Corporate Close-Up: Pennsylvania Courts Strike New Blow Against Cap on Net Operating Losses


While Pennsylvania continues to face a budget crunch, the state faces another potential shortfall, as the Pennsylvania Commonwealth Court ruled once again in RB Alden Corp. v. Pennsylvania that the state’s cap on the net operating losses (NOLs) that can be claimed as a deduction in a particular taxable year is unconstitutional.

Background Case

The defeat for the state builds on a previous Commonwealth Court ruling in November 2015 that found in favor of the taxpayer. Nextel Communications of the Mid-Atlantic, Inc. v. Pennsylvania ruled that the state’s cap on NOLs violated the uniformity clause of the state’s constitution. For tax years that began in 2007, Pennsylvania had imposed a cap on the amount of net operating losses that any corporate taxpayer was allowed to carry over as a deduction, which was set at the lesser of 12.5 percent of taxable income or $3 million.

Nextel challenged the caps, arguing that they were unconstitutional as unequal treatment of similarly situated taxpayers because taxpayers with taxable income higher than $3 million could not reduce their taxable income to zero. Pennsylvania responded by arguing that there was no violation of the uniformity clause because the same rate applied to the same base for all taxpayers. Even if the cap effectively created some form of nonuniform classification of taxpayers, the caps still satisfied the test of “rough uniformity” because only 1.2 percent of taxpayers were affected in the 2007 tax year, the state said.

The court ruled in favor of the taxpayer, finding that the limitation creates two classes of taxpayers—those with $3 million or less in taxable income who could effectively reduce taxable income to zero, and those with more than $3 million in taxable income who could not. The court’s ruling had far reaching implications in the state, as taxpayers filed protective refund claims for year in which NOLs had been limited by the caps, which currently stand at the lesser of 30 percent of taxable income or $5 million.

Current Case

In RB Alden, the Pennsylvania Commonwealth Court previously ruled in June 2016 that the holding in the Nextel case was not limited to the 2007 tax year or only to taxpayer refund requests and directed the state’s Board of Finance and Revenue to re-determine the taxpayer’s income. Pennsylvania filed exceptions to the decision, arguing that the court was incorrect to use effective tax rates rather than statutory rates to determine uniformity, and further arguing that the caps had a legitimate state purpose in limiting a deduction for budgetary planning purposes that should be sufficient to withstand a uniformity challenge.

In this most recent ruling, the court disagreed with the state’s contentions, again ruling that the caps created separate classes of taxpayers based solely on income, and that Pennsylvania law “clearly provides that the amount of a taxpayer’s income is not a reasonable distinction on which to treat taxpayers differently.” The court further noted that it did not agree with the state’s contention that the nonuniformity stemmed from the NOL carryover deduction itself, not the limitation, stating that the only distinction between a corporate taxpayer entitled to take the deduction to cover all its taxable income for a given year and a taxpayer limited to the capped amount is the taxable income of those taxpayers.

Further, while the state argued that the court should strike the entire NOL carryover deduction, the court explained that its decision was predicated on the limitation to the deduction creating the lack of uniformity rather than the deduction itself and refused, overruling the state’s exceptions.

Why RB Alden Matters

This case is the latest to put more pressure on Pennsylvania as it tries to meet its budgetary needs. As noted by Leslie Pappas in the Bloomberg BNA Daily Tax Report: State (subscription required), currently the Nextel case is under appeal in the state Supreme Court. As the state scrambles to find enough funding for its operations, should the Pennsylvania Supreme Court find in favor of the taxpayers and invalidate the caps, the state would face numerous claims for refunds.

However, as Pappas notes, the state is currently considering legislation that would eliminate the fixed dollar portion of the caps and instead apply only the percentage of income limitation, which would solve the issue of uniformity. While the case remains under consideration by the state Supreme Court, Pennsylvania’s next move under the specter of a budgetary crisis remains to be seen.

Continue the discussion on Bloomberg BNA’s State Tax Group on LinkedIn: Will Pennsylvania’s Supreme Court strike down the caps on NOLs for violating the uniformity requirement of the state’s constitution?

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