CFTC regulates certain event contracts as financial products.

That distinction is becoming increasingly important for both regulators and taxpayers.

North Carolina recently enacted legislation imposing a 6% tax on the net trading fee revenue earned by prediction-market operators attributable to the state. The same legislation also increased the state's sports wagering tax.

The significance of the law is not simply that another tax was enacted.

Instead, North Carolina chose to recognize federally regulated prediction-market platforms separately from traditional sports wagering. Rather than attempting to classify these markets as gambling, the state acknowledged the federal regulatory framework established by the CFTC.

For individual investors, this law does not create a new state tax on their trading activity.

Instead, it signals that lawmakers are beginning to build tax systems around prediction markets as their own asset class. That is an important development because once governments begin creating industry-specific tax rules, additional guidance often follows.

The federal government is also playing an increasingly important role.

The CFTC has consistently maintained that federally regulated event-contract markets fall within its jurisdiction rather than under state gambling laws. The agency has recently defended that position in litigation involving state attempts to regulate prediction-market activity.

Although those legal disputes primarily affect the operators of prediction-market exchanges, they also demonstrate that these markets are becoming an established part of the U.S. financial system.

As that recognition grows, additional tax guidance and reporting expectations are likely to follow.

One of the biggest challenges facing investors is that the IRS has not issued comprehensive guidance specifically addressing the taxation of prediction market transactions. As a result, tax professionals currently evaluate several possible approaches based on existing tax law.

One possible approach is to treat prediction market winnings as gambling income. Under this view, net winnings are generally taxed as ordinary income at the taxpayer's marginal tax rate. Gambling losses generally may only offset gambling winnings if the taxpayer itemizes deductions, and current law limits the deduction for gambling losses to 90% of those losses. In some situations, that limitation could result in taxable income even if the taxpayer breaks even economically over the course of the year.

Another possibility is to treat prediction market contracts as capital assets. Under this approach, gains and losses would generally be reported similarly to other property transactions, with individual trades reported on Form 8949. Net capital losses may offset capital gains and, subject to annual limits, up to $3,000 of ordinary income.

A third possibility may exist for certain contracts traded on Commodity Futures Trading Commission (CFTC)-designated contract markets. Depending on the nature of the contract and applicable tax rules, some transactions could potentially qualify for treatment under Section 1256 of the Internal Revenue Code, providing the favorable 60% long-term and 40% short-term capital gain split regardless of the holding period.

Because the IRS has not provided definitive guidance, there is currently no one-size-fits-all answer for every prediction market transaction.

In the absence of clear IRS guidance, many tax professionals favor a conservative reporting position.

Treating prediction market winnings as ordinary income generally represents the most audit-resistant approach because it applies the least favorable tax treatment to the taxpayer. While this may result in paying more tax than might ultimately be required under future guidance, it significantly reduces the risk that the IRS could later argue income was underreported.

A conservative reporting position also helps reduce the likelihood of accuracy-related penalties if the IRS ultimately adopts a stricter interpretation of these transactions.

Importantly, if the IRS later issues formal guidance establishing more favorable treatment, taxpayers may have the opportunity to amend previously filed returns. In general, a taxpayer has three years from the date the original return was filed, or two years from the date the tax was paid, whichever is later, to claim a refund by filing an amended return.

For many investors, paying slightly more tax today may be preferable to facing additional tax, interest, and penalties later if the IRS adopts a less favorable interpretation.

Whenever a new investment product becomes popular, tax issues usually follow.

Prediction markets are no exception.

Investors should be asking questions such as:

• How should my gains and losses be reported?
  
  
• Which tax treatment is appropriate for my transactions?
  
  
• Will reporting requirements change?
  
  
• What records should I maintain?
  
  
• Will more information eventually be reported directly to the IRS?
  
  
• How will my state treat these transactions?

These are not questions to answer after receiving a tax organizer. They are planning questions that should be discussed before filing your return.

Investors who have been involved with cryptocurrency have seen this pattern before.

In cryptocurrency's early years, tax reporting guidance was relatively limited, and many taxpayers assumed the IRS would devote little attention to digital assets. Over time, however, the IRS dramatically increased enforcement efforts, expanded reporting requirements, revised tax forms, and required more extensive disclosures.

Prediction markets are not cryptocurrency, and there is no indication they will be regulated in exactly the same way.

However, they share one important characteristic: both represent emerging financial products that developed faster than the tax rules surrounding them.

As prediction markets continue to grow, it would not be surprising to see additional IRS guidance, expanded information reporting, or new state reporting requirements.

Regardless of how future tax rules develop, good records remain one of the best ways to protect yourself.

If you actively trade prediction contracts, you should retain documentation such as:

• Trade confirmations
  
  
• Purchase and settlement dates
  
  
• Contract values
  
  
• Trading fees
  
  
• Account statements
  
  
• Annual tax reporting documents

Maintaining organized records throughout the year makes tax preparation significantly easier and allows us to properly report your transactions while identifying potential planning opportunities.

It can also help support your return if questions arise later.

North Carolina is unlikely to be the last state to address prediction markets.

As these markets continue to expand, additional states will likely examine how to tax businesses operating within their borders and determine how prediction-market activity fits within existing tax systems.

Some states may adopt approaches similar to North Carolina by recognizing federally regulated platforms while imposing operator-level taxes.

Others may pursue more aggressive regulation.

Still others may wait for additional federal guidance before taking action.

Regardless of the path they choose, the trend appears clear: prediction markets are no longer viewed as a niche product. They are becoming part of the broader financial marketplace, and tax policy is beginning to catch up.

Too often, investors think about taxes only after the year has ended.

By then, many planning opportunities have already been lost.

If you actively trade prediction market contracts, one of the most important decisions may not be how much you made—it may be how you report those gains and losses. With the IRS yet to issue definitive guidance, choosing a reasonable reporting position and documenting that position can be just as important as calculating the tax itself.

A proactive review of your trading activity before your return is filed can identify reporting issues, evaluate the most appropriate tax treatment based on current law, and prepare you to respond if the IRS issues additional guidance in the future.

Prediction markets are moving from an emerging financial product to a recognized part of the regulated investment landscape.

North Carolina's recent legislation is significant not because it creates a new tax for individual traders, but because it demonstrates that governments are beginning to develop tax policies specifically for this growing industry. At the same time, the absence of definitive IRS guidance means investors must make thoughtful reporting decisions based on existing tax law while remaining prepared for future developments.

The rules are changing, and proactive tax planning today can help prevent surprises tomorrow.

Prediction market taxation is still evolving. If you're actively trading these contracts, let's review your activity now so you can stay ahead of changing federal and state tax rules.