Pennsylvania: Court Denies Refund Related to NOL Cap

Listen to a brief overview of state tax developments this week, including Pennsylvania, or read full Pennsylvania development below.

Detailed Pennsylvania Development

The Pennsylvania Commonwealth Court recently rejected a taxpayer’s claim for a refund related to tax paid for the 2014 tax year when the taxpayer’s use of NOLs was limited by the 25 percent NOL cap. For the tax year at issue, NOLs were limited to 25 percent of taxable income or $4 million dollars, whichever amount was greater. As a result, taxpayers with $4 million or less in taxable income were able to use NOLs to offset 100 percent of their income; other taxpayers, like the taxpayer at issue, ended up paying some amount of tax when they applied the 25 percent cap. 

In the 2017 Nextel case, the flat dollar cap, which was $3 million for the tax year at issue (2007), was struck down as violating the state’s Uniformity Clause. The percentage NOL cap was preserved, as it applied uniformly to all taxpayers. Following the decision, the Department applied the holding prospectively. In other words, the Department did not assess taxpayers that had benefitted from the flat dollar cap in pre-2017 tax years; nor did it allow refunds to taxpayers whose use of NOLs was limited by the percentage cap.  In the instant matter, the taxpayer argued that by failing to apply the percentage cap to smaller corporations, the Department violated the Uniformity Clause and the only way to cure the “discriminatory application” of the percentage cap was to treat the taxpayer the same as the corporations that benefitted from a full deduction of their losses. The taxpayer also asserted that the Due Process and Equal Protection Clauses of the U.S. Constitution and the Remedies Clause of the Pennsylvania Constitution entitled it to a remedy.

In a lengthy decision, the Commonwealth Court rejected the taxpayer’s position that the “only suitable remedy” to cure the Department's “discriminatory application” of the percentage cap statute was to provide it a refund. To reach this conclusion, the court first had to determine whether Nextel, which was decided in 2017, applied retroactively or prospectively only. This analysis was guided by the factors set forth in the Chevron decision governing when a judicial decision should be applied retroactively. Those three factors examine: (1) whether the decision establishes a new principle of law; (2) whether retroactive application of the decision will further the operation of the decision; and (3) the relevant equities.  The most significant of those factors—the “weighing of equities”— is intended to evaluate whether retroactive application would produce “substantial inequitable results.” The court concluded that application of the decision retroactively, which would involve assessing thousands of taxpayers that relied on the flat-dollar deduction prior to the Nextel decision, would produce a substantially inequitable result. Because the taxpayer calculated its tax liability for the 2014 tax year applying 2014 law, which was not unconstitutional and was valid, in toto, until 2017, the taxpayer paid the correct amount of tax and was not entitled to a refund. The court further rejected the taxpayer’s other constitutional claims. Please contact Mark Balistrieri with questions on Alcatel-Lucent USA Inc. v. Pennsylvania

This Week's Developments

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Sarah McGahan

Sarah McGahan

Managing Director, State & Local Tax, KPMG US