As the calendar turns to January 18, 2026, millions of Americans are opening their mailboxes and email inboxes to find a new kind of tax document. Following the explosive growth of prediction markets throughout 2025—a year defined by massive volume in election contracts, Fed rate cut forecasts, and climate milestones—the Internal Revenue Service (IRS) is preparing for its most significant season of event-contract reporting in history.
For traders on platforms like Kalshi, PredictIt, and the newly regulated Polymarket US, the tax bill for 2025 is no longer a theoretical concern. With billions of dollars in volume traded over the last twelve months, the IRS is paying closer attention than ever to how "event contract" proceeds are categorized. Whether you were betting on the outcome of the D.C. Circuit Court cases or the latest inflation prints, understanding the difference between a 1099-MISC and a self-reported DeFi audit is the difference between a smooth filing and a costly audit.
The Market: What’s Being Predicted
The current "market" being predicted by tax professionals and platform operators is the finality of IRS guidance. For the 2025 tax year, the industry remains in a transitional state. On regulated exchanges like Kalshi and Interactive Brokers Group, Inc. (NASDAQ: IBKR), activity has shifted from niche political betting to a mainstream financial asset class. These platforms are now competing directly with traditional options for the attention of retail and institutional traders alike.
Liquidity in these markets reached record highs in late 2025, particularly following the relaunch of Polymarket’s US-regulated entity in December. While the global version of Polymarket continues to operate on the Polygon blockchain, the US version has adopted a strict Know Your Customer (KYC) and reporting framework. This has created a bifurcated tax landscape: one where domestic platforms provide neat, government-ready forms, and another where decentralized participants must play detective with their own digital wallets.
The "resolution criteria" for this tax season are the April 15, 2026, filing deadline. Traders are currently betting on whether the IRS will issue a last-minute Revenue Ruling to clarify the treatment of these contracts. Until then, most platforms are defaulting to the most conservative reporting standards, leaving the burden of interpretation on the individual taxpayer.
Why Traders Are Strategizing
The core of the 2025 tax debate centers on classification: Are these earnings gambling winnings, capital gains, or "Other Income"? Most traders are finding that their profits are being pushed toward Schedule 1, Line 8z as "Other Income." The reason is largely administrative. The IRS has historically lacked a specific "event contract" category, and in the absence of a designated brokerage form like a 1099-B for all platforms, the 1099-MISC has become the default for Kalshi and PredictIt.
However, a growing number of "whales" and professional traders are pushing back, citing the landmark 2024-2025 legal victories. Specifically, after the CFTC dropped its appeal against Kalshi in May 2025, prediction markets were effectively codified as federally regulated derivatives. This has led aggressive tax strategies to favor Section 1256 treatment. Under this rule, 60% of gains are taxed at long-term capital gains rates and 40% at short-term rates, regardless of the holding period—a massive tax break compared to the ordinary income rates found on Line 8z.
This tension is driving recent movement in tax-preparation software and crypto-audit tools. Traders who used the global version of Polymarket are currently using blockchain explorers to calculate their "cost basis" for every share of "Yes" or "No" they held. Because these tokens are technically "disposed of" at the moment of market resolution, every single trade is a taxable event, much like trading stocks on Robinhood Markets, Inc. (NASDAQ: HOOD).
Broader Context and Implications
The 2025 tax season is the first to feel the impact of the One Big Beautiful Bill Act (OBBBA), signed into law on July 4, 2025. A little-known provision in the OBBBA limits gambling loss deductions to 90% of winnings for non-professional bettors. This has created a panicked rush to ensure prediction market activity is classified as "derivative trading" rather than "wagering." If the IRS views your Polymarket activity as gambling, you could be taxed on your wins while being unable to fully deduct your losses.
This regulatory friction reveals a growing pains phase for the industry. While the CFTC now views these markets as legitimate financial instruments, the IRS's lag in updating Form 1040 instructions has created a "gray zone." Historically, the IRS has been slow to move on new asset classes—as seen with the decade-long wait for clear crypto guidance—but the sheer volume of the 2025 election cycle may force their hand sooner than expected.
The accuracy of these markets as forecasting tools has already been proven; now, their survival as a viable investment class depends on tax parity. If prediction market gains continue to be taxed as ordinary "Other Income" (potentially reaching rates as high as 37%) while traditional futures enjoy the 60/40 split of Section 1256, liquidity may migrate to more tax-efficient, if less accurate, financial products.
What to Watch Next
Between now and the April filing deadline, the most important milestone is the potential release of an IRS "Internal Technical Advice" memo. This document would provide the first official hint at whether the IRS will honor the CFTC’s classification of event contracts as derivatives. Traders should also watch for the 1099-MISC mailings from PredictIt and Kalshi, which are expected to land in late January and early February.
Furthermore, the "Polymarket Split" will be a key scenario to monitor. Many US traders likely used the global platform via VPNs in early 2025 before switching to the regulated US app in December. These individuals will face a nightmare of cross-platform reporting, needing to reconcile decentralized wallet history with the centralized 1099s they receive from the new US entity.
If a major court case emerges in the next few months—perhaps a trader suing for the right to use Section 1256—it could set a precedent that changes the math for the entire industry. For now, the probability remains high that most casual users will simply follow the platforms' lead and report on Line 8z to avoid the "red flag" of an unconventional filing.
Bottom Line
The 2025 tax year represents the end of the "Wild West" era for prediction market taxation. As the IRS catches up to the volume of the past year, the distinction between "Other Income" on Schedule 1 and capital gains on Schedule D has become the most important trade of the season.
Regulated platforms like Kalshi and PredictIt have simplified the process with 1099-MISC forms, but in doing so, they have largely locked their users into ordinary income tax rates. Meanwhile, Polymarket users face the double-edged sword of self-reporting: more work and higher audit risk, but the potential to argue for more favorable capital gains treatment.
As we move toward the April 15 deadline, one thing is certain: the era of "tax-free" prediction market gains is over. Whether you viewed your 2025 trades as a hobby, a hedge, or a high-stakes bet, the IRS is now an uninvited partner in every market you enter.
This article is for informational purposes only and does not constitute financial or betting advice. Prediction market participation may be subject to legal restrictions in your jurisdiction.
PredictStreet focuses on covering the latest developments in prediction markets.
Visit the PredictStreet website at https://www.predictstreet.ai/.
