Tax Battle Over Prediction Markets: Are Sports Contracts Pure Gambling?

The world of prediction markets has evolved rapidly from a niche activity into a massive economic force. Analysts now forecast an annual trading volume of one trillion dollars. This growth is no longer driven just by political forecasts or weather patterns; it is centered on sports betting, traded on platforms such as Kalshi or Polymarket under the guise of event contracts. This development has prompted tax legal experts to demand a clear line be drawn between investing and wagering.

The core of the debate lies in the federal tax treatment of these transactions. While winnings from traditional sports betting in the U.S. are subject to specific excise taxes and strict limitations on loss deductions, some market participants attempt to declare these contracts as financial instruments like options or futures. The Tax Law Center, in its recent analysis, warns that this could lead to significant inequities and revenue losses. The resemblance to regular gambling is, according to the experts, structural rather than coincidental.

Numbers and facts

The dominance of sports in these markets is overwhelming. Estimates suggest that approximately 80 to 90 percent of the volume on the leading U.S. prediction market comes from sports event contracts. A particularly clear example was provided during the recent World Cup. According to one analyst, 27 percent of U.S. sports bets during the tournament took place on prediction markets. This represents a tripling of market share since the beginning of that year.

A direct comparison shows minimal differences from traditional bookmakers. A fan who placed 100 dollars on the Atlanta Braves to beat the New York Mets on the morning of August 10 would have received a total of 170.42 dollars from DraftKings, resulting in a 70.42 dollar profit. On the Kalshi platform, the same 100 dollar investment in "Yes" event contracts would have yielded a payout of 169.91 dollars. The risk is identical, and the payout is nearly the same. Yet, there is currently no explicit case law specifically addressing the federal tax treatment of these contracts.

"The best reading of the code is that sports event contracts on prediction markets appear to be 'wagers' and 'wagering' and subject to the federal tax rules that apply to sports gambling." - Tax Law Center, Analysis in Tax Notes

Background

The Tax Law Center emphasizes that the argument claiming wagers are actually investments has a long and unsuccessful history. Gamblers have repeatedly tried to recharacterize their stakes as business investments in court to gain tax advantages. However, courts have consistently rejected this logic. The experts are now calling on the IRS to issue public guidance. Without such clarification, there is a risk that taxpayers will treat gains and losses inconsistently on their tax returns.

A crucial point is the regulatory effect of taxes. Proposals exist to increase the federal wagering excise tax to minimize gambling harm, bankruptcies, and risks to minors. If prediction markets were exempt from these rules, they would become a tax-advantaged substitute for conventional sports betting. The goal of influencing gambling behavior through taxation would be virtually impossible to achieve.

Why it matters for German players

For German players, the situation is very clearly defined by the Interstate Treaty on Gambling 2021 (GlüStV 2021), providing a sharp contrast to the current U.S. debate. In Germany, sports betting and online casino games are strictly regulated to ensure youth and player protection. Providers must hold a license from the Joint Gambling Authority of the States (GGL). For customers, this means they can rely on fixed protection mechanisms, such as the cross-provider monthly deposit limit of 1,000 euros, monitored via the LUGAS system.

A transfer of U.S.-style prediction markets to Germany would immediately raise licensing questions. Since these contracts structurally resemble traditional bets, they would have to fall under the strict rules for sports betting. This includes the 1 euro per spin limit for virtual slots, though sports betting has its own specific limitations. German players should note that while gambling winnings for recreational players are tax-free in Germany, providers must pay a sports betting tax. Anyone acting on unlicensed overseas platforms loses all legal protection and enters illegal territory.

What it means for GGL-licensed casinos

For casinos and betting providers with a GGL license, the development in the U.S. serves as a warning. The trend shows that gambling products are increasingly disguised as financial products to bypass regulation and taxes. Licensed providers in Germany invest heavily in compliance and player protection to meet the requirements of GlüStV 2021. The emergence of prediction markets without corresponding licensing obligations would mean an unfair competitive advantage for unregulated platforms.

The GGL monitors such international market developments closely to ensure no circumvention schemes are established. For legal providers, a clear distinction between wagering and investing means legal certainty. It prevents the market from being distorted by hybrid products that function like bets but ignore the high standards of German player protection.