PA Commonwealth Court Holds NOL Tax Deduction Cap is Unconstitutional, Creating Potential Refund Opportunities

Ballard Spahr LLP

The Pennsylvania Commonwealth Court unanimously held in a 7-0 decision that Pennsylvania's net operating loss (NOL) cap that limits a corporation's ability to deduct NOL carryforwards for corporate net income tax (CNIT) purposes is unconstitutional.

In Nextel Communications of the Mid-Atlantic, Inc., v. Commonwealth of Pennsylvania, although all seven judges agreed that the NOL cap is unconstitutional, the Court decided 5-2 that Nextel can deduct its full NOL carryforward in its 2007 tax year with no cap, and therefore Nextel is entitled to a refund. This decision creates potential refund opportunities for other taxpayers that could not use all of their NOL carryforwards to offset their CNIT income.

For CNIT purposes, a taxpayer is permitted to carry forward NOLs to offset current CNIT income. But the law caps the amount of NOL carryforwards that a taxpayer may use against its CNIT in any given tax year. For 2007, the cap was the greater of 12.5 percent of a taxpayer's CNIT income or $3 million.[1] In its 2007 tax year, Nextel had over $150 million of NOL carryforwards and $45 million of CNIT income. As a result, its NOL carryforward deduction for 2007 was limited by statute to $5.6 million (12.5 percent of taxable income).

To demonstrate that the NOL cap violates the Uniformity Clause, Nextel had to show both that the cap resulted in some classification—i.e., that similarly situated taxpayers are treated differently—and that the classification is unreasonable and not rationally related to any legitimate state purpose. The Court agreed with Nextel that the cap created classifications of taxpayers according to their taxable income because taxpayers with more than $3 million of CNIT income are treated differently than taxpayers with less than $3 million of taxable income. The Court noted that 98.3 percent of taxpayers with NOL carryforwards were able to reduce their CNIT taxable income to zero, whereas Nextel had to pay tax on almost $40 million of CNIT income even though its NOL carryforwards far exceeded that amount. The Court also found that sound budgetary reasons for imposing the NOL cap do not amount to a sufficient reason for creating this classification and, thus, determined the NOL cap violates the Uniformity Clause of the Pennsylvania Constitution.

The Commonwealth Court's discussion of the appropriate remedy for Nextel is as interesting as its conclusion that the NOL cap is unconstitutional. The Pennsylvania Department of Revenue (DOR) argued that the appropriate remedy was to strike the NOL deduction in its entirety. Alternatively, the two judges who disagreed with the majority's remedy argued that the Court could strike only the $3 million dollar cap, with the result being that only the percentage-based cap would apply to all CNIT taxpayers. But the majority of the Court concluded that the only proper remedy was to put Nextel in the same position as those taxpayers who were able to use their NOL carryforwards to reduce their CNIT taxable income to zero. Thus, the Court struck the NOL caps as they applied to Nextel for its 2007 tax year, permitted Nextel to reduce its CNIT income for 2007 to zero, and ordered the DOR to refund to Nextel almost $4 million of CNIT it paid for its 2007 tax year.

The Court was careful to note that its decision applies only to Nextel for its 2007 tax year because the Court held that the NOL cap is unconstitutional as it applies to Nextel, not on its face. However, the Court acknowledged that its opinion could be far-reaching and suggested that the General Assembly should be guided accordingly.

The Commonwealth is expected to appeal the Nextel decision to the Pennsylvania Supreme Court. Nevertheless, taxpayers that could not deduct all of their NOL carryforwards against their CNIT income because of the statutory cap should consider whether and when to seek refunds for their CNIT tax years that remain open. Under Pennsylvania law, the DOR is not required to process amended CNIT returns. Therefore, a CNIT refund should be claimed by filing a Petition Form with the Department of Revenue Board of Appeals.


[1] The statutory cap has varied and for tax years starting after December 31, 2014, the cap is the greater of 30% of taxable income or $5 million.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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