Can You Hear Me Now? Nextel Backers Seek to Nix Losses Cap

The Bloomberg BNA Tax Management Weekly State Tax Report filters through current state developments and analyzes those critical to multistate tax planning.

By Leslie A. Pappas

Aug. 23 — Will the wealthiest 1.2 percent of Pennsylvania businesses soon get a new multi-million dollar tax break, or will almost 20,000 smaller businesses in the commonwealth soon see their taxes go up?

Those are the stakes in an appeal now pending before the Pennsylvania Supreme Court over the state's net operating loss (NOL) deduction, according to a deluge of amicus briefs filed in the case ( Nextel Commc'ns of the Mid-Atlantic, Inc. v. Commonwealth, Pa., No. 6 EAP 2016 ).

The filings call on Pennsylvania's highest court to uphold the Commonwealth Court's Nov. 23 decision in Nextel v. Commonwealth that the state's statutory cap on the net loss carryover deduction is unconstitutional. Most of the briefs call for elimination of the cap entirely, arguing that it is unfair, anti-business, and that any other remedy could burden tens of thousands of Pennsylvania taxpayers.

“Pennsylvania is an outlier” in terms of capping net operating losses, Jonathan Liss, a senior director for state and local tax in accounting firm BDO USA LLP's Philadelphia office, told Bloomberg BNA. “There's no other state that has anything like it.”

The Commonwealth Court's en banc panel ruled 7-0 that the state discriminated against Nextel Communications of the Mid-Atlantic, Inc. in 2007 by imposing a $3 million carryover cap on operating losses, because the cap prevented Nextel from reducing its taxable income to zero as thousands of other Pennsylvania taxpayers with prior-year losses were able to do.

Since 2006, Pennsylvania has capped the amount of net operating losses that businesses may apply to their taxable income to either a flat dollar amount or a percentage of income. In 2007, Pennsylvania's law limited the amount of net losses a company could carry over to $3 million or 12.5 percent of income, whichever was larger. The current cap is the larger of $5 million or 30 percent of taxable income.

‘Bad Tax Policy.'

Capping the NOL deduction is simply “bad tax policy,” the Council On State Taxation (COST) argued in its June 24 amicus brief. “By limiting the NOL deduction only for taxpayers with large taxable income, those taxpayers with more income are discouraged from locating or expanding their operations in the Commonwealth,” wrote the Washington, D.C. trade association that promotes equitable and nondiscriminatory state and local taxation. “In the long run, this will reduce jobs and harm the Commonwealth's economy as well as reduce the state's overall tax revenues.”

Nextel argued that Pennsylvania's statute only affects corporations with large amounts of income, and the larger the income, the greater the effect. In 2007, a total of 19,537 corporations in Pennsylvania had net loss carryovers in excess of their 2007 income, Nextel said in its appellate briefs.

The record shows that 19,303 of them had income of $3 million or less, and were thus able to reduce their taxable income to zero. The other 234 corporations—about 1.2 percent of the total—had income over $3 million, and were therefore restricted to the 12.5 percent limitation. The higher the income, the greater the cost: For Nextel, 87.5 percent of its net loss deduction was disallowed.

“There's an innate unfairness in that,” Catie Oryl, staff attorney for COST, told Bloomberg BNA shortly after the COST brief was filed June 24. “There's a lot of other states that have NOL deductions, but none of them cap it like Pennsylvania does.”

Cap Since 2006

There hasn't always been a cap in Pennsylvania, the Institute for Professionals in Taxation, an Atlanta-based professional organization that certifies tax professionals and promotes uniform, equitable taxation, pointed out in its June 23 filing with the court.

Pennsylvania enacted a NOL deduction in 1980 and initially provided for an uncapped deduction, the brief said. “Not until tax years beginning after December 31, 2006 did a percentage-based ‘cap' on net operating losses become a feature of Pennsylvania's Corporate Net Income Tax.”

Pennsylvania and New Hampshire were the only states in 2007 to have caps on net operating loss carryforwards, the institute said. Federal law allows taxpayers to carry net operating losses forward to 20 years, without limitation on amount.

“Far from being a ‘loophole,' the ability to carry forward net operating losses is essential to a fair and equitable income tax system,” the institute argued. “Without the net loss carryover allowance, investment would be discouraged, research and development would be stymied, and businesses would be less apt to take risks.”

What Remedy?

In its November decision, the Commonwealth Court unanimously agreed that the $3 million cap violated the state constitution's uniformity clause because it taxed similarly situated taxpayers differently. The court split 5-2, however, on what to do about it.

The majority ruled that Nextel should be able to ignore the cap, reduce its taxable income to zero in 2007, and get a $3.9 million tax refund. It then called on the state's General Assembly to take action without specifying what the action should be. Two dissenting judges argued that to make things uniform for all taxpayers, Pennsylvania should eliminate the flat dollar cap while keeping the percentage cap.

Pennsylvania continues to maintain that neither cap violates the uniformity clause, and the lower court's decision should be reversed. Should the court disagree, the commonwealth wrote in its brief, “the remedy for any constitutional disparity should be the severing of the dollar cap on the net loss deduction leaving the percentage cap in place.”

‘Draconian' Result

Such a remedy would be “draconian,” the Pennsylvania Chamber of Business and Industry wrote in its June 23 brief, which argued that all caps should be removed. “This would result in a broad based tax increase for all of the PA Chamber's members that currently utilize the flat cap net operating loss deduction and will result in the assessment of thousands of taxpayers.”

In 2007, all of the 19,303 corporations with income of $3 million or less were able to deduct 100 percent of their loses, without limitation, argued the chamber, the largest broad-based business association in Pennsylvania with more than 8,000 members ranging from sole proprietors to Fortune 100 companies. “Therefore, the Commonwealth is advocating this Court essentially disallow 87.5 percent of the losses deducted by the almost twenty thousand corporations that relied on the statute.”

Pennsylvania is advocating “that in order to solve the uniformity violation against one taxpayer (Nextel), the Court should order the assessment of thousands of dollars against 19,303 corporate taxpayers,” the brief continued. “The Court should reject that remedy.”

Wider Impact

The chamber implored the court to think carefully about how to remedy to the problem, especially given the impact that the case would have on others.

Despite the court's attempt to limit the remedy only to Nextel and only for the year 2007, the Nextel case is already being applied in other cases, the brief notes. In RB Alden Corp. v. Commonwealth, the court referenced the Nextel decision to find that the $2 million net operating loss cap in 2016 was also unconstitutional (2016 Weekly State Tax Report 11, 6/17/16).

Getting the remedy correct is essential to improving the business climate in Pennsylvania, Sam Denisco, vice president of government affairs for the chamber, told Bloomberg BNA Aug. 23.

“The issue of the net operating loss has been at the top of our tax advocacy platform forever,” said Denisco, who favors elimination of all caps. “If the Commonwealth were to uncap this, we would be sending a message that Pennsylvania is a business-friendly state.”

The Pennsylvania Business Council, the Greater Philadelphia Chamber of Commerce and the Greater Pittsburgh Chamber of Commerce also filed amicus briefs in the case. The Republican Caucus of the Pennsylvania House of Representatives applied Aug. 22 to file an amicus brief and is awaiting the court's decision.

Kyle O. Sollie of Reed Smith, who represents Nextel, told Bloomberg BNA that the earliest the court will hear oral arguments in the case will be November.

To contact the reporter on this story: Leslie A. Pappas in Philadelphia at

To contact the editor responsible for this story: Ryan Tuck at

For More Information

Text of COST's amicus brief is at

Text of the Institute for Professionals in Taxation's amicus brief is at

Text of the Pennsylvania Chamber of Business and Industry's amicus brief is at

Copyright © 2016 Tax Management Inc. All Rights Reserved.