Prediction Market Taxation: Gambling, Derivative, or Something New?

A client walks in and hands you a statement from Kalshi. They made $50,000 predicting Fed rate decisions last year. They want to know what they owe.

I ran into this exact question while doing some reading a few weeks ago. And what I found surprised me: there’s no clean answer. The IRS hasn’t said a word about how prediction market income should be classified. Not a Revenue Ruling. Not a Private Letter Ruling. Not even an FAQ update. Nothing, as of March 2026.

Meanwhile, Kalshi processed $23.8 billion in trading volume in 2025. Robinhood reported 12 billion prediction market contracts traded by over a million customers. This money is showing up on tax returns right now, and accountants are being asked to make a judgment call with no authoritative guidance to lean on.

What are prediction markets, exactly?

Platforms like Kalshi and Polymarket let you buy and sell contracts on the outcome of real-world events. Will the Fed cut rates in September? Will a certain candidate win? What will the price of oil be? You take a position, and if you’re right, the contract settles in your favor.

Economically, it looks a lot like a bet. But the platforms argue it’s something different — a financial contract regulated by the Commodity Futures Trading Commission, not a wager regulated by state gambling commissions. That distinction is the entire foundation of the tax debate.

Three treatments, three very different outcomes

Right now there are three defensible ways to treat prediction market income on a federal return. None is bulletproof. Here’s how they break down on that $50,000 gain:

Section 1256 — the most efficient, highest risk

Kalshi is a CFTC Designated Contract Market. Some practitioners argue that makes its contracts eligible for Section 1256 treatment — the 60/40 rule originally written for commodity and currency futures in the 1980s. Under 1256, 60% of gains are taxed at long-term capital gains rates and 40% at short-term, regardless of how long you held the position. On $50,000, that works out to roughly $13,400 in tax at a 37% bracket. The problem: the IRS has never confirmed this applies to binary event contracts, and CFTC oversight is necessary but not sufficient. If you take this position, filing Form 8275 is the smart move for penalty protection.

Gambling income — middle ground with new complications

If prediction markets are gambling products, income is ordinary, losses are itemized only to the extent of winnings, and starting in 2026 the One Big Beautiful Bill Act caps loss deductions at 90% of winnings. That means if your client won $10,000 and lost $10,000, they still owe tax on $1,000 of net income. The same $50,000 gain at ordinary rates comes to around $18,500. The gambling treatment also requires per-session tracking, which is cumbersome for anyone doing dozens of trades.

Ordinary income — safest, least efficient

Reporting gains as “Other Income” on Schedule 1 is the most conservative path. It’s unlikely to be challenged, it avoids the gambling loss cap complications, and you can file an amended return within three years if the IRS clarifies things in the taxpayer’s favor. The cost is paying ordinary rates on the full gain with no capital treatment upside.

Platform matters as much as the underlying bet

Here’s what makes this especially tricky for clients: the same economic prediction — say, “the Fed holds rates” — carries a different tax result depending on which platform they used.

• Kalshi is CFTC-regulated, issues 1099-INT and 1099-MISC, and has the strongest case for Section 1256. But it still doesn’t issue a comprehensive 1099-B for event contracts.
• Robinhood routes through Kalshi and issues nothing for event contracts. Self-reporting required.
• Polymarket (offshore) is built on the Polygon blockchain, settles in USDC, and issues no tax forms whatsoever. Every single trade is a taxable crypto event requiring Form 8949. If a client did hundreds of trades, they’re looking at hundreds of line items.
• Polymarket US launched in December 2025 as a CFTC-regulated entity — which means clients who used the offshore version earlier in 2025 and then switched face a split-treatment year.

Why this is getting more consequential, not less

Three things converged to make 2025 the year this landed on CPAs’ desks.

First, the OBBBA’s 90% gambling loss cap took effect January 1, 2026. Classification now has real dollar consequences for active traders with mixed win/loss years. Second, the platforms went fully mainstream — Robinhood says prediction markets are its fastest-growing revenue line, and DraftKings and FanDuel have both launched their own products. Third, a federal judge dissolved Kalshi’s preliminary injunction in November 2025, ruling sports contracts weren’t swaps. A coalition of 39 state attorneys general filed amicus briefs. Ninth Circuit oral arguments are set for April 16, 2026. A Supreme Court fight is likely by 2027.

If the courts ultimately classify these as gambling products at the state level, the Section 1256 argument collapses. The regulatory classification fight and the tax fight are the same fight.

What to do right now

Baker Tilly’s James Creech put it plainly in a December 2025 CNBC interview: “There is not an easy answer here. Everybody’s going to have to come up with an answer depending, in part, on how risk-adverse they want to be.”

• Ask which platform(s) they used — the answer determines reporting complexity and the defensibility of each treatment
• Default to ordinary income if uncertain — it’s the safest position and leaves the door open to amend
• If claiming Section 1256 for Kalshi activity, file Form 8275 for penalty protection under IRC §6662
• For offshore Polymarket activity, help clients reconstruct their trade history using blockchain explorers or crypto tax software
• Watch the Ninth Circuit — April 16, 2026 oral arguments could reshape the entire regulatory and tax foundation

Key takeaways

• The IRS has issued zero formal guidance on prediction market taxation as of March 2026
• Three treatments are each defensible: Section 1256 (60/40), gambling income, or ordinary income
• Kalshi has the strongest Section 1256 argument — but CFTC oversight is necessary, not sufficient
• Offshore Polymarket activity is crypto property — every trade is a Form 8949 event
• The OBBBA 90% loss cap makes gambling classification materially more costly starting in 2026
• Same bet, different platform — potentially different tax bill. Clients will ask about this.

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