Prediction markets have exploded in popularity over the past two years, with platforms like Kalshi, Polymarket, and Robinhood attracting millions of traders betting on everything from election outcomes to sports results. Yet as trading volumes surge, a critical problem persists: the IRS has not settled on a single tax classification for event contracts, leaving traders and accountants scrambling to determine their actual tax obligations.
The Tax Classification Problem
Unlike traditional securities or cryptocurrency, prediction market contracts occupy an undefined space in the tax code. The IRS has not issued explicit guidance on how to treat gains and losses from event contracts, which means traders may face four different tax treatments depending on their circumstances, platform, and how they report. Understanding how prediction markets are taxed requires examining each possible classification and recognizing that no single answer applies universally.
The Four Possible Tax Treatments
Prediction market traders could potentially report their activity under ordinary income, capital gains, Section 1256 contracts, or wagering loss provisions. Each treatment produces dramatically different tax outcomes.
Ordinary Income treats prediction market gains as business income or miscellaneous income. This approach is unfavorable because gains are taxed at full ordinary rates (up to 37 percent federally) with no capital gains discount. If a trader reports this way, losses may be deductible only against other business income, creating asymmetry.
Capital Gains Treatment classifies event contract profits as long-term or short-term capital gains. This is more favorable because long-term gains receive preferential rates (0, 15, or 20 percent depending on income). However, this classification is only available if the trader meets the “trader in securities” standard, which requires substantial activity, consistent intent, and significant time commitment. Most casual prediction market users do not qualify.
Section 1256 Contracts would allow traders to use the 60/40 favorable treatment, where 60 percent of gains are treated as long-term capital gains and 40 percent as short-term, regardless of holding period. This is attractive, but prediction market contracts have not been formally designated as Section 1256 contracts by the IRS. Claiming this treatment without explicit guidance is aggressive.
Wagering Loss Provisions treat prediction market activity as gambling. Under this classification, losses are deductible only against gambling winnings in the same year, creating severe limitations. A trader with 10,000 dollars in losses and no winnings cannot deduct those losses against other income.
The Platform Tax Reporting Gap
The lack of IRS guidance compounds another problem: platforms themselves are not providing consistent or complete tax reporting. This means traders cannot rely on their year-end tax forms to capture their actual tax position.
Kalshi’s Incomplete 1099 Forms
Kalshi, a CFTC-regulated prediction market platform, issues 1099-INT and 1099-MISC forms to users. These forms report interest earned on deposits and rewards received from the platform. They do not, however, report trading profit or loss. If a trader deposited 5,000 dollars, earned 200 dollars in rewards, and made 3,000 dollars in net trading gains, the 1099 only captures the 200 dollars. The trader must manually calculate and report the 3,000 dollars in trading profit, creating both complexity and audit risk if calculation methods are not sound.
Polymarket’s On-Chain Reporting Absence
Polymarket, which operates primarily as a decentralized protocol on Polygon, does not issue tax forms to traders at all. Users must pull transaction data directly from the blockchain and categorize each trade themselves. For active traders with hundreds or thousands of transactions, this process is tedious and error-prone. Many traders are unaware they need to report this activity, and the absence of a 1099 creates a false sense that the activity is not taxable.
Robinhood’s Nonstandard Annual Statement
Robinhood recently launched prediction market contracts through Robinhood Crypto and provides an annual statement to users. However, the statement format does not align with standard IRS tax form categories. The data cannot be directly transferred to tax software and requires custom interpretation. Robinhood does not clarify whether gains should be reported as capital gains, ordinary income, or Section 1256 contracts, leaving traders to guess at the appropriate classification.
Common Mistakes Traders Make
The tax reporting gaps have led to predictable errors. Many traders assume that because Polymarket sends no 1099, the income is unreported and therefore untaxable. This is false. The IRS requires reporting of all taxable income regardless of whether a form is issued. Other traders assume Robinhood’s statement format constitutes “official” guidance and report accordingly, without realizing the IRS may disagree with the classification.
Another mistake is treating all prediction market activity the same way. A trader might file a tax return reporting half their contracts as capital gains and half as ordinary income, creating an inconsistent narrative that attracts IRS scrutiny. The correct approach requires a clear, consistent methodology applied uniformly across all positions.
What Changes in 2026
Traders often miss several regulatory and tax developments scheduled for 2026. The IRS has not announced formal guidance on prediction market taxation, but practitioners expect clarification may arrive in 2026 or be included in updated Forms and instructions. Additionally, more platforms are entering the space, and some states are proposing separate tax rules for prediction market activity. For example, certain states may treat event contracts differently from gambling or securities trading, creating a multistate compliance burden.
Tax law changes under consideration could reclassify prediction markets as a specific category with dedicated tax treatment, or they could remain ambiguous. Traders who have been reporting gains one way may need to amend prior returns if new guidance contradicts their approach. This is another reason to maintain clear, contemporaneous records of all trades, the classification method used, and the reasoning behind it.
Practical Steps for Compliance
Traders should document the basis for their tax classification choice. Write a memo explaining why you treat event contracts as ordinary income, capital gains, or another category. This memo becomes evidence of reasonable cause if audited. Export all transaction data from your prediction market platforms monthly, do not wait until tax time, and maintain spreadsheets that summarize trades by category and date.
Consult a tax professional who understands prediction markets before filing your return. Generic tax software cannot handle the ambiguity correctly, and filing without expert guidance exposes you to audit and penalty risk. A specialized CPA can also help you decide whether your trading activity qualifies for capital gains treatment or whether ordinary income is more defensible given your facts.
The prediction market boom is real, but the tax answer is not settled. Traders who ignore this ambiguity do so at their peril. Professional guidance is not optional for serious investors in event contracts.
The post How Prediction Market Taxes Work in 2026: Kalshi, Polymarket & IRS Rules appeared first on Ventureburn.
