Litigation Financing Tax Proposal: A Life Sciences Perspective
Through the month of June and into the week of July 4th, 2025, national attention was largely focused on a sweeping federal spending bill moving through Congress as part of the budget reconciliation process. But while media and public attention was centered on healthcare and social welfare funding, most Americans were not aware that the bill also briefly included a contentious litigation finance tax proposal.
The “Tackling Predatory Litigation Funding Act” (S.1821), first introduced in the Senate on May 20, 2025, represented a significant legislative effort to regulate and tax third-party litigation funding (TPLF), a rapidly growing and controversial industry. It proposed a significant tax (>40%) on ”qualified litigation proceeds,” directly affecting both foreign and domestic litigation funders, including law firms and investors.
The House-passed version of the budget reconciliation bill did not include any TPLF provisions before it reached the Senate, but the core taxation provision from S.1821 was inserted into the Senate’s draft during Senate negotiations. The addition triggered vocal debate and lobbying, both in support and opposition, from attorneys and their business clients, including those in the commercial insurance and life sciences industry. Proponents argued that the proposal would curb foreign influence in U.S. litigation, close tax loopholes, and deter frivolous lawsuits by making litigation funding less profitable. However, amid mounting pressure, the provision was removed from the Senate draft before the bill was brought to the floor for a vote.
While the proposal did not make it into law, its brief inclusion highlighted growing bipartisan scrutiny of TPLF, concern over its lack of transparency, and perceived impacts on U.S. litigation. Debate will no doubt continue in the insurance and life science communities–and in the public at large–over whether the government should take steps to curb or regulate litigation financing.
What is Litigation Financing?
Litigation financing involves the advancing of funds by a third party, often an investment group or one of its affiliates, to another party involved in litigation in return for a share of any financial recovery from a judgment or settlement. Litigation financing may take many forms, such as (i) purchasing all or a portion of a claim directly from the plaintiff for a share of the potential reward; (ii) advancing funds to law firms to share in contingent fees; or (iii) purchasing debt, equity, or other economic rights in a company that will use the proceeds to finance its own litigation. Most litigation financers typically advance money to plaintiffs or their law firms on a non-recourse basis, meaning that if the lawsuit fails, the plaintiffs or the law firms do not pay the money back. But if the litigation is successful, funders can potentially reap windfall profits of 20% or more.
The TPLF industry has grown into a $16 billion market with investments spanning personal injury cases—such as the talc litigation against Johnson & Johnson—and patent infringement suits brought by small inventors against larger companies.
Litigation Funding Proposals
When plaintiffs win or settle a lawsuit, the money they receive is generally taxable as income, though some exceptions do apply. Plaintiff proceeds can be subject to ordinary income taxes, both federal and state. Similarly, their attorneys working on contingency fees pay ordinary income tax on their share of the litigation proceeds. Things get interesting, however, for litigation funders. Depending on how the funding is structured, the proceeds from their investment can be taxed at much lower rates (e.g., capital gains or interest income) and in some cases, may not even be taxed at all. Proposals like the S.1821 (and its companion bill introduced in the House), seek in part to close the tax loopholes that currently allow financers to pay less taxes than plaintiffs and their counsel and permit foreign governments and tax-exempt entities to pay no taxes.
Supporters of TPLF legislation also argue that allowing uninterested parties to fund lawsuits incentivizes the filing of frivolous complaints, especially in the mass tort arena, and encourages long court fights that increase the costs of such litigation and lead to inflated settlement amounts. They also cite pressing national security concerns, arguing that the practice allows foreign investors to “meddle” in the American legal system, influencing industries, developing technologies, and the economy. These concerns have led to the introduction of the “Litigation Transparency Act of 2025” (H.R.1109) and the “Protecting Our Courts from Foreign Manipulation Act of 2023” (S.2805) at the federal level, and a range of legislation at the state level requiring funding disclosure or prohibiting various forms of foreign investment.
Counterarguments from TPLF Proponents
Supporters of litigation financing dispute the claim that the practice leads to frivolous lawsuits, arguing that litigation financers invest only in meritorious cases and profit only when cases are upheld on appeal. They further argue that the majority of investors are domestic, not foreign, and that the proposed tax would unfairly penalize all investors. The ultimate result would be a chilling effect that would weaken America competitively.
As explained by the Inventors Defense Alliance in opposing S.1821, small inventors (many of whom are life science startups) utilize TPLF as a means to protect their intellectual property. According to the Alliance, large companies, particularly big tech firms, engage in a practice often referred to as “efficient infringement.” This practice entails large companies appropriating smaller rivals’ technology and then using their deep pockets to drag out patent infringement suits until the smaller innovators run out of resources. TPLF proponents claim that only recently have smaller innovators evened the playing field by partnering with litigation financiers who front the cost of the lawsuits in exchange for a share of any winnings. In opposing the legislation, the Alliance concludes:
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This massive tax hike will chill innovation, harm institutional investors, and make it harder for American businesses to protect their intellectual property rights. If lawmakers want to discourage frivolous lawsuits, they ought to reform the tort system directly — not deprive inventors of the funding needed to defend their intellectual property from deep-pocketed corporate infringers.
The Path Forward
Although the litigation financing tax proposal was ultimately not enacted into law, the controversy over litigation financing is far from over. Key questions remain. Should taxation be used to deter frivolous lawsuits, including those claiming personal injury from life science products? Can it protect the legal system from foreign influence?
TPLF advocates suggest more balanced reforms, such as requiring disclosure of financing arrangements to the courts under seal to balance transparency with protection of sensitive and confidential information while maintaining access to funding for small innovators.
As Congress and state legislatures continue to evaluate the role of litigation financing, they must balance the need for tort reform against the imperative to safeguard intellectual property rights and foster innovation, especially in sectors like life sciences where legal protection is often vital to survival.
Authored by: Authored by: Phillip Skaggs, JD, CPCU, ARC, Berkley Life Sciences, VP, Chief Legal & Regulatory Affairs Officer