If you watched the Super Bowl this year, you might have noticed a surge of advertisements for prediction market contracts on the big game. These markets have rapidly emerged as a focal point for retail traders, regulators (both federal, state, and Indian tribal authorities), and the public at large, while their tax treatment remains a gray area. The explosive growth of these markets has created a host of unresolved tax questions, with significant implications for traders, exchanges, and the broader financial system.
This article offers a high-level overview of the fast-growing prediction market landscape, highlighting certain tax considerations for which the Internal Revenue Service (IRS) provides limited guidance. It is not intended as an extensive analysis, but rather to outline key issues impacting traders, exchanges, and the financial system at large.
Surge in Demand, But Not New
Prediction markets, while not new, have seen a dramatic surge in activity since late 2024 and throughout 2025. Event contracts — which are financial instruments that allow participants to trade on the outcomes of real-world events — are increasingly capturing the attention of retail participants and regulators alike. These contracts are listed for trading on derivatives exchanges registered with the Commodity Futures Trading Commission (CFTC) and offer exposure to a diverse range of outcomes, from Federal Reserve interest rate decisions to the winners of major sporting events such as the Super Bowl or the NBA championship.
This surge has been met with intense, widespread litigation, including numerous federal lawsuits and actions by state regulators. The core conflict centers on whether the sports-related contracts listed on CFTC-registered exchanges constitute illegal, unregulated sports betting or federally regulated, event-based derivatives.
The Gray Area in Tax Treatment
A central question is how to characterize sport prediction market transactions for tax purposes. Are the sports event contracts financial instruments or do they represent a form of gambling? The answer has far-reaching consequences for how participants report their activity, the deductibility of losses, and the rates at which gains are taxed. The lack of clear IRS guidance leaves participants in a state of uncertainty, potentially leading to inconsistent reporting and compliance risks.
If treated as financial instruments, are the gains and losses capital in nature or ordinary, or a combination of both? Do event contracts — particularly those based on sports outcomes — qualify as Section 1256 contracts under the Internal Revenue Code? Section 1256 contracts, which include certain regulated futures and options, benefit from favorable tax treatment: gains and losses are marked to market at year-end, and a blended tax rate applies (60% long-term, 40% short-term). If event contracts are classified as Section 1256 contracts, participants could see significant differences in their tax liabilities compared to treatment as gambling or as contracts that generate ordinary income.
And the tax issues described above are not uniform across all participants. CFTC-registered exchanges face questions about information reporting obligations and the classification of their revenues. Prediction market traders must navigate the uncertainty around income characterization and loss deductibility. Market makers, who may engage in high-frequency trading or provide liquidity, may face additional complexities related to inventory accounting and mark-to-market rules.
An Additional Tax Issue Resulting from the One Big Beautiful Bill Act
The One Big Beautiful Bill Act (OBBBA) has further complicated the landscape by limiting the deductibility of gambling losses to 90% of those losses. This provision creates the risk of “phantom income,” taxable income that exceeds actual net winnings, if prediction market activity is classified as gambling. Adding to this complexity, there is no clear guidance on what constitutes a "gambling session" in these markets, making it difficult to consistently apply the loss limitation. The distinction between gambling and financial contracts is thus not merely academic but has immediate and material tax consequences for market participants.
Conclusion
Given the evolving nature of prediction markets and the unsettled tax landscape, it is crucial for all participants to consult with qualified tax advisors. The IRS has yet to issue definitive guidance on these issues, with the potential for retroactive enforcement or changes in interpretation. Until the IRS provides clarity, careful planning and professional advice are essential to manage risk and ensure compliance.
