Prediction Market Taxes: Why Current Developments Matter for Investors
Prediction markets have experienced significant growth over the past few years, drawing interest from investors, cryptocurrency enthusiasts, and high-net-worth individuals across the country, including right here in the Twin Cities. Platforms like Kalshi have introduced many traders to an alternative type of market where participants buy and sell contracts based on the probability of future events.
While the mechanics of these platforms have dominated public discussion, an equally critical issue is taking shape behind the scenes: how these activities are treated for tax purposes. At Paul Haglund & Co, we believe in helping our clients navigate these emerging trends to avoid surprises and make smart, timely decisions.
Recent legislative activity in North Carolina highlights that state governments are beginning to craft specific tax frameworks for prediction markets. Although this new law targets operators rather than individual traders, it signals a broader shift. Federal and state regulators are increasingly treating prediction markets as a permanent component of the financial system, meaning that reporting requirements and compliance standards will continue to evolve. If you are actively trading event contracts, now is the time to understand the tax implications.
What Are Prediction Markets?
Prediction markets allow participants to trade contracts tied to the outcomes of future occurrences. Instead of purchasing traditional equity shares or mutual funds, traders buy contracts that fluctuate in value based on whether a specific event takes place.
Typically, these contracts revolve around questions such as:
- Will the Federal Reserve raise interest rates this year?
- Will inflation exceed a certain percentage?
- Will Congress pass a specific piece of legislation?
- Will a particular economic indicator hit a designated level?
Although these platforms might seem similar to sports wagering at a glance, a critical legal distinction exists. Many prediction-market platforms operate under the oversight of the Commodity Futures Trading Commission (CFTC), the federal agency that regulates U.S. derivatives. Instead of classifying these platforms as sportsbooks, the CFTC regulates certain event contracts as distinct financial products—a distinction that is becoming highly consequential for both taxpayers and regulators.
Why North Carolina's New Law Matters
North Carolina recently enacted legislation that levies a 6% tax on the net trading fee revenue earned by prediction-market operators attributable to the state, while also raising its sports wagering tax. The significance of this law extends far beyond the implementation of a new tax.
By enacting this statute, North Carolina chose to recognize federally regulated prediction-market platforms separately from traditional sports wagering. Rather than attempting to lump these transactions under gambling laws, the state acknowledged the federal regulatory framework established by the CFTC.
For individual investors, this legislation does not introduce a direct state tax on individual trading activities. However, it demonstrates that lawmakers are beginning to design tax structures around prediction markets as an independent asset class. When governments start establishing industry-specific rules, further guidance for individual taxpayers typically follows.
The Federal Regulatory Picture Is Taking Shape
The federal government is playing an increasingly active role in shaping how these markets are perceived. The CFTC has consistently maintained that federally regulated event-contract markets fall squarely under its jurisdiction, rather than state gambling regulations. The agency has recently defended this stance in litigation surrounding state-level attempts to regulate prediction-market activity.
While these legal disputes primarily impact the exchanges themselves, they confirm that prediction markets are cementing their position in the U.S. financial landscape. As federal recognition solidifies, taxpayers should expect additional tax guidance and reporting expectations to follow.
How Are Prediction Market Winnings Taxed?
One of the main challenges for investors is that the IRS has yet to issue comprehensive, dedicated guidance on how prediction market transactions are taxed. Consequently, tax professionals currently evaluate several potential frameworks under existing tax law.
The Gambling Income Approach
One potential method is to treat prediction market winnings as gambling income. Under this treatment, net winnings are generally taxed as ordinary income at your marginal tax rate. Furthermore, gambling losses can typically only offset gambling winnings if you itemize your deductions, and current rules restrict the deduction for gambling losses to 90% of those losses. In certain situations, this limitation can create a taxable event even if you only broke even economically over the course of the year.
The Capital Asset Approach
Another path is to treat prediction market contracts as capital assets. Under this framework, gains and losses are reported similarly to other property transactions, with individual trades documented on Form 8949. Net capital losses can be used to offset capital gains, and subject to annual limitations, up to $3,000 can be used to offset ordinary income.
The Section 1256 Approach
A third possibility exists for specific contracts traded on CFTC-designated contract markets. Depending on the structure of the contract and applicable regulations, certain transactions might qualify for treatment under Section 1256 of the Internal Revenue Code. This would grant the taxpayer a favorable split of 60% long-term and 40% short-term capital gains, regardless of how long the contract was actually held.
Because the IRS has not delivered definitive guidance, there is no single standard that applies to every prediction market transaction.
Why Conservative Tax Reporting May Be the Safest Approach
In the absence of clear instructions from the IRS, many tax advisors recommend a conservative reporting strategy. Treating prediction market winnings as ordinary income is generally the most audit-resistant stance because it applies the least favorable tax treatment. While this approach might mean paying more tax than ultimately required once permanent rules are established, it greatly minimizes the risk of the IRS alleging that income was underreported.
Adopting a conservative stance also reduces the likelihood of facing accuracy-related penalties if the IRS eventually takes a more restrictive view of these assets. Importantly, if the IRS later publishes formal guidelines that establish a more favorable tax treatment, taxpayers can look into amending their prior returns. Generally, you have 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, paying a bit more today is preferable to facing back taxes, interest, and penalties later.
What Does This Mean for Investors?
As with any popular new financial product, tax complexities are fast to follow. If you are trading prediction contracts, you should ask yourself the following planning questions:
- 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 critical planning questions that should be evaluated long before tax season arrives, rather than when you are filling out your annual tax organizer.
Remember What Happened With Cryptocurrency
Investors who participated in the early days of cryptocurrency will recognize this pattern. Initially, tax reporting guidelines for digital assets were scarce, and many assumed the IRS would not heavily police the space. Over time, however, the IRS dramatically stepped up enforcement, revised tax forms, expanded information reporting, and demanded comprehensive disclosures.
While prediction markets are not digital assets and may not be regulated in the exact same manner, both represent rapid financial innovations that outpaced the tax code. As these platforms continue to grow, expanded IRS guidance, updated reporting requirements, and new state rules are highly likely.
Good Recordkeeping Is More Important Than Ever
No matter how future regulations unfold, maintaining meticulous records remains your best line of defense. If you trade prediction contracts, you should carefully preserve the following documentation:
- Trade confirmations
- Purchase and settlement dates
- Contract values
- Trading fees
- Account statements
- Annual tax reporting documents
Staying organized throughout the year simplifies tax preparation and allows your tax professional to report your activities accurately while identifying potential planning opportunities.
More States Are Likely to Follow
North Carolina's legislative shift is likely just the beginning. As these platforms expand, more states will review how to tax operators within their borders and how prediction-market activity aligns with existing state tax systems. Some states may follow North Carolina's lead by taxing operators while acknowledging the CFTC's federal oversight, while others may implement more aggressive regulations or wait for clearer federal guidelines. Regardless of the path, prediction markets are transitioning from a niche interest into the mainstream financial landscape, and tax policy is catching up.
Proactive Tax Planning and Reviewing Your Activity
Many investors make the mistake of thinking about taxes only after the calendar year closes, missing valuable planning windows. If you actively trade prediction market contracts, your reporting choices and documentation are just as vital as calculating your net figures. Engaging in a proactive review before filing your returns allows us to evaluate the most appropriate tax treatment under current law, establish a solid reporting position, and ensure you are prepared for future IRS determinations.
At Paul Haglund & Co, we serve clients in Lakeville, the South Metro Twin Cities, and across Minnesota to bring clarity to evolving tax regulations. If you are active in prediction markets, let's connect to review your trading activity and build a clear, audit-resistant strategy that keeps you ahead of changing rules.
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