What’s hotter right now: your World Cup team or prediction markets? The good news is that you don’t have to choose. The bad news is that moving sports wagers to a prediction market is unlikely to give you more favorable tax treatment on the outcome of your sporting events. This article explains what a prediction market is, how regulators may be thinking about these contracts, and why the tax treatment remains uncertain.
Prediction Markets
Prediction markets are online platforms where participants may buy or sell event contracts1 to manage price risks around whether events stated in the contracts will occur. Contracts may relate to various events such as economics, elections, climate or sports. The price of a contract varies based on the perceived likelihood of an event underlying the contract occurring, and participants may trade in and out of the contracts up until the occurrence of the underlying event. Accordingly, the price of an event contract at any given time reflects the market’s collective view on the probability of that event occurring, making these online platforms a form of crowd‑sourced forecasting. The Commodity Futures Trading Commission (“CFTC”) has asserted that most event contracts fall within CFTC jurisdiction, often falling within the definition of “swap” under the Commodity Exchange Act (“CEA”).2 As a result, the online platforms on which these contracts trade must be registered as designated contract markets or swap execution facilities.
Taxation of Event Contracts
The U.S. federal income tax treatment of payouts from prediction market contracts is unsettled. Several theories exist, each with different consequences for taxpayers:
Notional principal contract ("NPC") treatment
Section 1256 contract treatment
Ordinary income treatment, which raises potential trade or business issues and gambling loss limitation considerations
Below, we will walk through each alternative.
A. Notional Principal Contract
NPC treatment is attractive because termination payments generally produce capital gain for the recipient. The losing side of the contract, however, would prefer an ordinary loss — capital losses are subject to limitations.
But the definition of an NPC under Treasury Regulations does not align neatly with the CEA’s definition of a swap. Under Treas. Reg. §1.446‑3(c), an NPC must:
reference a specified index,
At first glance, event-based contracts fail this test — they typically reference a binary outcome, not an index.
However, Treasury Regulations proposed in 2011 broaden the definition of a “specified index” to include non‑financial indices based on objectively determinable information outside the parties’ control, including weather related outcomes. This could theoretically encompass event-based outcomes. But the 2011 proposed regulations require NPCs to provide for two or more payments, which is generally inconsistent with how event contracts work.
Unless Treasury finalizes regulations that explicitly accommodate event contracts, prediction market contracts are unlikely to qualify as NPCs.
B. Section 1256 Contracts
Section 1256 contracts receive blended 60/40 capital gains treatment, producing an effective tax rate of 26.8% for many taxpayers. This category includes:
Prediction market contracts do not fit neatly into any of these buckets. So, it is unlikely that Section 1256 treatment would apply to event contracts.
Another complication: Section 1256 contracts are marked to market at year‑end. If Section 1256 treatment applies, it means your Super Bowl contract could be taxed in December even though the NFL season hasn’t concluded. While the rate may be attractive, the timing may not be.
C. Ordinary Income
If neither NPC nor Section 1256 treatment applies, payouts from prediction market contracts would most likely default to ordinary income.
i. Potential Gambling Income Risk
Since prediction markets allow participants to enter into event contracts referencing sports, including outcomes of matches (such as World Cup matches) as well as specific outcomes within matches (e.g., will Lionel Messi score a goal or score the first goal of a match?). These types of event contracts replicate typical gambling bets made on a traditional sportsbook (noting that several sportsbooks have converted their legal operating models to become designated contract markets). From a U.S. federal income tax perspective, entering into event contracts referencing sports on prediction markets could potentially be viewed as gambling activities.
The IRS has issued numerous rulings on gambling income, generally focused on whether a taxpayer is engaged in a gambling trade or business and what gambling-related expenses are deductible. Historically, gambling losses were deductible only to the extent of gambling winnings. The One Big Beautiful Bill of 2025 added a new 90% limitation on the deductibility of gambling losses. This limitation has irritated professional gamblers, since it can cause their taxable gambling income to exceed their net winnings.
Using a prediction market to place a sports wager does not automatically transform gambling income into something else. The 90% limitation would still apply to taxpayers that are engaging in the trade or business of gambling for U.S. federal income tax purposes. Taxpayers, including investment funds, that are not entering into sport related event contracts on a regular, continuous or substantial basis may not face the risk of gambling loss limitations, but individual taxpayers that do may want to consider these limitations and discuss their personal income tax positions with their personal accountants.
ii. Trading Safe Harbor Uncertainty
Foreign investors, including offshore investment funds, generally seek to avoid being engaged in a trade or business for U.S. federal income tax purposes. These investors and funds rely on safe harbors for their securities trading activities and their commodity trading activities to avoid being treated as engaged in a U.S. trade or business for U.S. federal income tax purposes. The commodities trading safe harbor under Section 864(b) applies when trading commodities “of a kind customarily dealt in on an organized commodity exchange and if the transaction is of a kind customarily consummated at such place.”
The CFTC has asserted that event contracts are a type of commodity, and designated contract markets are an organized commodity exchange for purposes of the commodities trading safe harbor. On its face, this suggests the safe harbor should apply to offshore investors, including offshore feeder funds, that are entering into event contracts.
However, gambling can constitute a U.S. trade or business. Conducting the activity on a prediction market does not necessarily change that characterization. Non‑U.S. persons should therefore recognize the risk that these activities could be treated as a U.S. trade or business despite the apparent availability of the commodities trading safe harbor. The nuance here is that event contracts referencing sports or other events could be viewed as gambling activity for U.S. federal income tax purposes and could create U.S. trade or business risk arising from these activities.
Since many prediction markets have offshore marketplaces, offshore investors can remain offshore to help avoid potential U.S. trade or business issues. The technical risk of a U.S. trade or business may exist, but some advance planning may help navigate these risks in practice.
Conclusion
Prediction markets may be innovative, efficient and increasingly popular (just like the U.S. team through two World Cup matches!) — but they are not a tax shelter for sports wagers. The regulatory framework is evolving. The CFTC may want to treat many event contracts as swaps, but the tax rules do not map cleanly onto that classification. As a result, taxpayers face uncertainty, and the most conservative view is that payouts are ordinary income, potentially subject to gambling‑loss limitations. Until Treasury or the IRS provides clearer guidance, participants in prediction markets, including non‑U.S. investors and funds, should proceed with caution and assume that favorable tax treatment is far from guaranteed.
Seward & Kissel LLP actively monitors tax changes and their impact on the investment management industry. For additional information on this topic, please contact a member of Seward & Kissel’s Tax Group.
Footnotes
1 While the term ‘‘event contract’’ is not a defined term in the CEA or the CFTC regulations, the CFTC has used the term “event contracts” to describe commodity derivative contracts, often with a binary payoff structure, based on the outcome of an underlying occurrence or event.
2 This is currently a highly contested position vis-à-vis state gaming regulators as it relates to sports event contracts in particular.