Prediction markets have gone from niche curiosity to mainstream phenomenon. Platforms like Kalshi — now fully CFTC-regulated — and Polymarket attract millions of dollars in volume daily, letting traders bet on everything from Federal Reserve rate decisions to election outcomes. But as the money flows in, a critical question looms: what does the IRS think about all of this?

The short answer: they think it’s taxable. The longer answer is more nuanced — and getting it wrong could cost you significantly more than a losing trade. This guide breaks down exactly how prediction market winnings are classified, how to report them, and what strategies are available to minimize your tax burden legally.

What Are Prediction Markets — And Why the IRS Cares

Prediction markets are platforms where users trade contracts tied to the probability of real-world events. If you believe there’s a 70% chance the Federal Reserve will cut rates in September, you might buy a “Yes” contract for $0.70. If the rate cut happens, your contract pays out $1.00. If not, you lose your stake.

The two biggest platforms for U.S. users right now are:

The IRS cares because money changing hands — in whatever form — is generally income. Whether a platform is regulated, offshore, or uses cryptocurrency is largely irrelevant to your tax obligation as a U.S. citizen or resident. The Internal Revenue Code (IRC) taxes worldwide income, and that includes your Polymarket USDC profits sitting in a crypto wallet.

How the IRS Classifies Prediction Market Income

Here’s where things get genuinely complicated. There is no IRS guidance specifically addressing prediction markets as of 2025. That means tax professionals must reason by analogy to existing rules — and there are three main possibilities:

Classification 1: Gambling Income (Most Common)

The IRS broadly defines gambling to include “winnings from lotteries, raffles, horse races, and casinos,” but also any wagering transaction where the outcome is uncertain and determined by chance or an event outside the bettor’s control.

Most tax attorneys believe unregulated platforms like Polymarket — and potentially even regulated ones depending on your trading style — could be classified as gambling under IRC Section 165(d). Under this classification:

• Winnings are reported as Other Income on Schedule 1, Line 8b
• Losses are deductible only if you itemize, up to the amount of winnings
• You cannot net wins and losses — you report gross winnings and separately deduct gross losses
• Self-employment tax does not apply

Classification 2: Commodity Trading (CFTC-Regulated Platforms)

Kalshi, as a CFTC-regulated Designated Contract Market (DCM), offers a potentially more favorable tax treatment. Contracts traded on a DCM may qualify as Section 1256 contracts, which receive the famous “60/40 rule”:

• 60% of gains treated as long-term capital gains (max 20% rate)
• 40% of gains treated as short-term capital gains (ordinary income rates)
• Losses can be carried back 3 years against prior Section 1256 gains
• Contracts are marked to market at year-end — you owe taxes even on unrealized gains

Classification 3: Speculative Investment / Ordinary Income

A third school of thought holds that prediction contracts — especially short-duration, binary-outcome contracts — are neither gambling nor regulated commodities, but simply speculative investments reported on Schedule D as capital gains (short-term, since most contracts are held under a year).

This approach is arguably the most favorable for active traders, but it is also the most aggressive and would face the greatest scrutiny in an audit without a supporting IRS ruling.

“The IRS has never explicitly ruled on prediction markets. Until they do, taxpayers and their advisors are left reading the tea leaves — and making a judgment call with real money on the line.” — Tax attorney and derivatives specialist, 2025

Polymarket Taxes: The Crypto Complication

Polymarket presents a unique two-layer tax problem because it operates using USDC, a cryptocurrency stablecoin. This means every transaction may be a taxable crypto event in addition to the gambling or trading income question.

Here’s how the tax layers stack up for a typical Polymarket trade:

1. Converting USD to USDC Generally not a taxable event if done at a 1:1 rate, since USDC is pegged to the dollar. But document this conversion with timestamps and amounts.
2. Buying a “Yes” or “No” Contract This is your cost basis establishment. Track the USDC amount paid and the USD fair market value at time of purchase.
3. Contract Resolves (You Win) The difference between your payout and your cost basis is taxable income — likely gambling income, but possibly capital gain depending on your tax position.
4. Converting Winning USDC Back to USD If USDC has deviated from $1.00 (rare but possible), there may be a small additional capital gain or loss on the conversion itself.
5. Reporting on Your Return You must report crypto transactions on Form 8949 and answer “Yes” to the digital asset question on Form 1040, Line 7a. Separately report gambling income on Schedule 1.

Kalshi Taxes: The 1099-B Situation

Kalshi is the more straightforward of the two platforms from a tax documentation standpoint. As a regulated exchange, Kalshi issues Form 1099-B to users whose accounts meet certain thresholds, reporting proceeds from contract transactions.

However, there are important caveats even with Kalshi’s 1099-B:

Even if Kalshi sends you a 1099-B suggesting Section 1256 treatment, your tax preparer should independently evaluate whether this classification is defensible given your specific situation. IRS agents reviewing returns are not bound by how a platform chose to characterize transactions.

How to Report Prediction Market Income on Your Tax Return

The exact forms and lines depend on how your income is classified. Here’s a roadmap for each scenario:

If Treated as Gambling Income (Polymarket / casual Kalshi users)

• Form 1040, Schedule 1, Line 8b: “Gambling Winnings” Report your total gross winnings here. Do not net against losses.
• Schedule A, Line 16: “Gambling Losses” Deduct gross losses here — only if you itemize deductions and only up to your winnings amount.
• Form 1040, Line 7a: Digital Asset Question Answer “Yes” if you used Polymarket or any crypto-based platform.
• Form 8949 + Schedule D (Polymarket only) Report any crypto-to-crypto or crypto-to-fiat transactions separately as capital gains events.

If Treated as Section 1256 Contracts (Kalshi / regulated platforms)

• Form 6781: Gains and Losses from Section 1256 Contracts Report your net gain or loss. The 60/40 split is automatically calculated here.
• Schedule D The results from Form 6781 flow to Schedule D, Line 8 (long-term) and Line 4 (short-term).
• Mark-to-Market Adjustment If you hold open contracts on December 31, they are deemed sold at fair market value. Include unrealized gains/losses.

Are You a Professional Gambler? It Matters.

If you trade prediction markets frequently, systematically, and for profit — not just as a hobby — the IRS may consider you a professional gambler. This changes everything:

Professional gambler status requires meeting a multi-factor test established in Commissioner v. Groetzinger (1987): you must be engaged in the activity full-time (or close to it), with the primary purpose of income or profit, and on a regular and continuous basis. Courts have upheld this status for serious bettors who document their activity rigorously.

Record-Keeping: Your First Line of Defense

Whether your platform issues a 1099 or not, the IRS expects you to maintain records sufficient to reconstruct your income and deductions. For prediction markets, this means:

• Date of each trade (entry and exit)
• Contract description (e.g., “Fed rate cut September 2025 — Yes”)
• Number of contracts purchased
• Price paid (cost basis in USD or USD equivalent for crypto)
• Payout received upon resolution
• Net gain or loss per trade
• Wallet addresses and transaction hashes for any crypto-based platform

Export your complete trade history from each platform at year-end. Many platforms allow CSV downloads. For Polymarket, blockchain explorers like Polygonscan can help you reconstruct transaction histories if you’ve lost records.

Don’t Forget State Income Taxes

Federal taxes are only part of the picture. Most U.S. states with an income tax also tax gambling or investment income — and their treatment may differ significantly from federal rules.

California, notably, does not allow gambling loss deductions at all — meaning California residents who trade prediction markets owe state income tax on every dollar of winnings, with no offset for losses. For high-income Californians, this can mean an effective state rate of 13.3% on top of federal taxes.

Frequently Asked Questions

Bottom Line: Take Prediction Market Taxes Seriously

Prediction markets are one of the most interesting financial innovations of the decade — and the IRS is watching. The combination of legal ambiguity, crypto complexity, and platforms that don’t issue tax forms creates a perfect storm for mistakes. Those mistakes can be expensive: back taxes, penalties, and interest add up quickly.

The best approach in 2025 is to document everything, work with a CPA who understands both derivatives and digital assets, and take a conservative, defensible tax position. The field is evolving rapidly — Kalshi’s CFTC regulation is a watershed moment that may lead to clearer IRS guidance in the coming years.

Until then, when in doubt, report the income. The cost of under-reporting is always higher than the cost of a CPA.