Hedge-fund winnings from courtroom bets aren’t capital gains

You can bet on the Super Bowl, wager on a presidential primary, or put serious money on whether the Fed cuts in June. The IRS taxes those winnings the same way it taxes your paycheck: ordinary income, withheld at the top end. But when a hedge fund stakes $20 million on a mass tort and walks away with $200 million, somehow the IRS is supposed to treat it like a lucrative investment into an early Silicon Valley unicorn.

That is the tax loophole quietly powering a $13.5 billion industry called third-party litigation finance, or TPLF. Outside money fronts plaintiff lawyers in exchange for a cut of any settlement. It is the closest thing modern American finance has to legalized betting on a public courthouse. Worse yet, Washington still treats the funder’s cut as a capital gain rather than what it is: a wager. That distinction matters.

Closing that loophole was supposed to be in Trump’s One Big Beautiful Bill last year. A version was. Then trial-lawyer lobbyists started donning MAGA hats — months after writing checks to the other team — and the Senate parliamentarian pulled the plug on a procedural technicality. The merits of the argument never lost. The Byrd rule did.

Now US Sen. Thom Tillis, R-NC, is back with the Tackling Predatory Litigation Funding Act, which does the obvious and necessary thing: It taxes the funder’s slice of the settlement as ordinary income at the highest rate. No more pretending the hedge fund that bought a piece of someone else’s lawsuit is a patient venture capitalist nurturing a startup. California US Rep. Darrell Issa’s Litigation Transparency Act (HR 1109) does parallel work in the courtroom, requiring disclosure of who is bankrolling federal cases. Both bills should ride whatever moving vehicle the GOP majority can find in this Congress.

North Carolinians will know this well. Camp Lejeune — the Marine base in Jacksonville where toxic water sickened hundreds of thousands of veterans and their families over three decades — became one of Wall Street’s favorite courthouse bets. Litigation funders committed nearly $2 billion to the law firms filing those claims, with at least one-third of all cases backed by outside investors. When those settlements finally land, the funders will pocket a cut of a veteran’s compensation and book it as a capital gain.

For everyday Americans, this is an affordability story before it is a tax story. A new Perryman Group analysis commissioned by Citizens Against Lawsuit Abuse pegs TPLF’s drag on the US economy at $54 billion a year in lost output, more than 454,000 lost jobs, $15 billion in lost tax revenue, and a hidden cost of more than $607 per American family. That bill does not fall on Wall Street. It falls on the price of insurance, a prescription, a contractor’s quote, and a used pickup. Every dollar that flows through a TPLF-stoked mass tort gets baked into what consumers pay at the register.

This is America. It is a free country. People should be able to take bets on prediction markets, on sports, or on the over-under for a presidential pardon. I’m game for it. But there is a difference between betting on a game and betting on a verdict, and there is a difference between buying equity in a company and buying equity in a lawsuit. The first is investing. The second is speculation against the civil justice system. It deserves to be taxed like the gambling income it functionally is, not structured like a convertible note created on Wall Street.

The critics of Tillis’ tax reform argue that litigation finance is the last line of defense against “woke” corporations, and have hammered the outgoing senator. It is a red herring, and not a clever one. 

The funders’ actual book of business is climate lawfare bankrolled by the Soros Economic Development Fund through Aristata Capital, ESG-flavored mass torts financed out of Australia, and foreign IP ambushes like the Shenzhen-tied Purplevine IP outfit that quietly underwrote patent suits against Samsung. The real check on a company you do not like has always been the same — do not buy its product, sell its stock, vote with your wallet. It is not, and has never been, a Cayman-parked hedge fund silently underwriting a no-name plaintiff in Delaware.

Trump’s agenda does not grow lawfare. It’s supposed to smother it entirely. The president has been clear about ending the abuse of the courts as a political cudgel, and TPLF, with its foreign funders, its taste for sprawling class actions, and its industrial-scale settlement machine, is precisely the lawfare engine he campaigned against. Letting that engine keep running on a tax loophole is an unforced error.

Americans are free to gamble on just about anything. They are not free to dodge the IRS for it. The hedge funds betting on America’s courtrooms should not be either.

Published in Carolina Journal (archive #1, #2)