Supreme Court of Pennsylvania Holds That the State’s Net Operating Loss Deduction Limitation as Applied is Unconstitutional

December 2017


On October 18, 2017, the Supreme Court of Pennsylvania issued its decision in Nextel Communications of the Mid-Atlantic, Inc. v. Commonwealth, No. 6 EAP 2016 (Pa. Oct.18, 2017).  The Supreme Court affirmed the Commonwealth Court’s holding that the state’s net operating loss deduction (NOLD) limitation as applied to Nextel’s 2007 taxable year violated the Uniformity Clause of the Pennsylvania Constitution.  But, for purposes of a remedy, the Supreme Court only struck the $3 million flat cap limitation and not also the percentage of taxable income limitation.  See the BDO SALT Alert that discusses an earlier Commonwealth Court decision in Nextel.


Nextel reported taxable income of approximately $45 million before the NOLD on its 2007 Pennsylvania Corporate Net Income Tax return.  Nextel had Pennsylvania NOL carryforwards totaling approximately $150 million – the full use of which would have reduced its taxable income to zero.  However, as a result of Pennsylvania’s 2007 NOLD limitation, which limited the use of NOLDs to the greater of $3 million or 12.5 percent of taxable income, Nextel utilized only $5.6 million of its available NOL carryforwards.  As a result, Nextel reported and paid tax of $3.9 million.  Pennsylvania applies a similar NOLD limitation in other taxable years, but with different flat cap and percentage amounts, but only the 2007 NOLD limitation was at issue in Nextel.
Nextel was one of the 1.2 percent of Pennsylvania taxpayers that had NOL carryforwards that exceeded the amount of taxable income for the year and was unable to fully offset income due to the 2007 NOLD limitation.  It had an 8.7 percent effective tax rate for the year, whereas, those taxpayers that were not impacted by the 2007 NOLD limitation and able to fully offset taxable income had a zero percent effective tax rate.

Nextel filed petitions with the Board of Appeals and the Board of Finance and Revenue seeking refund of the tax paid on the basis of a Uniformity Clause violation – a clause in the Pennsylvania Constitution that requires all taxes be uniform upon the same class of subjects.  Each tribunal denied Nextel’s petition on grounds that the NOLD limitation was properly applied as per the statute and that they lacked the authority to consider the constitutional issue raised by Nextel.
On appeal, the Commonwealth Court found that, although all corporate taxpayers were subjected to the same 9.99 percent statutory tax rate, the disparate effective tax rates caused by the application of the 2007 NOLD limitation created two classes of taxpayers distinguished only because of the size of the corporations.  The court dismissed the Commonwealth’s argument that the Uniformity Clause only requires uniformity in the statutory rate applied and “rough” uniformity based on the number of taxpayers negatively impacted by the 2007 NOLD limitation (e.g., only 1.2 percent of taxpayers were impacted).  The court reasoned that the Uniformity Clause prohibits the legislature from treating similarly situated taxpayers differently with no legitimate distinction, and a method or formula for computing tax violates the uniformity requirement where it produces a discriminatory result in operation or effect.
The court thus held that the 2007 NOLD limitation as applied to Nextel violated the Uniformity Clause, concluded that the NOLD limitation as applied to Nextel should be eliminated in its entirety and directed the Department to refund Nextel $3.9 million.  The Department filed an appeal with the Pennsylvania Supreme Court, which the court granted as a matter of right.

The Court’s Analysis
In what appeared to be a slightly more narrow holding than the Commonwealth Court’s, the Supreme Court held that the flat $3 million dollar cap created two classes of taxpayers among corporations that had NOL carryforwards that exceeded their taxable income.  However, the court agreed with the Commonwealth Court that, while the Uniformity Clause does not require absolute equality and perfect uniformity in taxation, if no legitimate distinction exists between the classes subject to differing tax treatment and a substantially unequal tax burden is imposed on similarly-situated taxpayers, the tax violates the Uniformity Clause.  The court reasoned that the only factor that distinguishes between those who paid no tax as a result of the $3 million cap and those that paid some, was the value of the property involved (i.e., the amount of taxable income) – a classification that cannot withstand scrutiny under the Uniformity Clause.  Additionally, the court agreed with Nextel that the number of taxpayers affected has no bearing on whether or not the Uniformity Clause was violated.
With respect to the remedy, the Supreme Court reversed this portion of the Commonwealth Court’s decision, resulting in no refund to Nextel.  The court reasoned that the remedy employed must be consistent with the legislature’s initial intent in enacting the NOLD, as identified by the legislative history of the statute.  The NOLD was initially introduced without a cap in 1980.  Upon finding that the NOLD was significantly deleterious to the state’s budget a few years later, the legislature eliminated the NOLD.  When it was reinstated in 2001, the NOLD included limits in recognition that the state budget could not sustain an unlimited deduction.  In light of this, the court determined that striking the $3 million cap, and upholding the 12.5-percent cap rectified the constitutional violation, while preserving the legislature’s intent.
H.B. 542, Reg. Sess. 2017-2018 (Pa. 2017)
Only 12 days after the Nextel decision, the Pennsylvania Governor signed H.B. 542, which removes the flat cap NOLD limitation and increases the percentage of taxable income limitation.  For taxable years beginning after December 31, 2017, and December 31, 2018, a net operating loss carryforward is limited to 35 percent of taxable income and 40 percent of taxable income, respectively.
Corporation Tax Bulletin 2017-01 (Nov. 16, 2017)
In recently issued Corporation Tax Bulletin 2017-01, the Department stated that the flat-dollar cap would not be applied for taxable years beginning 2017 and after.  The Department does not provide guidance with respect to earlier taxable years, but does note that it is taking steps to provide greater clarity for taxpayers.

BDO Insights

  • The Supreme Court held that the 2007 NOLD limitation was unconstitutional “as applied” to Nextel.  Given that the NOLD limitation as applied to other taxpayers or in other taxable years operates no differently, presumably, if a court were to hear a case for another taxpayer or another year, it would similarly rule.
  • On November 1, 2017, Nextel filed an Application for Reargument with Application for Consolidation with R.B. Alden Corp. v. Commonwealth, 60 MAP 2017 or with Application for Remand to Correct a Factual Error, which the court may grant reargument at its discretion.  If granted, the court may restore the matter to the calendar for argument and the final outcome of this matter and guidance from the Department may be delayed for some time.
  • Taxpayers considering the effect of Nextel and the Pennsylvania NOLD limitation should consult with their financial statement auditor and tax advisor to evaluate and determine the potential financial statement implications under ASC 740, including the impact on current and deferred taxes, uncertain tax benefits, and disclosures.

For more information, please contact one of the following practice leaders: 
West:     Southeast:
Rocky Cummings
Tax Partner
    Scott Smith
Tax Managing Director
Paul McGovern
Tax Managing Director
    Tony Manners
Tax Managing Director

Northeast:     Southwest:
Janet Bernier
Tax Principal
    Tom Smith
Tax Partner
Matthew Dyment
Tax Principal
    Gene Heatly
Tax Managing Director

Central:     Atlantic:
Nick Boegel
Tax Managing Director
    Jonathan Liss
Tax Managing Director
Joe Carr
Tax Partner
    Angela Acosta
Tax Managing Director
Mariano Sori
Tax Partner
Richard Spengler
Tax Managing Director