Prediction Markets Are Booming — But The Tax Bill Could Be Brutal
Prediction markets exploded in 2025, but the tax playbook is still being written. And the Prediction Market Tax Bill could be costly for those who trade in, and for the market makers who fuel this multi-trillion-dollar financial sector.
That’s the core takeaway from KPMG’s deep dive into the taxation of sports event contracts—a space that sits somewhere between Wall Street derivatives and traditional sports betting sites. The problem? Nobody—not regulators, not the IRS, not even the exchanges—has fully agreed on what these things actually are. And until that’s settled, the Prediction Market Tax Bill is a moving target.
"The explosive growth of sports event contracts on prediction markets is creating new opportunities alongside significant tax uncertainty for investors, market makers, and stakeholders. While the legal and regulatory framework continues to evolve in real time, a pivotal tax question remains: are these contracts classified as financial instruments or wagering transactions?" Lead Tax Partner, Gaming Robert Stoddard said.
At a high level, KPMG frames prediction market contracts as financial instruments first, wagers second—at least for purposes of analysis. These contracts, often traded on platforms like Kalshi or CME-linked exchanges, which also host political betting sites markets, are essentially binary bets: either the event happens, and you get paid, or it doesn’t, and you lose your stake.
But unlike your typical sportsbook wager, these contracts trade in real time like stocks, with fluctuating prices and the ability to buy or sell positions before settlement. That’s where things start to get complicated—and why the tax treatment isn’t straightforward.
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“It depends” — And That’s The Problem
KPMG’s executive summary, issued Monday and written in part by Stoddard, makes it clear: the tax outcome hinges entirely on classification.
Stoddard previously told Bookies.com that this question may take considerable time to settle. "Treasury may wait until some of these court cases play out," he said.
If prediction market contracts are treated as financial derivatives, they could fall under existing tax regimes for commodities or options. That opens the door to capital gains treatment—generally more favorable for bettors—especially if they qualify under Section 1256 rules, which allow a blended 60/40 split between long-term and short-term capital gains, regardless of holding period.
But that’s far from guaranteed.
If the IRS or courts determine these contracts don’t meet those definitions—or if they’re traded on platforms that don’t qualify as regulated exchanges—the tax hit could look very different. In some cases, gains may be treated as ordinary income and taxed at higher rates, while losses may not be fully deductible.
And here’s where it gets even more bettor-unfriendly.
KPMG notes that in certain scenarios, losses on prediction market contracts could be completely nondeductible for casual users—worse than traditional sports betting apps, where losses can at least offset winnings (up to limits).
That asymmetry—taxable wins, limited or no loss deductions—is the nightmare scenario for retail users.
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Is It Trading . . . Or Gambling?
The elephant in the room is whether prediction markets are fundamentally just sports betting in a different wrapper.
KPMG doesn’t take a formal stance but acknowledges the tension. Structurally, these contracts look like derivatives. Functionally, they often behave like wagers.
That distinction matters because the tax code treats those worlds very differently.
If classified as gambling, losses are capped (currently at 90% of winnings under the updated law), but at least they’re recognized. If classified as financial instruments, taxpayers might get capital gains treatment—but risk falling into gray areas where losses don’t cleanly offset gains.
KPMG essentially says the system hasn’t caught up to the product.
Why Where You Live Matters
One of the more important takeaways is that where and how these contracts trade could determine everything.
Contracts listed on CFTC-regulated exchanges offer a stronger argument for commodities or option treatment. That could unlock favorable tax treatment and clearer reporting standards.
But contracts outside that framework—or those that fail to meet technical definitions— head into less favorable buckets. That includes ordinary income treatment.
Translation: you could owe taxes on gains without the usual capital loss offsets.
And some states have begun drafting special tax laws specifically pertaining to prediction market trades - regardless of what might happen in the courts or in Congress.
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Professional vs. Casual Users
KPMG also draws a sharp line between user types.
High-frequency traders, market makers, and institutional players may elect mark-to-market accounting and treat gains and losses as ordinary income—less favorable on the upside, but cleaner and more consistent.
Casual users, on the other hand, face the most uncertainty—and potentially the worst outcomes.
There’s even a scenario where the IRS could classify prediction market activity as a “hobby.” In that case, users would owe taxes on winnings but get zero deductions for losses or expenses.
That’s about as bad as it gets.
The Bottom Line: A Gray Zone
KPMG’s conclusion: the tax treatment of prediction markets remains unsettled, highly fact-specific, and likely to evolve alongside regulation.
The biggest driver remains classification—whether these contracts end up treated as derivatives, wagers, or something entirely new. That decision will shape everything from tax rates to loss deductibility to reporting requirements.
Until then, the industry is operating in a gray zone.
For bettors and traders, the takeaway is clear: the edge you think you have in the market might not survive the tax bill.
And for regulators? The longer this ambiguity lasts, the more likely it is that Congress—or the IRS—steps in to draw a brighter line between betting and trading in the fastest-growing corner of the gambling world.
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