Don’t weaponize the tax code against the litigation finance industry

OPINION:

Senate Republicans are about to make it harder for ordinary Americans to hold big business, bureaucrats and even terrorists accountable in court.

Sen. Thom Tillis, North Carolina Republican, wants his colleagues to weaponize the tax code to hobble the litigation finance industry, which helps individuals and small businesses bring strong legal claims. Earlier this month, he sneaked into the One Big Beautiful Bill Act a staggering tax hike that exposes funders to punitive tax rates of 41% or more.

Mr. Tillis is making an extraordinary bid to prevent ordinary citizens from challenging powerful interests in court. Just as troubling, he is creating a dangerous precedent for how lawmakers, including tomorrow’s Democratic majorities, can use punishing tax hikes to kill whatever industry they don’t like.

When the Obama IRS illegally targeted tea party groups for special scrutiny when they applied for tax-exempt status, a third-party funder helped those groups successfully sue the IRS.

When Hamas and other terrorists killed American soldiers and citizens, third-party funders helped the victims’ families seek justice.

When Big Tech companies steal from innovative small businesses, such as when Facebook allegedly stole trade secrets from a tiny company called Neural Magic, litigation funders help those small businesses hold megacorporations accountable.

If Mr. Tillis has his way, cases like these may no longer be possible.

Mr. Tillis is delivering a big favor to the big businesses backing him and a punishing blow to ordinary American voters.

Litigation is very expensive, especially if you have been wronged by a major company or the government. Most Americans don’t have millions of dollars to finance these cases themselves. If they can’t ask someone else for financial help, wrongdoers will escape accountability.

Litigation funders restore balance to this tilted playing field. They provide money to individuals and small businesses to pursue strong claims against well-funded opponents. Funders don’t control litigation, and they are repaid only if the case wins.

Kill litigation finance, and justice becomes a luxury available only to the wealthy.

Fortunately, many conservatives recognize there’s nothing conservative about the tax hike and vocally oppose Mr. Tillis’ proposal.

The Tillis tax tries to destroy funding through several features that flout long-standing principles of American tax policy. It creates a blueprint for Washington lawmakers to destroy any industry they dislike.

First, the bill’s 41% punitive minimum tax on litigation finance is substantially higher than the capital gains rates applied to comparable investments.

Second, the bill contains several provisions that further increase the effective tax rate and try to make litigation finance unsustainable. The bill prohibits funders from offsetting gains and losses, which is essentially unheard of. The tax applies at the entity level, eliminating pass-through tax treatment, taxing tax-exempt investors and risking double taxation. It also imposes onerous withholding obligations on lawyers.

This abuse of the tax code to kill an industry is seemingly unprecedented in the annals of American tax law, and the rationales for the bill do not withstand scrutiny.

Mr. Tillis says he is concerned that foreign entities are profiting from U.S. litigation, but his bill taxes U.S. and foreign funders indiscriminately, exposing his justification as a pretext.

Others claim that litigation funders prolong litigation and interfere with the attorney-client relationship, but the evidence shows that funding more likely reduces overall litigation and strengthens the attorney-client relationship.

Even if you’re not passionate about litigation finance, you should care about the precedent the Tillis tax would set.

If Washington lawmakers can abuse the tax code to tax the litigation finance industry into oblivion, who will they come for next?

• William C. Marra is a director at Certum Group, a litigation finance company, and a lecturer in law at the University of Pennsylvania Carey Law School, where he teaches a course on litigation funding. He previously clerked for Justice Samuel A. Alito Jr. on the U.S. Supreme Court.