The States Are Coming For Prediction Markets: A New Frontier In Tax Policy

Highlights

• The rapid growth of prediction market platforms has triggered a wave of state-level tax and regulatory actions, escalating a jurisdictional battle with federal regulators and creating an unsettled landscape.
• States are taking divergent approaches, ranging from enforcement actions and quasi-prohibitive tax regimes in states such as Kentucky and Illinois to North Carolina's more cooperative model recognizing Commodity Futures Trading Commission jurisdiction while imposing a modest state tax.
• The emerging patchwork raises significant questions for tax practitioners, including characterization, federal preemption, sourcing, nexus, apportionment and the proper tax base for prediction market transactions.

The rapid growth of prediction market platforms has triggered a wave of state-level tax and regulatory actions – and, in turn, an escalating jurisdictional battle with federal regulators. As of mid-2026, the landscape is anything but settled, with states adopting divergent approaches to these platforms through both legislation and litigation.

In 2026 alone, at least 15 states considered legislation addressing prediction markets. During July 2026, North Carolina became the latest state to overtly tax prediction markets. For tax professionals, the emerging patchwork of state taxes on prediction markets presents novel questions about characterization, preemption and compliance.

What Are Prediction Markets?

Prediction markets allow participants to buy and sell contracts whose value depends on the outcome of future events such as an election, sporting event, economic indicator or another real-world occurrence. As these platforms have expanded beyond political forecasting into sports and other widely traded event markets, they have attracted increasing attention from federal regulators and state governments.

The Federal Backdrop: CFTC Jurisdiction

At the federal level, prediction markets are not classified as gambling. Instead, prediction market platforms are registered with the Commodity Futures Trading Commission (CFTC) as designated contract markets. The CFTC's position is that it has exclusive regulatory authority over these markets and that the Commodity Exchange Act (CEA) preempts the application of state gambling laws to CFTC-regulated exchanges. A growing number of states dispute that position, particularly with respect to sports-related event contracts, and are challenging the CFTC's asserted exclusive jurisdiction in ongoing litigation.

State Approaches: 3 Models

States have responded to prediction markets in three general ways: prohibition, heavy-handed taxation and light-touch accommodation. Each carries distinct tax implications.

Prohibition and Enforcement

Several states have moved to shut down prediction markets under existing gambling statutes through cease-and-desist orders, civil enforcement actions and related litigation. New York issued one of the earliest cease-and-desist letters in October 2025, and similar enforcement efforts have now expanded to Connecticut, Wisconsin, Rhode Island and, most recently, Michigan. The CFTC has responded with a series of federal preemption actions, and the dispute now spans nine states.

On July 7, 2026, the U.S. District Court for the Southern District of New York denied a prediction market platform's request for a preliminary injunction against New York's enforcement efforts. The ruling is now on appeal. On July 14, 2026, Michigan became another significant front in the dispute after a state court ordered a prediction market platform to cancel previously executed trades. The CFTC responded by exercising its emergency authority to prevent the cancellation, describing the order as the first attempt by a state to interfere directly with executed derivatives transactions.

Aggressive Taxation as Quasi-Prohibition

Kentucky represents one of the more aggressive tax approaches. In April 2026, the Kentucky General Assembly enacted House Bill 757, imposing a 14.25 percent excise tax on prediction market operators' transaction fees, effective January 1, 2027. Notably, Kentucky defines "transaction fee" to include both the operator's execution fee and amount paid by the consumer to purchase an event contract, thus expanding the tax base beyond the operator's fee revenue. The CFTC filed suit against Kentucky, invoking late Chief Justice John Marshall's observation in McCulloch v. Maryland that "the power to tax involves the power to destroy" and arguing that the tax is designed to make prediction market operations economically impossible in the state.

Illinois took a different but equally contentious approach. As part of its fiscal year (FY) 2027 budget, Illinois amended its Sports Wagering Act to treat certain sports-event contracts offered on prediction markets as "exchange wagers." Covered platforms are therefore subject to the state's sports-wagering licensing requirements, including a $15 million licensing fee for the first four years and $1 million for each four-year renewal period thereafter. The law also imposes a tiered transaction tax of 1.75 percent on the first 5 million exchange wagers in an FY and 3.5 percent thereafter. The CFTC has challenged the Illinois law, arguing that the licensing and taxing provisions are preempted by the CEA.

"Cooperation" Plus a More Modest Tax

North Carolina has staked out what may become the most consequential middle ground. On July 7, 2026, Gov. Josh Stein signed Senate Bill 257 as part of the state's 2026 budget. The legislation makes North Carolina the first state to formally codify CFTC jurisdiction over prediction markets in its statutes, explicitly recognizing that the CEA establishes "exclusive federal regulatory authority" over these platforms.

Rather than requiring a separate state gambling license, North Carolina provides that a prediction market registered and licensed by the CFTC may operate lawfully in the state if it complies with CEA and CFTC regulations. The state imposes a 6 percent tax on net trading fee revenue apportionable to North Carolina, with apportionment tied to event-contract trading by residents who are domiciled and present in the state at the time of the trade, effective January 1, 2027. For context, North Carolina's sports betting operators face a 23 percent tax on gross wagering revenue – nearly four times the prediction market rate.

Holland & Knight Insights

For state tax practitioners, this evolving landscape raises several key questions:

• Characterization. Is a prediction market transaction a "wager" subject to state gaming taxes, a federally regulated derivative or "swap" subject to federal oversight only, or something else entirely? The answer determines not only the applicable tax regime but potentially whether the state has taxing authority at all.
• Preemption. State efforts to regulate, restrict, or tax prediction markets are being challenged by prediction market platforms and the CFTC. If courts determine that state taxes on CFTC-regulated instruments are preempted by the CEA, states pursuing revenue from prediction markets may need to find alternative approaches or follow North Carolina's model of "cooperation."
• Sourcing, Nexus and Apportionment. North Carolina and Kentucky have adopted materially different sourcing rules, requiring platforms to determine where event-contract transactions occur and which states may tax them. As additional states adopt their own prediction market tax regimes, those differing approaches are likely to create complex sourcing, compliance and constitutional issues.
• Tax Base. Kentucky taxes a significantly broader base than North Carolina, which limits its tax to net trading fee revenue. Those contrasting approaches may influence both the economic impact of the tax and whether it is viewed as a legitimate revenue measure or an impermissible attempt to regulate CFTC-regulated markets.
• Rate Differentiation. North Carolina's decision to tax prediction markets at 6 percent while taxing sportsbooks at 23 percent raises questions about the policy rationale for disparate treatment. Is this a principled distinction based on the nature of the activity or a race-to-the-bottom incentive to attract platform business?