Two years ago, the Commonwealth Court sided with corporate taxpayers in Nextel Communications of the Mid-Atlantic, Inc. v. Commonwealth of Pennsylvania, declaring unconstitutional the state’s cap on deductible net operating losses (NOL). Last week, Pennsylvania’s Supreme Court unanimously upheld the lower court’s ruling.
Tax treatment of net operating losses in Pennsylvania
The Nextel case stems from Pennsylvania’s limitation of the use of NOL by corporations. Pennsylvania’s Tax Code allows corporate taxpayers to deduct losses from one year from their state corporate net taxable income over subsequent years.
As one of several states that limits the amount of NOL that businesses are allowed to carry over, Pennsylvania caps NOL at the greater of either $5 million or 30 percent of taxable income. Other examples of state NOL treatment include New Hampshire’s $10 million cap, Utah’s $1 million cap, West Virginia’s $300,000 cap, Idaho’s $100,000 cap and Delaware’s $30,000.
Ruling’s impact and potential legislative fix
Although all nine of the Supreme Court Justices agreed that the limitation or cap on NOL deductions violated the uniformity clause of the Pennsylvania Constitution, the court’s proposed remedy is the cessation of the flat dollar amount cap and the continuation of the percentage cap (which stands at 30 percent since the last update in 2015).
Ultimately, any change to the state tax code must move through the standard legislative process. With 2017-18 Fiscal Year budget negotiations still underway in the Capitol, this could be an opportune time to address the NOL issue and provide some clarity and consistency for business taxpayers.
Around the same time of the Supreme Court Nextel ruling, Pennsylvania’s House of Representatives passed HB 542, its latest version of a revenue plan for the 2017-18 state budget. The bill would remove the NOL cap on dollar amount and would increase the percentage cap to 35 percent for taxable years after December 31, 2017, rising to 40 percent one year later.
HB 542 does not, however, bar the Pennsylvania Department of Revenue (PA DOR) from issuing assessments for open years on C corporations, which benefit from the dollar cap and represent the vast majority of business entities that took advantage of the NOL deduction.
Implications of NOL ruling remain unclear
In the absence of explicit legislative or judicial prohibition on the practice and given its recent uptick in enforcement programs, concerns remain that DOR will revisit C corporations that deducted NOL under the dollar cap amount and begin to assess tax for open years using the percentage of income limitation. This type of action could result in a reduction of the NOL and an increase in the corporate net income tax for any taxpayers who availed themselves of the dollar cap.
The full impact of the Supreme Court’s ruling and the fate of HB 542 at this time is unknown, but RKL’s state and local tax team is closely monitoring this situation as it develops. Readers who have questions or wish to discuss the potential ramifications of the Nextel ruling should contact me at 717.394.5666 or firstname.lastname@example.org.
Contributed by Frank J. Tobias, CGFM, Principal in RKL’s Tax Services Group. He specializes in the area of multi-state planning and compliance, with extensive experience in all areas of Pennsylvania taxation.