How Are Event Contracts Taxed?

TL;DR: Event Contract Taxation at a Glance

  • Section 1256 Status: Regulated exchanges like Kalshi often qualify for a 60/40 tax split, where 60% of gains are taxed at long-term rates and 40% at short-term rates.
  • Mark-to-Market Rule: Active traders must value open positions at the end of the year and pay taxes on unrealized "paper gains" as of December 31.
  • 90% Loss Deduction: Under the 2025 "One Big Beautiful Bill Act" (OBBBA), positions classified as "gaming" only allow for a 90% deduction of losses against winnings.
  • Form 6781 vs. Schedule D: Regulated event contracts are typically reported on Form 6781, while on-chain platforms may require reporting as capital assets on Schedule D.
  • 3-Year Carryback: Section 1256 allows traders to carry back losses three years to offset previous gains, providing a significant liquidity advantage.

Updated: March 2026

The IRS classification of your event contract profits can be the difference between a 15% and a 37% tax rate. In 2026, the regulatory landscape for prediction markets has shifted from a legal gray area into a structured financial sub-sector. While the CFTC has embraced these markets as derivatives, the tax burden depends entirely on which platform you use and how you structure your trading activity.

Does Your Trading Qualify for Section 1256 Treatment?

Most professional traders seek Section 1256 status for their event contracts. This classification applies to regulated futures and nonequity options. Under this rule, your profits receive a blended tax rate. Specifically, 60% of the gain is treated as a long-term capital gain. The remaining 40% is treated as a short-term capital gain. This results in a maximum effective tax rate significantly lower than standard income rates.

According to a 2026 report by KPMG, the 60/40 split can reduce a high-earner’s tax liability by nearly 12% compared to ordinary income. However, not every platform qualifies. Markets on Kalshi or CME are designed to meet these criteria. They are designated contract markets (DCMs). If you are wondering is Kalshi legal in the US, the answer is yes, and its regulated status is exactly what unlocks these tax benefits.

Section 1256 also requires "mark-to-market" accounting. You must treat all open positions as if they were sold on the final business day of the year. If your contract has increased in value but has not yet settled, you still owe taxes on that gain. This can create "phantom income" where you pay taxes on money you have not yet withdrawn from the exchange.

How the 2025 OBBBA Changed the Rules

The "One Big Beautiful Bill Act" (OBBBA) of 2025 introduced a major hurdle for casual traders. Before this law, speculators could deduct 100% of their losses against their winnings. The OBBBA reduced this deduction to 90% for activities classified as "gaming" or "positioning." This change makes the difference between trading and event contracts a critical tax distinction.

If the IRS views your activity as speculation, you could face a tax bill even if you broke even for the year. For example, if you won $10,000 and lost $10,000, you can only deduct $9,000. You would owe taxes on the remaining $1,000 of "phantom income." This makes using professional-grade tools like PillarLab AI essential for maintaining profitability under tighter tax margins.

"The 2024 event contracts proposal reflected the prior administration's frolic into merit regulation," says Michael S. Selig, CFTC Chairman, in a February 2026 statement. "It is time for clear rules that treat these as financial instruments, not games." This regulatory pivot is helping many traders argue that their activity is "investing" rather than "gaming," potentially bypassing the 90% loss cap.

The PILLAR Tax Framework for Event Traders

To navigate the complexity of 2026 tax filings, we developed the PILLAR Framework. This helps traders categorize their liabilities based on platform and contract type. AI models at PillarLab use these categories to help users track their estimated tax drag in real-time.

  • P - Platform Jurisdiction: Is the exchange a US-regulated DCM like Kalshi? If yes, look toward Section 1256.
  • I - Instrument Type: Is it a binary contract? Most binary options on regulated exchanges qualify for 60/40 treatment.
  • L - Loss Deductibility: Are you filing as a professional trader (Schedule C) or a hobbyist? Professionals can often deduct 100% of expenses.
  • L - Liquidity Reporting: Are you trading on-chain? Polymarket trades may be treated as property transactions rather than derivatives.
  • A - Annual Valuation: Have you performed your December 31 mark-to-market calculation for all open positions?
  • R - Reporting Forms: Ensure you receive a 1099-B. If you get a 1099-MISC, you may need to manually reconcile on Form 6781.

Taxation for On-Chain Markets like Polymarket

On-chain platforms like Polymarket present a different challenge. Because they operate on the Polygon blockchain, the IRS often views these transactions as "property" exchanges. Every time you buy a "Yes" share, you are exchanging USDC for a digital asset. This usually falls under standard capital gains rules rather than Section 1256.

Traders on these platforms must track their cost basis for every trade. This includes understanding the minimum trade size on Polymarket and how it affects your transaction history. If you hold a position for less than a year, you pay short-term capital gains at your ordinary income rate. There is no 60/40 split for most on-chain event markets as of early 2026.

According to a 2025 Chainalysis report, 23% of prediction market volume shows patterns that require advanced reconciliation software. Many users find that how to withdraw from Polymarket involves a taxable event if the USDC value has changed. You should use a dedicated crypto tax tool to sync your wallet and generate a Form 8949.

Qualifying for Professional Trader Status

If trading event contracts is your primary income, you may qualify for Trader Tax Status (TTS). This allows you to deduct business expenses like platform fees and AI research tools. It also enables you to make a Section 475(f) election. This election treats all gains and losses as ordinary income but allows for unlimited loss deductions against other income sources.

To qualify, your trading must be substantial, regular, and continuous. "It’s far from clear whether Kalshi more resembles futures trading or speculation income," says Alan Cole, Tax Foundation Economist. "The 1256 treatment is likely more taxpayer-favorable but a bit more complex for the average user." Professionals often prefer TTS because it eliminates the 90% loss cap imposed by the OBBBA.

Using PillarLab AI can help demonstrate professional intent. By utilizing advanced metrics like expected value (EV) and implied probability, you show the IRS that your activity is based on quantitative analysis. This documentation is vital if your "investor" status is ever challenged during an audit.

The Power of the 3-Year Loss Carryback

One of the most overlooked benefits of Section 1256 is the loss carryback. If you have a net loss in 2026, you can apply that loss to gains from 2023, 2024, or 2025. This can trigger an immediate tax refund from previous years. This is a unique feature of regulated event contracts that is not available for standard stock trading or speculation.

This provides a massive safety net for those who understand how liquidity affects odds and market volatility. If a "black swan" event causes a major loss, the carryback rule helps you recover capital. This liquidity management is a cornerstone of professional event trading. It ensures that one bad year does not end your trading career.

Katten, a leading law firm, noted in a 2026 advisory that Section 1256 status is not automatic. Contracts must meet specific margining or "nonequity option" criteria. Traders should verify with their exchange if their specific contracts, such as sports or political events, are eligible for this carryback benefit.

Handling Mark-to-Market Reporting

Mark-to-market is the "fair value" accounting method required for Section 1256 contracts. On December 31, you must record the closing price of every open position. You then calculate the gain or loss as if you had closed the position. This amount is added to your realized gains and losses for the year.

This can be tricky if you are trading long-term events like the future of prediction markets in 2030. If the odds shift in your favor, you owe taxes today. If the odds shift against you the following year, you get a deduction then. This creates a timing mismatch that requires careful cash flow management.

Most regulated exchanges provide a year-end statement that does this math for you. However, if you are using arbitrage in event trading across multiple platforms, you must manually consolidate these values. PillarLab AI helps by pulling live API data to give you a daily estimate of your mark-to-market liability.

Taxation of Political and Sports Contracts

Political and sports markets are the most controversial in the eyes of the IRS. For years, the CFTC tried to ban these as "gaming." After the landmark *KalshiEX LLC v. CFTC* ruling, these are now legally recognized as regulated derivatives. This court victory paved the way for them to be taxed under financial rules rather than speculation rules.

When you trade on what moves political markets, you are often hedging real-world risk. A business owner might trade on tax policy outcomes to offset potential future costs. The IRS generally respects this "hedging" intent if the trader is consistent. However, sports contracts remain in a "gray area" for some tax professionals.

If you are trading on what moves sports prediction markets, ensure your platform issues a 1099-B. If they issue a W-2G, they are classifying you as a speculater. This classification triggers the 90% loss deduction limit and prevents 60/40 tax treatment. Always check the "Tax Information" section of your exchange settings before the year ends.

Avoiding Common Reporting Mistakes

The most frequent mistake is ignoring unrealized gains. Many traders only report what they withdraw to their bank account. This is incorrect for both Section 1256 and capital gains assets. The IRS receives data from US-regulated exchanges and will flag discrepancies between your 1099-B and your tax return.

Another mistake is failing to separate "Other Income" from "Capital Gains." Some platforms, like Robinhood, have historically issued 1099-MISC forms for event contracts. This reports the total winnings without subtracting the cost of the contracts. You must use Form 6781 to properly adjust these figures so you only pay tax on your actual profit.

Finally, many traders forget to account for how fast odds update at the end of the year. A major price move on December 31 can significantly change your mark-to-market liability. "The 1256 treatment is likely more taxpayer-favorable but a bit more complex," notes Alan Cole. Using an automated tracker is the only way to stay accurate.

The Event Trader’s Tax Prep Checklist

Before you file your 2026 taxes, follow these steps to ensure compliance and maximize your after-tax returns. These steps apply whether you are a hobbyist or a professional.

  • Download All 1099s: Check for 1099-B, 1099-MISC, and 1099-K forms from every exchange you used.
  • Reconcile On-Chain Data: Use a tool to export your Polymarket history and calculate gains in USD at the time of each trade.
  • Calculate Mark-to-Market: Determine the fair market value of all positions held at midnight on December 31.
  • Identify Deductible Expenses: Total your costs for subscriptions like PillarLab AI, data feeds, and specialized hardware.
  • Choose Your Form: Use Form 6781 for regulated contracts and Schedule D for on-chain property transactions.
  • Consult a Pro: If your trading volume exceeds $50,000, hire a CPA who specializes in Section 1256 contracts.

The IRS is expected to release formal guidance on "Event-Based Derivatives" by late 2026. This will likely clarify whether all sports contracts can qualify for Section 1256. There is also a push in Congress to restore the 100% loss deduction for all financial instruments to fix the "phantom income" issue created by the OBBBA.

As prediction markets integrate with traditional finance, we may see how prediction markets integrate with Google Finance lead to more standardized reporting. This would make it easier for casual traders to see their tax liability directly on their dashboard. For now, the burden of accuracy remains on the individual trader.

Staying informed on is Polymarket fully legal in the US 2026 is also important. Any change in its legal status could immediately change how its contracts are taxed. If it gains a US license, it could shift from "property" taxation to the more favorable Section 1256 framework.

FAQs

What is a Section 1256 contract?

It is a type of investment, including regulated futures and nonequity options, that qualifies for a 60/40 tax split. This means 60% of gains are taxed at long-term capital gains rates and 40% at short-term rates. Most regulated US event contracts now fall under this category.

Can I still deduct 100% of my losses?

If your trading is classified as "gaming" under the 2025 OBBBA, you can only deduct 90% of your losses against your winnings. However, if your activity is classified as financial trading on a regulated exchange, you may still be able to deduct 100% of losses.

How do I report Polymarket winnings?

Polymarket is typically treated as "property" for tax purposes. You must report each trade on Form 8949 and Schedule D, calculating the capital gain or loss in USD. It does not currently qualify for the 60/40 Section 1256 tax split.

What happens if I don't close my position by year-end?

Under the mark-to-market rule for Section 1256 contracts, you must pay taxes on the unrealized increase in value as of December 31. You treat the position as if it were sold and then immediately repurchased at the start of the new year.

Is it better to be a professional trader for taxes?

Yes, qualifying for Trader Tax Status (TTS) allows you to deduct business expenses and potentially elect Section 475(f) accounting. This can eliminate the 90% loss deduction cap and allow you to offset trading losses against other types of income.

Final Takeaway

Taxation for event contracts is no longer a "best guess" scenario. If you trade on regulated exchanges like Kalshi, you likely benefit from the 60/40 tax split but must handle mark-to-market reporting. If you trade on-chain, prepare for complex cost-basis tracking. Always use professional tools like PillarLab AI to monitor your positions and consult a tax professional to navigate the 90% loss deduction rules of the OBBBA.