PA Net Loss Carryover Deduction Unconstitutional

The Pennsylvania Supreme Court held that, as it was applied in 2007 to a 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 severe 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 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.

For 2007, the amount of the NLC deduction was limited to the greater of 12.5% of the taxpayer’s taxable income or $3 million. As a result, 98.8% of taxpayers in a positive net loss carryover position under the limitation paid no tax because of the $3 million alternative cap, while taxpayers who had taxable net income of over $3 million had to pay a tax. The only factor that distinguished the two classes of taxpayers that were created by the NLC provision during 2007 was the amount of their taxable income.

The lower court found that in the exercise of its taxing power, the General Assembly favored taxpayers whose taxable income was valued at $3 million or less. The department appealed, arguing that the NLC did not violate the Uniformity Clause by capping the amount of the net loss deduction based on income and that, if it did violate the Uniformity Clause, severance of the $3 million flat deduction cap was the appropriate remedy.

Uniformity Clause

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 the 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:

  • sever the flat $3 million deduction from the remainder of the NLC;
  • 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
  • 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.

Nextel Communications of the Mid-Atlantic, Inc. v. Commonwealth of Pennsylvania, Pennsylvania Supreme Court, No. 6 EAP 2016, October 18, 2017, ¶204-605

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All stories by: CCHTaxGroup