Taxing the Future: Why Prediction Markets Are the Next Big Compliance Hurdle
Over the last few years, prediction markets have experienced rapid growth, drawing interest from investors, crypto enthusiasts, and high-net-worth individuals looking for new ways to participate in financial markets. Platforms like Kalshi have introduced a different trading model, allowing users to buy and sell contracts based on the probability of future events.
While the mechanics of these platforms dominate discussions, an equally critical issue is developing behind the scenes: the tax implications.
Recent legislative activity in North Carolina highlights that state governments are actively designing tax structures for prediction markets. Though currently focused on platform operators rather than individual traders, this represents a broader shift. Both state and federal regulators now treat prediction markets as a permanent fixture of the financial ecosystem, meaning compliance rules and reporting expectations will continue to evolve. If you actively trade these contracts, preparing for these shifts is essential.
Understanding Prediction Markets as Financial Products
Prediction markets let participants trade contracts tied directly to future outcomes. Unlike purchasing stock or mutual fund shares, traders buy contracts that fluctuate in value depending on whether a specific event occurs.
These platforms commonly feature contracts centered on economic and political questions, such as:
- Whether the Federal Reserve will raise interest rates within the year.
- Whether inflation rates will exceed specific thresholds.
- Whether Congress will pass targeted legislation.
- Whether key economic indicators will reach designated levels.
Although these platforms can surface similarities to sports wagering, they are legally distinct.
Many prediction-market exchanges operate under the oversight of the Commodity Futures Trading Commission (CFTC), which regulates these event contracts as financial products rather than gambling. This regulatory separation has major implications for how these assets are treated under tax law.
The Shift in State-Level Taxation: Why North Carolina Matters
North Carolina recently established a 6% tax on the net trading fee revenue earned by prediction-market operators attributable to the state, passed alongside an increase in the state's sports wagering tax.
The real significance of this law extends beyond a new tax rate.
By enacting this legislation, North Carolina formally distinguished federally regulated prediction-market platforms from traditional sports betting, respecting the regulatory oversight of the CFTC.
For individual investors, this law does not impose a direct state tax on personal trading activity. However, it indicates that state lawmakers are beginning to formalize tax policies around prediction contracts as a distinct asset class. Once states begin codifying industry-specific rules, further guidance for individual participants typically follows.
Federal Regulatory Clarifications Are Evolving
At the federal level, the CFTC continues to assert that federally regulated event-contract markets fall strictly under its jurisdiction rather than state-level gambling oversight. The agency has defended this position in litigation involving state attempts to regulate these markets.
While these legal battles directly impact platform operators, they also underscore that prediction markets are cementing their position in the U.S. financial system. As federal recognition solidifies, taxpayers can expect more robust tax reporting mandates to emerge.
The Three Potential Paths for Taxing Winnings
Because the IRS has not yet published comprehensive guidance addressing prediction market transactions, tax professionals must assess several potential reporting frameworks based on existing law.
First, transactions could be treated as gambling income. Under this framework, net winnings are taxed as ordinary income at your marginal rate. However, gambling losses can only offset gambling winnings if you itemize your deductions, and tax law currently limits the deduction for gambling losses to 90% of those losses. This limitation could result in taxable income even if you broke even over the course of the year.
Second, prediction contracts could be treated as capital assets. In this scenario, gains and losses would be reported on Form 8949, similar to other property transactions. Net capital losses would offset capital gains, and up to $3,000 of ordinary income could be offset annually.
Third, certain contracts traded on CFTC-designated contract markets might qualify for treatment under Section 1256 of the Internal Revenue Code. This would apply a favorable 60% long-term and 40% short-term capital gains split to transactions, regardless of how long the contracts were actually held.
Due to the lack of explicit IRS guidance, there is no single reporting standard that applies universally to every transaction.
Why a Conservative Reporting Position Offers the Best Protection
Without clear administrative rules, adopting a conservative reporting approach is often the most prudent strategy.
Reporting prediction market winnings as ordinary income generally represents the most audit-resistant stance because it applies the least favorable tax rate. While this may mean paying more tax than ultimately required under future guidance, it minimizes the risk of the IRS claiming you underreported your income. It also helps protect you from accuracy-related penalties if the IRS later establishes strict reporting requirements.
If the IRS eventually issues guidance that provides more favorable tax treatment, you can file an amended return to claim a refund. 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 submit an amendment. For many investors, paying a higher rate today is preferable to facing back taxes, interest, and penalties later.
Critical Planning Questions for Active Traders
As with any emerging asset class, popularity is inevitably followed by tax enforcement. If you actively trade prediction contracts, you should address several key planning questions before the end of the tax year:
- How should your gains and losses be structured on your tax return?
- Which of the potential tax treatments fits your specific trading activity?
- Are reporting requirements likely to shift in the near future?
- What records do you need to maintain to verify your trades?
- Will platforms begin reporting transactions directly to the IRS?
- How does your state of residence treat these specific transactions?
Answering these questions during the tax year rather than when filling out your tax organizer ensures you are prepared for changing requirements.
Parallels to the Early Days of Cryptocurrency
Investors who navigated the early years of digital assets will recognize this regulatory pattern.
In the early days of cryptocurrency, formal reporting rules were scarce, and many assumed the IRS would not focus on digital assets. Eventually, the agency launched extensive enforcement programs, expanded reporting requirements, updated tax forms, and mandated strict transaction disclosures.
While prediction markets are distinct from cryptocurrency, both represent innovative financial products that outpaced the development of corresponding tax regulations. As prediction markets mature, expanded IRS reporting rules and state-level compliance mandates are highly likely.
Implementing Robust Recordkeeping Strategies
Regardless of how future federal and state tax policies materialize, meticulous recordkeeping remains your strongest defense. Active traders should consistently document:
- Trade confirmations
- Exact purchase and settlement dates
- Contract values at transaction times
- Associated trading fees
- Monthly or quarterly account statements
- Annual tax documents provided by the platforms
Maintaining organized financial records makes tax preparation straightforward, allows us to structure your reporting accurately, and ensures we can identify valuable tax-planning opportunities.
Anticipating the Expansion of State Tax Frameworks
North Carolina is unlikely to remain the only state regulating these platforms. As trading volumes increase, more states will review how to tax operators running businesses within their borders and evaluate how transaction revenues fit into existing state tax brackets.
Some states will follow North Carolina's model by establishing operator-level taxes that recognize CFTC oversight. Others might implement more restrictive rules, while some may pause until definitive federal rules are established. Ultimately, prediction markets are transitioning from a niche trading activity into a mainstream financial product, and tax authorities are moving quickly to adapt.
Structuring Your Strategy Before the Tax Deadline
Waiting until after the close of the tax year to evaluate your trading activity often means missing valuable tax planning opportunities. If you trade prediction contracts, selecting a defensible, well-documented reporting position is just as critical as calculating your net gains. A proactive review allows us to assess your activity, determine the most appropriate tax treatment under current laws, and protect your wealth from unexpected regulatory actions.
The landscape is changing rapidly. At Ember Coaching & Financial Services, Chris Conway, CPA, and our team help purpose-driven entrepreneurs and high-net-worth investors navigate complex tax situations. Let's review your prediction market trading activity now to keep you ahead of shifting state and federal tax codes. Contact our offices in Breckenridge, CO, or Destin, FL, to schedule a tax strategy consultation today.
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