Where They’re Legal, Where They’re Not, and What’s Changing
The landscape of prediction markets in the United States is a complex mosaic of federal authorization, state-level challenges, and evolving regulatory frameworks, demanding careful navigation from both platforms and participants. While the Commodity Futures Trading Commission (CFTC) has asserted federal jurisdiction over these innovative financial instruments, regulating them as "event contracts" under the Commodity Exchange Act, the legal picture quickly fragments below the federal level. Two prominent platforms, Kalshi and Polymarket, currently operate with varying degrees of CFTC oversight, yet their legal standing is frequently contested by state gambling regulators who argue for local control, particularly over events resembling traditional wagering. This guide, updated as of February 2026, delves into the intricate legal status of prediction markets, exploring federal and state regulations, tax implications, and the inherent legal risks for traders.
Federal Oversight: The CFTC’s Evolving Framework
At the federal apex, prediction markets are largely deemed legal. The CFTC, established to regulate commodity futures and options markets, has extended its purview to event contracts. These are typically binary options that pay a fixed amount ($1.00) if a specified future event occurs and nothing if it does not. The agency classifies these as swaps or futures, thereby bringing them under the strictures of the Commodity Exchange Act. This classification is pivotal, as it theoretically places event contracts on par with traditional financial derivatives like corn futures or oil options, implying federal preemption over state laws.
The CFTC’s involvement stems from the recognition of prediction markets’ potential for "price discovery" – their ability to aggregate dispersed information and reflect collective wisdom on future events, from economic indicators to geopolitical shifts. This function is seen as valuable for businesses, policymakers, and researchers, distinguishing them from pure gambling, which typically serves entertainment purposes without such a broader societal benefit.
Kalshi’s Pioneering Path to Regulation:
Kalshi emerged as a trailblazer in 2020, securing the first Designated Contract Market (DCM) license from the CFTC. This license is a gold standard in commodity regulation, subjecting Kalshi to the same rigorous oversight as established exchanges like the Chicago Mercantile Exchange. Operating as a DCM entails stringent requirements, including the segregation of customer funds, robust market surveillance to prevent manipulation, and regular, transparent reporting to the CFTC. This framework is designed to ensure market integrity and protect participants, aligning Kalshi with traditional financial institutions.
Kalshi’s journey was not without significant regulatory friction, particularly concerning political event contracts. In 2023, the CFTC, then under a different administration, attempted to block Kalshi from listing markets predicting the control of Congress. Kalshi challenged this decision in federal court, arguing that such contracts were legitimate instruments of price discovery, not gambling. In a landmark decision in September 2024, a federal judge sided with Kalshi, and the D.C. Circuit Court of Appeals upheld this ruling. This legal victory paved the way for Kalshi to legally offer political event contracts by the November 2024 election, setting an important precedent for the industry.
The regulatory environment further stabilized for prediction markets with the appointment of CFTC Chairman Mike Selig in early 2025 by the Trump administration. Selig has been a vocal proponent of prediction markets, publicly emphasizing their "price discovery function" and asserting the CFTC’s "exclusive jurisdiction" over event contracts traded on regulated exchanges. This stance signals a federal commitment to fostering the growth of this market segment under federal oversight.
Polymarket’s Strategic Re-entry into the US:
Polymarket, a decentralized prediction market platform, initially operated without formal US regulatory approval. This led to a significant enforcement action by the CFTC in 2022, resulting in a $1.4 million settlement and an agreement to geoblock US users. This event highlighted the CFTC’s resolve to regulate platforms serving US citizens, regardless of their decentralized nature.
However, Polymarket orchestrated a strategic return to the US market in 2025. This was achieved through the acquisition of QCX, a company that already held a CFTC registration, for approximately $112 million. This acquisition provided Polymarket with a crucial regulatory conduit. The US version of Polymarket subsequently launched in late 2025, operating under a CFTC "no-action letter." This letter signifies the CFTC’s agreement not to pursue enforcement actions as long as Polymarket adheres to specific operational guidelines, which include stringent Know Your Customer (KYC) requirements, such as Social Security number and government ID verification.
It is crucial to differentiate a "no-action letter" from a full DCM license. While it provides a temporary shield from enforcement, it offers less regulatory certainty and permanence than Kalshi’s DCM status. A no-action letter can be withdrawn with relatively little notice, leaving Polymarket’s US operations potentially vulnerable to future regulatory shifts. Meanwhile, the international version of Polymarket continues to operate globally with minimal KYC, serving users outside the US regulatory ambit.
The Scope of CFTC Authority:
The CFTC’s regulatory framework primarily focuses on the exchanges themselves (like Kalshi and Polymarket US) and the structural integrity of the event contracts. It does not typically regulate individual traders beyond standard anti-fraud and anti-manipulation rules that apply across financial markets. The CFTC’s consistent position is that its authority under the Commodity Exchange Act preempts state-level gambling regulations for event contracts traded on federally regulated platforms. This principle of federal preemption is the bedrock of the CFTC’s argument for exclusive jurisdiction, aiming to create a uniform national standard for these financial instruments.
The Tug-of-War: Federal Preemption vs. State Sovereignty
Despite the CFTC’s clear stance, the most significant legal battleground for prediction markets lies in the ongoing conflict between federal preemption and state sovereignty over gambling laws. This jurisdictional dispute creates a complex and often contradictory legal environment.
Arguments for Federal Preemption:
The core argument for federal preemption rests on the Supremacy Clause of the US Constitution, which dictates that federal laws are supreme to state laws when there is a direct conflict. The CFTC and regulated platforms contend that event contracts, being federally regulated commodities, fall squarely under federal jurisdiction. They draw parallels to traditional commodity markets: just as states cannot unilaterally ban trading in corn futures on the Chicago Mercantile Exchange, they argue states should not be able to ban event contracts on federally supervised platforms like Kalshi or Polymarket. This perspective emphasizes the national, interstate nature of financial markets and the need for a consistent regulatory approach to avoid a fragmented, inefficient system.
Federal courts have offered some support for this position. In Kalshi’s 2024 lawsuit against the CFTC, the court acknowledged that properly regulated event contracts are indeed commodity transactions, distinguishing them from traditional gambling. However, the ruling deliberately avoided a definitive pronouncement on whether state gambling laws are explicitly preempted, leaving a critical legal ambiguity unresolved.
States Mount Resistance:
Several states have vigorously pushed back against the federal preemption argument, asserting their historical authority to regulate gambling within their borders. Their actions often stem from concerns about consumer protection, potential state revenue from gaming, and maintaining local control over activities perceived as wagering.
Nevada, a state with a deeply entrenched gaming industry, filed a lawsuit arguing that prediction markets, especially those on sports and entertainment events, fall under its exclusive gaming regulatory authority. Nevada’s position is that state gambling law should apply irrespective of federal commodity regulation, particularly for event categories that closely resemble sports betting or other forms of regulated wagering. This case, ongoing as of February 2026, is a crucial test of the limits of federal preemption.
New York has been particularly aggressive in its regulatory posture. The New York State Gaming Commission issued guidance in 2025, suggesting that prediction markets offering contracts on events resembling gambling (such as sports outcomes or entertainment events) might require a New York gaming license. The state has also voiced significant concerns about consumer protection, arguing that retail traders may lack the sophistication to safely engage in event contract trading, potentially exposing them to financial harm. Consequently, Polymarket’s US platform has had to restrict access for some New York residents, illustrating the practical impact of state-level resistance.
Massachusetts followed suit in late 2025, with its Attorney General’s office sending cease-and-desist letters to at least one prediction market platform. The state contended that event contracts violate existing state consumer protection statutes, indicating a readiness to pursue enforcement actions. Similarly, Maryland regulators have raised questions regarding the necessity of state gambling licenses for prediction markets, though no formal enforcement actions have yet been initiated.
Unsettled Legal Ground:
The legal landscape remains genuinely unsettled, with two primary issues awaiting definitive resolution by higher courts or comprehensive federal legislation:
- Automatic Preemption: Does the CFTC’s regulation of an exchange automatically preempt all state regulation of contracts traded on that exchange? The CFTC maintains this is the case, but several states vehemently disagree, particularly for contracts they perceive as traditional gambling. No appellate court has issued a definitive ruling on this specific question concerning prediction markets.
- Event Type Distinction: Does the nature of the underlying event matter for preemption? There’s a clear conceptual difference between a contract on a Federal Reserve interest rate decision, which strongly resembles a financial derivative, and a contract on, for example, the outcome of a reality TV show, which appears more akin to a wager. Some states are actively attempting to draw this line, arguing that federal preemption might apply to financial or political events but not to entertainment or sports outcomes, thereby preserving state authority over "gambling-like" activities.
A Patchwork Nation: State-by-State Regulatory Landscape
The current regulatory environment has resulted in a fragmented state-by-state breakdown, creating a patchwork of legality across the US. As of February 2026, the situation is dynamic, with ongoing legislative efforts and regulatory scrutiny continuously reshaping access.
The table provided in the original content illustrates this complexity. While many states show "Available" status for both Kalshi and Polymarket, indicating no current platform-imposed restrictions or active enforcement actions, this does not guarantee future stability. "Restricted" status, as seen in states like Connecticut, Hawaii, Illinois, Massachusetts, New York, and Nevada, signifies either direct platform blocking or active regulatory action that creates legal risk for traders.
Understanding the State Restrictions:
States like New York and Massachusetts often cite consumer protection as a primary concern, arguing that prediction markets, particularly those with speculative outcomes, pose risks to retail investors who may not fully understand the complexities or potential for loss. Their efforts to require state gaming licenses or issue cease-and-desist letters are rooted in this protective stance. Nevada, on the other hand, is driven by its established gaming regulatory framework and a desire to maintain control over any activity resembling wagering, potentially for revenue generation and industry oversight. Illinois has discussed prediction market regulation within the context of its sports betting framework, indicating a similar inclination to categorize them under existing gaming laws.
Emerging Legislative Trends:
Several states are actively considering legislation that could dramatically alter their prediction market status:
- Iowa introduced a bill in the 2025–2026 session aimed at explicitly classifying prediction markets as legal financial instruments, distinct from gambling. If passed, Iowa would become a pioneer in establishing a dedicated state-level regulatory framework for these markets.
- New York is grappling with conflicting legislative proposals. One bill seeks to mandate state gaming licenses for platforms offering certain event categories, while another aims to exempt CFTC-regulated platforms entirely from state gambling laws. The outcome of these bills will be critical in determining New York’s long-term stance.
- Connecticut has a pending bill that would categorize event contracts as a unique financial product, placing them under the purview of the state’s Department of Banking rather than its gaming commission. This approach mirrors the federal classification, treating prediction markets as financial services.
These legislative efforts highlight the ongoing debate and the varying philosophies states hold regarding the nature and regulation of prediction markets.
Navigating the Tax Maze: Reporting Prediction Market Gains
For US traders, profits from prediction markets are taxable income, but the specific tax treatment can vary significantly depending on the platform and contract structure.
Kalshi and Section 1256 Contracts:
Kalshi, as a CFTC-regulated DCM, facilitates contracts that qualify as "Section 1256 contracts" under the Internal Revenue Code. This classification offers a distinct tax advantage: 60% of gains are taxed at the lower long-term capital gains rate (which can be 0%, 15%, or 20% depending on income), and 40% are taxed at the ordinary income tax rate (short-term capital gains). This blended rate can result in substantial tax savings. For example, a trader in the 35% ordinary income bracket might see an effective tax rate of approximately 26.8% on their prediction market gains, a significant reduction compared to paying 35% on all gains if they were treated solely as ordinary income. Kalshi also simplifies reporting by issuing Form 1099-B and allows for mark-to-market treatment at year-end, where open positions are treated as if closed on December 31st for tax purposes, simplifying accounting but requiring taxes on unrealized gains.
Polymarket’s Ambiguity and Trader Responsibility:
Polymarket, especially its international version, generally does not issue 1099 forms to most users, placing the entire tax reporting burden on the individual trader. The IRS has not issued specific guidance on how to classify gains from decentralized finance (DeFi) protocols or USDC-denominated event contracts. Tax professionals offer differing interpretations: some argue that if Polymarket’s contracts are functionally identical to Kalshi’s, they should qualify for Section 1256 treatment, even if the platform isn’t a DCM. Others contend that without DCM status, the contracts might not qualify, and gains should be reported as short-term capital gains or even ordinary income, incurring a higher tax liability.
Given this ambiguity, the safest approach for Polymarket users is to consult a tax professional specializing in crypto or derivatives taxation. Meticulous record-keeping is essential, tracking every trade’s entry price, exit price, date, and outcome. Utilizing crypto tax tools like Koinly, CoinTracker, or TokenTax is highly recommended to manage this complex reporting requirement.
State Income Tax Considerations:
The tax landscape is further complicated by state income taxes. States like California, New York, and New Jersey tax capital gains at ordinary income rates, which can diminish the benefit of the federal 60/40 split. Conversely, states without income tax, such as Texas, Florida, Nevada, Washington, Wyoming, South Dakota, Alaska, and New Hampshire, offer a natural advantage for high-volume prediction market traders, as they only contend with federal taxation.
The Road Ahead: Key Legislative and Regulatory Developments
The future of prediction markets in the US hinges on several ongoing legislative and regulatory developments.
State-Level Initiatives:
As noted, Iowa‘s bill to classify prediction markets as legal financial instruments could set a precedent for other states seeking to attract financial innovation. In New York, the conflicting bills highlight the struggle to balance consumer protection with fostering new markets. The outcome will likely influence how other populous states approach the issue. Illinois‘ discussions within its sports betting framework suggest a potential path where prediction markets might be regulated under existing gaming licenses if deemed similar enough. Connecticut‘s bill to place event contracts under its Department of Banking could serve as a model for states wanting to treat them as financial services rather than gambling.
Federal Rulemaking by CFTC:
At the federal level, the most significant anticipated development is the CFTC’s ongoing rulemaking process for event contracts, expected to finalize in 2026. These rules are poised to more clearly define which types of event contracts can be listed on regulated exchanges and under what specific conditions. The outcome of this rulemaking could either significantly strengthen the federal preemption argument by broadly defining the CFTC’s jurisdiction or introduce limitations that might give states more room to assert their regulatory authority. The industry is closely watching to see how broadly the CFTC interprets its mandate.
Mitigating Risk: Essential Considerations for Prediction Market Traders
Even with the growing acceptance of prediction markets, traders must be aware of several inherent legal and operational risks.
Platform Stability and Regulatory Status:
The regulatory status of a platform directly impacts the security of trader funds. Kalshi’s DCM status, with its mandated fund segregation, offers robust protection. Polymarket’s CFTC no-action letter provides less certainty; it can be withdrawn, potentially disrupting US operations. For funds on Polymarket’s international version, there is no US regulatory backstop, meaning protections depend entirely on the platform’s terms and the laws of its operating jurisdiction, which may be minimal.
Dynamic State Regulatory Environment:
The risk of a state changing its legal stance on prediction markets is substantial, particularly in states currently scrutinizing the industry. If a state bans or heavily regulates event contracts, traders might be forced to close positions and withdraw funds on an inconvenient timeline. Historically, when states restricted daily fantasy sports, operators provided a grace period for users to wind down their activities, a model likely to be followed if prediction markets face similar bans.
Dispute Resolution Mechanisms:
Disputes over contract resolution, though rare, can occur. On Kalshi, traders have access to CFTC-mandated dispute resolution processes, offering a formal avenue for recourse. On Polymarket, especially its international version, resolution typically relies on underlying oracle systems (e.g., UMA’s optimistic oracle). A trader’s recourse in a dispute is generally more limited and decentralized, potentially requiring engagement with a community-driven resolution process rather than a formal regulatory body.
Strict Adherence to Tax Obligations:
Failing to report prediction market gains to the IRS can lead to significant penalties and interest. Kalshi’s direct reporting via Form 1099-B means the IRS is aware of these gains. While Polymarket does not typically issue 1099s, on-chain transactions are permanently recorded and increasingly accessible to IRS analytics tools. The financial and legal consequences of non-compliance with tax obligations far outweigh the cost of paying the required taxes.
Conclusion and Outlook
The legal landscape for prediction markets in the United States is undeniably dynamic, marked by a fascinating interplay between federal regulatory ambition and state-level resistance. While the CFTC has firmly established a federal framework, the jurisdictional battle with states over what constitutes a "commodity" versus "gambling" remains largely unsettled. The coming years, especially with anticipated CFTC rulemaking and ongoing state legislative efforts, will be critical in shaping the industry’s future. For traders, staying informed about these evolving legal nuances, understanding the specific regulatory status of their chosen platform, and diligently fulfilling tax obligations are paramount to navigating this complex, yet potentially lucrative, market segment. The ultimate outcome will not only define the future of prediction markets but also set important precedents for how innovative financial products are integrated into the existing regulatory structure of the US.
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