PA Clarifies Guidance on Corporate Income Tax NOL Deductions

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On May 10, 2018, the Pennsylvania Department of Revenue issued new guidance stating that a corporate taxpayer can calculate its 2007 through 2016 net operating loss (NOL) using the greater of:

  • the flat dollar cap; or
  • the percentage cap.

For tax years before 2007, Pennsylvania applies the flat dollar cap.

The turnabout in the Commonwealth’s position is based upon a relatively recent “pro-taxpayer” Supreme Court decision in the Nextel case. (See synopsis of case below)

Prior Guidance

In October 2017, following the Nextel decision, the Pennsylvania Department of Revenue issued a bulletin 2017-01. However, that bulletin did not address the application of the Nextel decision to years before 2017. It noted only that the Department would revise its forms and procedures to implement the decision of the Court prospectively. It stated that the flat-dollar $5 million cap on the NOL would not be available for taxable years beginning in 2017 and thereafter. And, the NOL limitation of 30% of taxable income will continue to be effective for taxable years beginning in 2017.

New Guidance

In May 2018, the Department provided clarity for corporate taxpayers, issuing bulletin 2018-02. This bulletin notes that the Department will not apply the Nextel decision to taxable years beginning prior to January 1, 2017. The Department will determine the corporate net income tax liability of taxpayers for taxable years beginning after December 31, 2006 through December 31, 2016, by allowing taxpayers the greater of the flat dollar cap or the percentage cap as authorized by statute prior to the issuance of the decision in Nextel.

Further, for taxable years beginning prior to January 1, 2007, the Department will determine the corporate net income tax liability of taxpayers by applying the flat dollar cap as authorized by statute prior to the issuance of the decision in Nextel.

Synopsis of Nextel Case

The Pennsylvania Supreme Court, on October 18, 2017, held that, as it was applied in 2007 to a Pennsylvania corporate net income taxpayer, a statutory limitation on the net loss carryover (NLC) deduction violated the state’s constitutional uniformity provision. Further, the court determined it was required to sever the $3 million flat deduction contained in the statute. The court was hearing an appeal to a lower court decision that found the statutory limitation on the NLC deduction violated the state’s constitutional uniformity provision. The lower court the struck down the flat and percentage based deduction caps and ordered the Department of Revenue to refund $3,938,220 to the taxpayer. The court overturned that direction because it severed the $3 million flat deduction.

The department argued that the lower court incorrectly held that the NLC violated the Uniformity Clause by mistakenly measuring uniformity based on the effective corporate income tax rate rather than the statutory rate. The taxpayer maintained that the NLC violated the Uniformity Clause because it allowed corporations with net loss carryover in excess of their 2007 income to deduct their losses without limitation if they had $3 million or less in taxable income, which reduced their taxable income to $0. However, corporations with over $3 million in taxable where limited in the amount they could deduct. The court noted that the NLC effectively created two classes of taxpayers among corporations. Because the NLC created disparate tax obligations between two classes of similarly situated taxpayers based solely on the value of the property involved — i.e., the amount of each class member’s taxable income — it was, as the Commonwealth Court determined, an arbitrary and unreasonable classification which was prohibited by the Uniformity Clause.

By applying the statutory rules of construction, the court determined that it was required to sever the $3 million flat deduction. The department argued that the $3 million flat deduction should be severed. The taxpayer argued that the only remedy that would leave it in the same position as the other taxpayers, which paid no taxes at all, was the removal of the net loss limitation. The taxpayer reasoned that, if the flat deduction was severed, the only alternative would be to apply the 12.5% limitation to the other taxpayers and to assess them for the amount of tax owed. However, this was not possible because 2007 was outside the 3 year statute of limitations. The court reasoned there were three available options: (1) sever the flat $3 million deduction from the remainder of the NLC; (2) sever both the $3 million and 12.5% deduction caps and allow corporations to claim an unlimited net loss, as the lower court had done; or (3) strike down the entire NLC and, thus, disallow any net loss carryover. The court determined that the legislature’s intent to have the NLC jointly further investment and ensure the state’s financial health by having a capped deduction could best be achieved by severing the $3 million flat deduction from the NLC. The court determined that the lower court’s chosen remedy, striking all caps in the NLC, contravened the legislature’s intent to limit the NLC deduction.

Final Thoughts

The use of net loss carryovers in Pennsylvania changes profoundly with the Nextel decision and the Department’s bulletins. If you have questions or comments regarding your corporation’s use of it net loss carryovers, please contact Bob Grossman or Don Johnston at 412-338-9300.

 

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