Tackling Predatory Litigation Funding Act
The Tackling Predatory Litigation Funding Act creates a new federal tax regime on income that third-party litigation funders receive from civil actions. It adds a new Chapter 50B to the Internal Revenue Code and imposes a tax (the “applicable percentage” of the funder’s proceeds) on qualified litigation proceeds received by a covered party. The tax rate is the highest marginal tax rate plus 3.8 percentage points, and for pass-through entities (like partnerships or S corporations) the tax is applied at the entity level. The bill also requires withholding at source of 50% of the applicable percentage from proceeds paid to funders, defines who is a “covered party” and what counts as a “litigation financing agreement,” and provides several important exclusions and special rules. It also excludes these proceeds from gross income for purposes of other tax rules, and it takes effect for taxable years beginning after December 31, 2025. In short, the bill would substantially increase the tax burden on third-party litigation funders and impose new withholding obligations, with the aim of reducing what it views as predatory litigation funding practices. It also codifies several definitions and exceptions to narrow the scope and uses a broad, cross-border approach to who can be a covered party.
Key Points
- 1Tax imposition and rate: Introduces a new tax (Chapter 50B) on “qualified litigation proceeds” received by a covered party. The tax rate is the sum of the highest current federal income tax rate plus 3.8 percentage points. For pass-through entities, the tax is applied at the entity level.
- 2Definitions:
- 3- Covered party: A third party (individual, company, partnership, or sovereign wealth fund) that receives funds under a litigation financing agreement and is not an attorney for the action.
- 4- Litigation financing agreement: Any written contract in which a third party funds a civil action and has a direct or collateralized interest in the proceeds, plus similar/substantially similar contracts or instruments identified by the Secretary. The definition includes broad forms and relationships related to the funding and the law firm, but excludes certain loan-like arrangements.
- 5Exclusions and limitations:
- 6- Small-funding exception: If total funding for an action is less than $10,000, the agreement is not a litigation financing agreement for tax purposes.
- 7- Loan-like exceptions: Arrangements that are primarily loans (with interest under specified caps) or that reimburse attorney fees, and that do not create a broader contingency interest, are excluded. Related-party relationships described in 267(b) are also excluded.
- 8Special rules and withholding:
- 9- Withholding at source: A person who controls, receives, or holds proceeds from a civil action with a litigation financing agreement must withhold 50% of the applicable percentage of payments to the third party.
- 10- Liability and credits: Withholding agents are liable for the tax withheld and the withheld tax can be credited against the recipient’s tax; refunds/credits follow standard withholding rules.
- 11Treatment of proceeds and related tax rules:
- 12- Qualified litigation proceeds are excluded from gross income for purposes of other tax provisions (Section 139J), and proceeds are not netted against ordinary or capital losses for calculating the tax on gains.
- 13- The proposal also amends capitalization rules to exclude these financial arrangements from capital assets.
- 14Effective date: The amendments apply to taxable years beginning after December 31, 2025.