If it’s a day ending in “Y,” there’s going to be discussion of whether prediction market profits should be taxed as investments or taxed as gambling.
in a new paper in the George Washington Law Review titled “Betting on Tomorrow: Prediction Markets and the Tax Treatment of Event Contracts,” Mirit Eyal, a law professor at the University of Alabama, and Jay Soled, a taxation professor at Rutgers Business School, assert that the vast majority of trades on prediction markets — sports or otherwise — should be treated as gambling.
And they say so in no uncertain — while very academic — terms.
“This article contends that participation in event-contract markets is predominantly a form of consumption-oriented wagering rather than profit-seeking investment,” the pair write.
That is their opinion, which counts for something, as there is no consensus, legal or otherwise, on how to classify winnings from prediction markets come tax time. There is zero guidance as to whether those profits should be classified as ordinary income, capital gains, futures income, or something else entirely.
A bet is a bet
The authors’ basic argument is pretty intuitive, at least for those who think sports event contracts are, at worst, close cousins to regular sports betting.
If Jim bet $100 at FanDuel on the Eagles to beat the Cowboys, and Jane spent $100 buying an event contract that pays if the Eagles beat the Cowboys, why should the IRS treat them differently?
What our theoretical Jim and Jane are doing is the same. They are putting money down on an uncertain outcome in the hopes of winning more money, the paper suggests.
How they are taxed is not an academic issue, as the academic paper notes. Ordinary income tax rates can reach 37%, while long-term capital gains generally top out at 20%. The authors are not on board with the notion that typical event contracts deserve capital gains treatment, saying the buyer isn’t acquiring an ownership stake in an asset. The trader is simply trying to correctly predict what happens next.
There’s also a paperwork mess developing for would-be taxpayers.
According to the paper, Kalshi issues a Form 1099-MISC for winnings and a 1099-INT for interest on cash balances, while also using 1099-B forms for certain transactions. Polymarket, meanwhile, does not issue tax information returns and directs users to generate their own tax forms.
Loss stop
Under the wildly unpopular tax changes that took effect this year, gambling losses can be deducted only up to 90% of gambling winnings, and taxpayers taking the standard deduction cannot deduct those losses.
The professors say Congress could simply bring prediction markets under the same framework, but they want to take it further. (Cover your eyes, pro gamblers.)
For ordinary retail prediction market users, the paper makes the case for eliminating the loss deduction altogether. Their argument is that betting is entertainment, and taxpayers don’t get to deduct entertainment expenses.
You can’t deduct a round of golf or a ticket to see Bruce Springsteen, so you also can’t deduct the fact you lost $50 on the Eagles event contract.
“Where an event contract serves as a wager on an uncertain public outcome, the Code should tax the payout as ordinary income and disallow the associated loss,” they write.
There would be exceptions to this draconian tax code that the authors are presenting. A company using weather contracts to hedge against weather-sensitive revenue is doing something different from Jim and Jane betting the Birds. The paper would allow for different treatment for legitimate hedging, professional market makers, and others who can show an actual business or risk-management purpose.
Their position here is deceptively simple: Call the product whatever you want — what matters is what the customer is actually doing.
“The vocabulary of the platform may determine how the transaction is marketed,” the authors write, “but its economic function should determine how it is taxed.”
