While the tax rules governing gambling are clear, the rise of prediction market bets – which are structured as investments – injects fresh uncertainty into how wagers are taxed.

The crux of the issue is whether the payouts from these prediction market bets are considered gambling, like wagers placed in sportsbooks and betting apps, or proceeds from financial instruments. The answer has major implications since US tax law gives preferential treatment to investment income while penalizing gambling. Treating prediction market bets like investments allows taxpayers to fully deduct losses and, under the most aggressive strategy, apply a lower tax rate. Though neither approach is without risk. 

Supporters of more favorable tax treatment argue prediction markets differ from traditional sportsbooks in ways that extend beyond branding. Rather than placing wagers with bookmakers, traders buy and sell standardized event contracts, with trades cleared through market infrastructure designed for financial products. 

Critics counter that the underlying economics remain the same: Participants risk money on uncertain outcomes in hopes of payouts. They argue courts and the Internal Revenue Service have historically looked beyond legal structure when deciding whether an activity amounts to gambling.

So far, the IRS has been silent on the issue. Some tax experts said the IRS may be reluctant to weigh in quickly given the politically charged environment surrounding prediction markets, including the involvement of President Donald Trump’s family in the sector.

Neither the Treasury Department nor the IRS returned a request for comment. 

Absent clear guidance, gamblers have been left to navigate the tax uncertainty themselves.

“This is kind of the Wild West right now. We don’t know who the sheriff in town is,” said Andrew Lautz, director of tax policy for the Bipartisan Policy Center.

Sports gambling has exploded in recent years with more than a quarter of Americans saying they have an active online sports betting account, according to the Research Institute at Siena University. State-regulated sports gambling revenue hit a record $16.96 billion last year, according to the American Gaming Association.

The increasing popularity of prediction markets as well as expansion into the space by cryptocurrency platforms, online sportsbooks and tech giants, such as Meta Platforms’ experimental foray, mean the issue is unlikely to disappear anytime soon.

Gambling or Not?

Betting apps, like the ones operated by DraftKings Inc. and FanDuel Inc., have dominated the explosion of online sports gambling. The platforms are regulated by states and are subject to both state levies and a federal excise tax. Payouts from bets placed on the platforms face the same tax treatment as casino winnings, including limited deduction of losses.

But more recently, prediction markets regulated on the federal level by the Commodity Futures Trading Commission, like Kalshi and Polymarket US, have emerged as a force in the sports-betting arena. Both DraftKings and FanDuel have also entered the space with their own prediction market products. 

While both types of platforms allow users to bet on the outcomes of athletic competitions, prediction markets have made the case that as federally regulated derivatives markets, they’re not subject to the same state-level rules as sports betting apps and casinos.

“The big question is: Is it gambling or not?” said James Creech, a principal at Baker Tilly’s specialty tax practice.

The big disadvantage for gambling income from a tax perspective is the treatment of losses. Gamblers can only deduct losses if they itemize their taxes, which few Americans do and would mean forgoing the $16,100 standard deduction. They also can’t write off more than they’ve won and are limited to deducting no more than 90% of their losses.

A FanDuel spokesperson said questions about how payouts could be taxed are a matter for the authorities.

Special Treatment

Some tax experts say prediction market payouts clearly fall under those rules, citing case law on wagers and the obvious similarities between betting on athletic competitions whether it’s on state-regulated app or federally regulated prediction market.

But some prediction market enthusiasts are warming to a different approach that involves treating event contracts like financial products, allowing them more generous loss deductions. A more aggressive interpretation even allows for a reduced tax rate on winnings.

“These are no longer sports bets,” said Nathan Goldman, an accounting professor at North Carolina State University’s Poole College of Management, citing the structure of the contracts, regulation by the CFTC and even the tax forms the markets distribute to customers.

That has opened two alternative tax approaches. The first, and more straightforward, is to treat the contract payouts as capital gains, allowing taxpayers to fully write off losses. If they lose more than they win, up to $3,000 in losses could be used to lower other taxable income from that year, and further losses could be carried forward to offset future income.

Another, more controversial pathway to yield even greater savings involves using a tax regime reserved for specific types of derivatives under Section 1256 of the tax code.

If prediction market wagers meet the parameters – which many tax experts said was doubtful – the provision would allow bettors to apply the lower, long-term capital gains rate to 60% of the payout, regardless of how long they’ve held the contract. The rest would be considered short-term gains, subject to the taxpayer’s usual income tax rate.

“Everyone would like them to be able to qualify” for that treatment, said Loren Lembo, a partner at Katten Muchin Rosenman LLP. But it’s not entirely clear sports events contracts would qualify for the provision, which has very specific parameters, she said.

Yet Carl Kennedy, a partner and co-chair of Financial Markets and Regulation at the firm, defended the alternative, investment-aligned approaches, saying that while the economic exposure online sports gambling apps and prediction markets provide may be identical, structurally the two products are different.

“When you go to a casino, it’s just you and the casino. You go to an online gambling site, that’s it,” Kennedy said. “There’s no third party. There’s no clearinghouse. There’s no regulator sitting on top imposing rules on every aspect of that relationship.”

Risk Tolerance

If the IRS takes the more conservative approach and deems prediction market contracts a form of gambling, taxpayers could be left holding the bag, owing back taxes and potential penalties.

Seth Hanlon, a senior fellow at the Tax Law Center at New York University School of Law, said past court cases point toward prediction market activities eventually being classified as gambling for tax purposes.

“There are cases where the taxpayers have argued that whatever they’re doing is not gambling and the courts have essentially said if it looks like gambling and smells like gambling, it’s gambling, regardless of whether you dress it up as something different,” Hanlon said.

It boils down to how big a gamble bettors are willing to take.

“It’s up to an individual to determine what is their risk tolerance here in the absence of clear definitive guidance,” said Robert Stoddard, a tax partner at KPMG LLP with expertise on the gaming industry.  “I’ve spoken with folks who are across all ends of the spectrum.”