Trading sports event contracts on prediction markets like Kalshi won’t protect consumers from federal gambling taxes, and market makers or the platforms themselves may be subject to eight times the legal gambling excise tax, researchers say. While prediction markets are not taxed by states — although they will be in North Carolina starting Jan. 1, 2027 — a paper from a non-profit tax group suggests the federal government can make a case for taxing the entities like gambling.
Tax Analysts published the study, “Are Sports Event Contracts on Prediction Markets Gambling for Federal Tax Purposes?” on Oct. 1. Tax Analysts Senior Fellow Seth Hanlon, Senior Attorney and adviser Miles Johnson, Deputy Director Michael A. Kaercher, Senior Attorney and adviser Kyle Sweeney, and attorney-adviser at New York University’s School of Law Tax Law Center Sophia Yan authored the research.
The research reveals that if the Internal Revenue Service (IRS) considers sports event contracts to be wagers, then the same reporting standards as for gambling will apply to prediction market consumers. For the most part, this will mean reporting prediction trading wins as ordinary income and losses as itemized deductions. The bigger ramifications may be for market makers and the platforms themselves. If the IRS determines that a prediction market is operating illegally in a state, it could assess a 2% excise tax vs. the .25% for legal operators.
Traditional sportsbooks already pay federal excise tax, which is one quarter of 1% of handle. Prediction markets, their market makers, and/or professional bettors may be on the hook for the same tax. Because “some tax professionals have suggested that sports event contracts traded on prediction market platforms may not be subject to the same rules,” the study authors set out to examine potential scenarios.
“The best reading of the code is that sports event contracts on prediction markets appear to be wagers and wagering and thus subject to the federal tax rules that apply to sports gambling,” the authors wrote.
The study uses only publicly available information and considers the tax code, case law, and legislative history. It focuses on two potential tax scenarios should the IRS consider sports event contracts to be wagers and does not consider or offer any guidance should the IRS consider those contracts to be financial instruments.
Muddy waters
How the IRS might interpret activity on prediction markets is muddied by many issues, including the legal age to trade or bet and how to determine where a bet is placed. For the purposes of the study, the authors write that sports event contracts fall under the “best” meaning of wagering.
The authors, however, do conclude that they do not believe that sports event contracts “qualify” as “(1) regulated futures contracts, (2) foreign currency contracts, (3) nonequity options, (4) dealer equity options, and (5) dealer securities futures contracts.”
In the courts, a key legal question is whether or not sports event contracts can be considered swaps. The regulator, the Commodity Futures Trading Commission (CFTC), argues that sports contracts do fall under the definition of swaps, while states and tribes argue that they are de facto sports betting. From a tax standpoint, whatever label the CFTC or any other agency puts on a sports event contract is moot because “federal tax law does not turn on the position of nontax regulators unless provided for in the code, regulations, or other tax authority.”
Scenario 1: Market makers, pro bettors taxed
At the outset, the authors state that legal sportsbooks pit a player against “the house,” while prediction markets use a “peer-to-peer” model that “does not necessarily mean that if a retail or casual bettor purchases a contract, there is a retail or casual user on the other side of that contract. Rather, prediction markets are driven in large part by professional participants.”
The study authors also point out that the tax code lists certain types of wagers, but does not define the word “wager.”
In the first scenario, based on the 1957 Calamaro Supreme Court case, market makers and professional bettors would be subject to the excise tax, but prediction markets themselves would not be. Per IRS regulations dating to 1959, “a person is engaged in the business of accepting wagers if he makes it a practice to accept wagers with respect to which he assumes the risk of profit or loss depending upon the outcome of the event or the contest with respect to which the wager is accepted.”
Market makers or professional bettors taking one side of a wager would fit the definition, the study authors wrote. Essentially, the entity that takes the financial risk, not the facilitator, would be on the hook for taxes.
“Under this definition, prediction market platforms themselves do not accept bets if they serve only as platforms for betting,” reads the report. “But users transacting in sports event contracts, including market makers and professional bettors, do appear to accept bets, as do the platforms’ trading arms.” The study authors go on to explain that the bar for determining who is involved in the business of taking wagers is “not high.”
Scenario 2: Operator taxed
In another scenario, if the IRS determines that a sports event trade meets the second definition of what a wager is — a bet “placed in a wagering pool with respect to a sports event” — the operators themselves may be taxed. The authors wrote that there is no definition in the tax code of what a “wagering pool” is, but it is generally accepted that traditional sportsbooks fall under the definition of wagering pools, or sports pools.
On that premise — a third party arranging for people to bet against one another — prediction platforms appear to fit the definition. Parimutuel betting that is regulated at the state level is exempt from the excise tax, but traditional sportsbooks are not. This is relevant, the authors write, because the tax code clearly views parimutuel betting as a “wagering pool.” Daily fantasy sports are also considered “wagering pools” by the IRS.
Considering the IRS code and case law, the authors wrote, “wagering pools” have “four common characteristics:” 1. the pool organizer sets the rules and profits; 2. there is an entry free, though fees could “differ” depending on the odds of winning; 3. at the conclusion on the event, the total pot, minus the fee to organizer, is awarded to participants; and 4. winnings are “determined by the outcome of the sports event.”
Prediction markets, per the study authors, appear to meet the definition of a “wagering pool,” and “should be liable for excise tax on amounts wagered by each bettor, including fees paid to the platform.”
Unclear if tax rate would be .25% or 2%
Under the federal tax code, the excise tax is .25% for wagers placed in legal betting states, and 2% for wagers placed in states where where wagering is not allowed. This dynamic could mean that in a state like Utah, where gambling is expressly illegal, the higher tax rate would be imposed on any prediction market trade. However, that higher tax rate of 2% applies to handle. The prediction market equivalent, and it’s not an apples-to-apples comparison, is volume.
The excise tax doesn’t only consider where a wager is authorized, it also considers where a wager is accepted. This question is not easily answered when the prediction market platform may be based in one state while the bettors are in other states. The idea of determining where a digital bet is placed has come up elsewhere in legal online sports betting — the Seminole Tribe has in its compact that any online sports bet placed anywhere in Florida is considered placed where accepted, and all bets flow through servers on Seminole land. Wisconsin’s tribes have negotiated a similar situation that will go into effect when sports betting goes live there.
In both of those cases, states with legal sports betting agreed to the concept that the bet is placed where received. In addition, federally recognized tribes must compact with states in order to offer gambling. There are no such agreements or mandates between states and prediction markets.
Age matters
Another issue with the legality — or not — of a wager in a certain state is the difference in the minimum age. Most legal U.S. sports betting states set the minimum age at 21 while prediction markets, including Kalshi, have set it at 18.
On that backdrop, consider this: OSB is legal in Louisiana, meaning the IRS could consider a sports event trade in the state legal and tax Kalshi or a market maker at .25%. But the legal age betting age in Louisiana is 21, so if a trade is made by a 19-year-old, it would be considered illegal by state law, and presumably subject to the 2% tax. How will regulators or operators sort through all transactions to find those made by people 18-21?
In the final analysis, the study authors are clear that their paper considers potential scenarios, but that clarity from the IRS is needed to allow all parties to properly “improve tax administration and taxpayer certainty.”
