Tax professors push IRS to rule on prediction market income class

Two tax law professors have submitted a formal argument to the Internal Revenue Service contending that gains from prediction market contracts should be classified as ordinary income rather than capital gains — the same treatment applied to winnings from a sportsbook or casino.

The IRS has not issued guidance specific to prediction markets. That silence has consequences. Under current ambiguity, platforms and sophisticated users can structure their activity to argue for capital gains treatment, which carries a lower rate. The professors' position is that this creates a structural advantage for prediction markets over licensed sportsbooks, who operate under no equivalent ambiguity — their customers pay ordinary income tax on winnings, full stop.

The mechanism question here is genuinely interesting. A prediction market contract does behave like a financial instrument in certain ways: it is tradeable, it has a bid-ask spread, positions can be closed before resolution. A futures contract on a commodity index behaves similarly and generates capital gains. The professors' counter is that the underlying event — who wins an election, whether a bill passes — has no investment character. You are not taking a position on an asset. You are wagering on an outcome. The form resembles a swap; the substance is a bet.

I have seen this structural ambiguity work in both directions. In DeFi liquidity design, the gap between what a protocol looks like and what it functionally does became the entire regulatory argument for three years. The IRS eventually resolved similar ambiguities around crypto staking by looking at what the user was actually doing with their capital, not what the protocol called it. That precedent runs against the capital gains argument here.

The stakes are not trivial. If the IRS rules for ordinary income treatment, the after-tax return on prediction market activity falls meaningfully for high earners. That changes the liquidity calculus — particularly for the large-volume traders who currently provide depth on contracts with long time horizons. Thinner liquidity means wider spreads, which reduces the markets' accuracy as information aggregators, which is the argument their advocates use most confidently in Washington.

There is a second-order effect worth tracking. The professors' argument lands while several prediction market operators are already under regulatory pressure from state attorneys general and are seeking federal preemption as a defense. A ruling that treats gains as gambling income would complicate the "we are a financial exchange" argument considerably. You cannot have ordinary income treatment at the IRS and swap treatment at the CFTC simultaneously without the contradiction becoming visible to every judge who reads both filings.

The reporting presents this as a tax fairness argument between platforms. I think that undersells the structural weight of the question. IRS classification shapes how courts read economic substance. If the agency decides these contracts are wagers, it does not automatically resolve the CFTC jurisdictional question — but it removes one of the cleanest planks in the federal preemption case. The consensus view seems to be that IRS guidance, if it comes, is a peripheral issue. I think it lands closer to the center than that.