Tackling Predatory Litigation Funding Act
- Sponsor
- Rep. Hern, Kevin [R-OK-1]
- Committees
- Ways and Means Committee (primary)
- Last action
- May 20, 2025
Bottom line
The bill aims to significantly tax and regulate the third-party litigation funding industry by imposing a high-rate tax on their profits and implementing new withholding requirements.
What it actually does
This bill establishes a new tax on income derived from litigation financing agreements by third-party entities, applying a high tax rate equal to the highest individual income tax rate plus 3.8 percentage points. It mandates withholding of this tax by parties involved in the litigation and makes technical amendments to the Internal Revenue Code to classify these proceeds as ordinary income and exclude them from the recipient's gross income after the entity-level tax.
Proponents argue
Proponents argue this bill addresses a growing concern about the influence of third-party litigation funders, who they contend profit excessively from legal disputes without being direct parties, potentially incentivizing frivolous lawsuits and increasing litigation costs. They may argue it levels the playing field and ensures a fairer distribution of litigation proceeds while generating federal revenue.
Opponents contend
Opponents would likely argue that this tax stifles access to justice for individuals and small businesses who rely on third-party funding to pursue legitimate claims against well-resourced defendants. They might contend it is an overreach that could reduce competition in the legal market and disproportionately harm those seeking redress, effectively benefiting large corporations.
The bill is relatively short but introduces a new tax regime with specific definitions and exceptions, requiring careful reading to understand its full implications.
Section 2(a), adding Chapter 50B, Sec. 5000E-1
Imposition of Tax on Qualified Litigation Proceeds
This provision establishes a new Chapter 50B in Subtitle D of the Internal Revenue Code, titled 'Litigation Financing.' It imposes a tax on 'qualified litigation proceeds' received by a 'covered party' at a rate equal to the highest individual income tax rate plus 3.8 percentage points. For pass-through entities, the tax is explicitly applied at the entity level, ensuring that the tax is collected before distributions to individual investors.
Supporters argue
Supporters argue this tax targets entities that profit from litigation without direct involvement, ensuring they contribute a fair share to public revenue and potentially curbing speculative or predatory funding practices that can inflate legal costs.
Critics contend
Critics contend this tax will make litigation funding less attractive, thereby limiting access to capital for plaintiffs who cannot otherwise afford to pursue legitimate claims, especially against large corporations or governments with extensive legal resources.
Tradeoffs
This provision balances the desire to regulate and tax a specific industry against concerns about potentially limiting access to justice for plaintiffs who rely on external funding to pursue their legal rights.
Section 2(a), adding Chapter 50B, Sec. 5000E-2
Defining Key Terms for Litigation Financing Tax
This section provides crucial definitions for the new tax chapter. It broadly defines 'civil action' and 'covered party' as a third-party funder (excluding attorneys). It meticulously defines 'litigation financing agreement' with specific criteria and exceptions, such as agreements under $10,000 or those limited to principal/interest repayment at a capped rate. 'Qualified litigation proceeds' are defined as realized gains, net income, or other profit from such agreements, explicitly prohibiting netting losses or excluding certain income types.
Section 2(a), adding Chapter 50B, Sec. 5000E-3(a)-(d)
Mandatory Withholding of Litigation Financing Tax
This section mandates that any 'applicable person' (defined as a named party or affiliated law firm in a civil action that has entered a litigation financing agreement) must deduct and withhold a tax equal to 50% of the applicable percentage from payments made to a third-party funder. It establishes liability for the withheld tax, credits the withheld amount against the recipient's tax liability, and outlines rules for refunds and credits, ensuring tax collection at the source.
Section 2(b)
Litigation Financing Arrangements Not Capital Assets
This amendment modifies Section 1221(a) of the Internal Revenue Code to explicitly state that any financial arrangement created by, or any proceeds derived from, a litigation financing agreement shall not be considered a capital asset. This means that gains from such arrangements would be treated as ordinary income, not qualifying for potentially lower capital gains tax rates.
Section 2(c)
Exclusion of Qualified Litigation Proceeds from Gross Income
This section adds a new Section 139J to the Internal Revenue Code, stating that gross income shall not include any 'qualified litigation proceeds' as defined in the new Chapter 50B. This means that while the tax is imposed at the entity level on these proceeds, the ultimate recipient of the proceeds (after the entity-level tax and withholding) does not include them in their own gross income for federal income tax purposes.
Specifies that 'qualified litigation proceeds' (realized gains, net income, or other profit) cannot be reduced or offset by any ordinary or capital loss in the taxable year.
Section 5000E-2(4)(B)
Why it matters:This is a technical detail common in tax legislation designed to prevent specific types of tax avoidance or arbitrage. While standard legislative practice, its placement can obscure its significant financial implications.
Case for: Supporters would argue this prevents funders from using losses from other investments or unsuccessful litigation to reduce their tax liability on profitable litigation financing, ensuring the tax is applied consistently to the intended income base.
Case against: Opponents might argue this creates an unfair tax burden by not allowing legitimate business losses to offset gains, treating litigation financing differently from other investment activities where netting is often permitted for overall business profitability.
Estimated impact: This rule could significantly increase the taxable income for funders with diverse portfolios or unsuccessful ventures, leading to higher federal tax revenues than if loss offsets were permitted.
States that in determining 'realized gain' for qualified litigation proceeds, amounts described in section 104(a)(2) (damages for personal physical injuries or sickness) and 892(a)(1) (income of foreign governments) shall not be excluded.
Section 5000E-2(4)(C)
Why it matters:This is a technical clarification to prevent existing tax exclusions from applying to the new tax base. It's standard legislative practice to define the scope of new taxes, but the specific cross-references require specialized knowledge.
Case for: Supporters would argue this ensures the tax applies broadly to all profits derived from litigation financing, regardless of the underlying nature of the damages or the foreign government status of the funder, preventing specific carve-outs and ensuring comprehensive taxation.
Case against: Opponents might argue that including income related to personal physical injuries or sickness in the tax base for funders is inappropriate, as such damages are typically tax-exempt for the direct recipient. Similarly, taxing foreign government income could raise diplomatic or international investment concerns.
Estimated impact: This provision expands the tax base for qualified litigation proceeds, potentially increasing federal tax revenue by preventing specific exclusions that might otherwise reduce taxable income.