Understanding the Evolving Tax Landscape of Prediction Markets
Over the past few years, prediction markets have experienced rapid growth, drawing in cryptocurrency enthusiasts, high-net-worth individuals, and active investors looking for unique ways to participate in financial markets. Platforms like Kalshi have introduced many traders to a distinct style of trading, allowing participants to buy and sell contracts based entirely on the likelihood of specific future outcomes.
While public attention has largely focused on how these event-driven markets function, a highly important issue is starting to emerge: the tax implications for active participants.
A recent legislative shift in North Carolina suggests that state governments are actively developing tax frameworks specifically tailored for prediction markets. Although this new law applies to prediction-market operators rather than individual traders, it highlights a much broader trend. Regulators at both the state and federal levels increasingly view prediction markets as a permanent fixture of the financial ecosystem. Consequently, tax rules, reporting requirements, and compliance expectations will likely continue to evolve. For active traders, now is the time to start paying close attention to these developments.
Understanding Event Contracts and Prediction Markets
Prediction markets allow participants to trade contracts tied directly to the resolution of future events. Rather than purchasing shares of stock in a corporation or investing in a mutual fund, traders purchase contracts that fluctuate in value depending on whether a designated event occurs.
These platforms often feature contracts based on economic and legislative 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 might resemble sports betting at first glance, a critical legal distinction exists between the two.
Many prediction-market platforms operate under the oversight of the Commodity Futures Trading Commission (CFTC), the federal regulatory agency responsible for governing U.S. derivatives markets. Rather than treating these platforms as sportsbooks, the CFTC regulates certain event contracts as financial products. This distinction is becoming increasingly important for both regulators and taxpayers.
The Implications of North Carolina's Recent Tax Legislation
North Carolina recently enacted legislation establishing 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 true significance of this law extends beyond a simple revenue-generating measure. By enacting this statute, North Carolina chose to recognize federally regulated prediction-market platforms separately from traditional sports wagering. Rather than classifying these markets under the umbrella of gambling, the state formally acknowledged the federal regulatory structure administered by the CFTC.
For individual investors, this legislation does not impose a new state tax on their trading activities. Instead, it signals that lawmakers are beginning to classify prediction markets as a distinct asset class. Historically, once governments establish industry-specific tax structures, additional regulatory and administrative guidance quickly follows.
Federal Oversight and CFTC Regulation
The federal government is also asserting its role in this space. The CFTC has consistently maintained that federally regulated event-contract markets fall strictly within its regulatory jurisdiction, rather than under the purview of state gambling laws. The commission has actively defended this position in litigation involving state-level attempts to regulate prediction-market activity.
While these legal disputes primarily impact exchange operators, they underscore the reality that these markets are cementing their position in the broader U.S. financial ecosystem. As this institutional recognition deepens, additional tax reporting expectations and guidance will likely emerge.
Three Potential Tax Treatments for Prediction Market Transactions
A major hurdle for active traders is that the IRS has yet to publish comprehensive, dedicated guidance addressing how prediction market transactions should be taxed. In the absence of direct rules, tax professionals analyze several possible treatments under existing tax law:
- Ordinary Gambling Income: One interpretation treats prediction market winnings as gambling income. Under this approach, net winnings are taxed as ordinary income at the taxpayer's marginal rate. However, gambling losses are generally only deductible if you itemize, and current law limits the deduction of gambling losses to 90% of those losses. This mismatch can sometimes create a tax liability even if you broke even economically over the tax year.
- Capital Assets: A second possibility is to treat prediction market contracts as capital assets. Under this framework, gains and losses are reported as property transactions on Form 8949. Net capital losses can offset capital gains, with up to $3,000 of excess loss offsetting ordinary income annually.
- Section 1256 Contracts: For certain contracts traded on CFTC-designated contract markets, transactions might qualify for treatment under Internal Revenue Code Section 1256. This classification provides a highly favorable tax split: 60% long-term and 40% short-term capital gains, regardless of how long the contract was held.
Because the IRS has not established a definitive rule, tax treatment is not uniform and depends heavily on the specific details of your transactions.
Why a Conservative Reporting Strategy Protects Investors
Given the lack of definitive guidance, taking a conservative reporting approach is often the most prudent course of action.
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.
What Does This Mean for Investors?
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.
Remember What Happened With Cryptocurrency
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.
Good Recordkeeping Is More Important Than Ever
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.
More States Are Likely to Follow
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, while 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.
Planning Before Tax Season Pays Off
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.
Navigating Shifting Rules in a Growing Industry
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. If you are actively trading these contracts, let us at MJ Ahmed CPA PLLC review your activity now so you can stay ahead of changing federal and state tax rules.
COMPLETE -->Want tax & accounting tips and insights?
Sign up for our newsletter.