The IRS Has Not Said How Prediction Markets Are Taxed, Now the Silence Is Starting to Cost People Money
Prediction markets are halfway through their biggest trading year on record. The World Cup alone generated more than $2.6 billion in volume on Polymarket.
Kalshi processed $30 billion in monthly trading volume during the tournament. Millions of Americans have made money, or lost it, on sports event contracts, political markets, and economic indicator bets, and they owe taxes on their gains. As of now, the IRS has not told them how much.
More than halfway through 2026, the IRS has published no notice, revenue ruling, regulation, or form instruction that directly addresses how prediction market contracts should be characterized for federal income tax purposes.
Tax professionals describe the situation consistently: it is essentially the Wild West. Traders are getting conflicting guidance. Accountants are making judgment calls. And the One Big Beautiful Bill, signed into law earlier this year, has made the stakes of getting the classification wrong significantly higher than they were twelve months ago.
Three Classifications, Three Very Different Tax Bills For PM Users
The central problem is that prediction market contracts do not fit cleanly into any existing tax category, and the IRS has not created a new one.
Tax experts see three possible treatments. The first is gambling income: profits taxed as ordinary income at rates up to 37%, with losses deductible only against winnings, no carryforward, and now subject to the 90% cap introduced in the One Big Beautiful Bill.
The second is capital gains: short-term gains are taxed at ordinary income rates for contracts held under a year, and long-term rates apply at 0%, 15%, or 20% for contracts held longer, with losses preserved via carryforward and a $3,000 annual offset against ordinary income.
The third is Section 1256 treatment: a 60/40 split with 60% taxed at long-term capital gains rates and 40% at short-term rates regardless of holding period, with losses carrying back up to three years to offset prior gains.
The difference in real dollars is significant and would have a major impact on prediction market users. A trader who made $50,000 on prediction markets in 2026 owes roughly $18,500 under gambling income treatment at the top rate. Under Section 1256, the same gain generates closer to $12,500 in federal tax. Under short-term capital gains, the treatment is similar to gambling income at the top bracket but meaningfully better for traders in lower brackets who can use capital loss carryforwards from prior years.
Some tax professionals said they do not think prediction market contracts meet the IRS’s strict criteria for Section 1256 contracts, but there is no consensus. Most practitioners advising clients on regulated platforms like Kalshi are defaulting to capital gains treatment as the most defensible conservative position, while noting the IRS could recharacterize those gains as gambling income on examination. Section 1256 is the most aggressive commonly filed position and carries meaningful examination risk.
How the One Big Beautiful Bill Made Silence More Expensive
The 90% gambling loss cap is the provision that turns the IRS’s silence from a paperwork inconvenience into a concrete financial problem.
Under prior law, a gambler who won $100,000 and lost $100,000 in the same year paid no net tax. The wins and losses offset dollar for dollar, which made it fairly straightforward. Under the One Big Beautiful Bill’s new framework, a taxpayer can only deduct 90% of gambling losses. A trader who broke even, winning $100,000 and losing $100,000, now owes taxes on $10,000 of phantom income they never actually received, which many have pushed back on, calling for changes.
That phantom income problem applies only if prediction market contracts are classified as gambling income. Under capital gains treatment, losses carry forward and can fully offset gains without the 90% cap. The classification question, which the IRS has not answered, determines whether a break-even trader owes thousands of dollars in taxes or nothing at all.
Todd Witteles, a professional gambler and consumer advocate, testified before a telephone-based IRS panel on July 17 specifically about the implementation challenges the 90% cap creates for professional gamblers. His testimony focused on practical compliance suggestions rather than prediction market taxation specifically, but the underlying issue he was addressing, how the cap creates taxable income for people who did not net a profit, applies with equal force to prediction market traders if the IRS eventually classifies their activity as gambling.
The CFTC Classification Does Not Solve the Tax Problem
The most common assumption among prediction market traders is that CFTC regulation means Section 1256 treatment. The assumption is understandable but legally it doesn’t align.
CFTC registration alone does not confer Section 1256 status. The CFTC has classified prediction market contracts as binary options that are swaps, a characterization that could trigger an exclusion under Section 1256(b)(2)(B) that Congress enacted specifically to prevent such contracts from receiving the favorable 60/40 treatment. A trader claiming Section 1256 treatment for Kalshi contracts is asserting that their specific contracts meet a statutory definition that the CFTC’s own classification may actually undermine.
The IRS and the CFTC operate under separate statutory frameworks. Whatever the CFTC says about prediction market contracts for regulatory purposes does not automatically determine how the IRS characterizes them for tax purposes. The legal classification fight being argued in federal appellate courts across the country, whether prediction market contracts are swaps, futures, or gambling products, is a fight about who regulates them. It is a separate question from how the IRS taxes them, and the latter has no court case driving it toward resolution.
The Sixth Circuit and the Likely Road to The Supreme Court
The Sixth Circuit heard oral arguments Wednesday in Cincinnati on the consolidated Ohio and Tennessee prediction market appeals. Whatever that court decides will significantly shape the regulatory landscape. A ruling that sports event contracts are not swaps and that states can enforce gambling law against them could prompt the IRS to classify the contracts as gambling income. A ruling in Kalshi’s favor could strengthen the Section 1256 argument, since it would confirm the contracts qualify as federally regulated financial instruments.
The Supreme Court justices appear to be aware that the issue is heading their way. Justices Barrett and Kagan both said they believed existing ethics rules already covered prediction market trading by court employees when asked about it in a congressional hearing last week, though the exchange satisfied few of the lawmakers pressing the point. CNN reported that legal questions about prediction markets will almost certainly reach the Supreme Court before the end of the year.
A Supreme Court ruling on the regulatory classification question would not automatically produce IRS guidance. But it would remove the IRS’s most convenient reason for continued silence: that it cannot classify contracts for tax purposes while courts are still arguing about what they are for regulatory purposes. Once that argument is resolved, the IRS will face direct pressure to act.
In the meantime, millions of traders are filing returns under whichever classification their tax professional selected based on imperfect analogies and unresolved legal questions. “It’s really the Wild West until the IRS provides guidance,” said April Walker, senior manager for tax practice and ethics at the American Institute of CPAs. “What is important for taxpayers to know is that they should report income earned from prediction markets in some way and keep detailed records.”
That advice is sound, but it is also a remarkably modest standard for a product that generated billions in trading volume in the first half of 2026 alone.
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