There were two separate cases brought challenging the flat deduction cap. In each, the taxpayers argued that the Nextel decision clearly meant that the NLC flat deduction violated the Pennsylvania Uniformity Clause.
In Nextel the Pennsylvania Supreme Court held that, as applied to a 2007 Pennsylvania corporate net income taxpayer, the:
- statutory limitation on the NLC deduction violated the state’s constitutional uniformity provision; and
- $3 million flat deduction had to be severed from the tax code.
The decision was appealed to the U.S. Supreme Court, but it declined to hear the case.
After the Nextel decision, Pennsylvania issued a corporation tax bulletin informing taxpayers that only the percentage cap would apply after 2016.
A second bulletin was issued informing taxpayers that they could calculate their 2007 through 2016 NOL using the greater of the:
- flat dollar cap; or
- the percentage cap.
The taxpayer argued, it and 133 other corporations, had their NLC deduction limited by the flat cap in 2001. Without the cap, the taxpayers could have applied their full carryover net losses to reduce taxable income to zero.
The taxpayer and Pennsylvania agreed that applying the Nextel decision meant the NLC flat deduction cap violated the Pennsylvania Uniformity Clause. That meant the court had to sever the deduction.
Severability of the Cap
There were two severability options available to the court:
- sever the flat $2 million deduction from the remainder of the law allowing corporations to claim an unlimited net loss; or
- strike down the entire NLC, disallowing any NLC.
Severing the flat-dollar limitation was the remedy that satisfied the due process, equal protection and remedies clause.
If the cap was severed, Pennsylvania argued that the taxpayer should not be able to seek a refund. The state argued that applying the Chevron Oil Company v. Huson, 404 U.S. 97 (1971) test precluded retroactive application of the decision.
In Chevron, the U.S. Supreme Court fashioned a three-factor test to determine if relief should apply retroactively or only prospectively. The three factors examine:
- whether the decision establishes a new principle of law;
- whether retroactive application of the decision will further the operation of the decision; and
- the relevant equities.
The court reasoned that in Nextel:
- the Pennsylvania Supreme Court did not apply a new principle of law;
- retroactive application of the decision furthered the operation of the decision; and
- Pennsylvania did not present evidence showing that refunds would impair its financial health.
Thus, Chevron did not prohibit the retroactive application of a remedy. The court applied the reasoning from the decision to the second case as well. Both cases were remanded to recalculate the taxpayer’s corporate net income tax without capping the taxpayer’s NLCs.
By Andrew Soubel, J.D.