Pennsylvania Supreme Court rules against retroactive application of NOL “cap” remedy

In brief

What happened?

In a 4-3 decision, the Pennsylvania Supreme Court concluded that its 2017 decision in Nextel – that a “cap” on the allowable net loss carryover deduction violated the Pennsylvania Constitution’s Uniformity Clause – should apply only prospectively.  

Four justices joined the majority opinion, with two of them filing concurring opinions. Two justices filed a concurring and dissenting opinion agreeing with the majority on the result, and one justice filed a dissenting opinion.  

[Alcatel-Lucent USA Inc. v. Commonwealth of Pennsylvania, No. J-20-2024, 11/20/24] 

Why is it relevant? 

In reversing the decision of the Commonwealth Court below, the Pennsylvania Supreme Court has determined that there is no due process violation in disallowing relief from the net loss carryover deduction cap for tax years prior to the 2017 Nextel decision. This decision impacts taxpayers with Pennsylvania loss limitations for open years or pending refund claims on this issue.  

Actions to consider 

Since the law was changed in 2017, the decision applies only to years prior to 2017, which generally would be closed under the three-year statute of limitations. Taxpayers amending returns due to a federal audit adjustment should consider applicability of the case. The taxpayer on December 4 requested that the Pennsylvania Supreme Court grant re-argument and order a remand to the Commonwealth Court to allow the parties to further develop the factual record in the case. 

2017 Nextel decision  

In 2017, the Pennsylvania Supreme Court in Nextel Communications of the Mid-Atlantic, Inc. v. Commonwealth of Pennsylvania found that the NLC deduction, as applied to Nextel for the 2007 tax year, violated the Uniformity Clause of the Pennsylvania Constitution. For the 2007 tax year, the NLC deduction was limited to the greater of 12.5% of the taxpayer’s taxable income or $3 million.  

The court concluded that the NLC deduction creates classes of taxpayers according to their taxable income. Taxpayers with taxable income in excess of $3 million could not reduce their corporate net income tax liability to zero, whereas similarly situated taxpayers with $3 million or less in taxable income could reduce their liability to zero.  

The court sought to apply a remedy that it deemed would be most consistent with the legislature’s intent in enacting the NLC. The court determined that striking down the fixed-dollar limitation, while retaining the percentage limitation, would be most consistent with the legislature’s intent to have the NLC balance the twin policy objectives of encouraging investment and maintaining the Commonwealth’s financial health. Click here for our Insight regarding Nextel.  

The Department implemented Nextel prospectively by removing the flat-dollar limitation beginning in 2017 and thereafter. Note that S.B. 654 enacted on July 11, 2024 increases the NLC deduction limitation from its current level of 40% of taxable income to 80% of taxable income by 2029. See PwC’s Insight for more details. 

Pennsylvania Supreme Court applies Nextel prospectively 

In Alcatel-Lucent, the Pennsylvania Supreme Court determined that General Motors was incorrectly decided because it only looked to the first prong of the Due Process inquiry, as to whether the decision established a new principle of law. Rather, the court in General Motors also should have looked at whether retroactive application of the decision would forward the operation of the decision and whether the relevant equities favor prospective application.  

Regarding the first prong of inquiry, the court determined that Nextel presented an issue of first impression. Specifically, the court found that Nextel upset the “dominant view” that corporate income taxes were subject to a “more liberal interpretation” of the Uniformity Clause inquiry than individual income taxes. Further, the court concluded that Nextel was “a novel holding” because the Nextel court held for the first time that fixed caps on deductions fail the uniformity test. 

Regarding the second prong, the court stated: “We do not believe that retroactively applying the holding in Nextel to taxes that were levied prior to the decision is necessary to further the operation of the rule that we announced in Nextel. Indeed, even under a fully retroactive approach, refunds would still only be available to those taxpayers that are within the window for filing—or have already filed—refund petitions with the Department of Revenue. Thus, while there may be inequities associated with prospective-only application of Nextel, such inequities seem inevitable given that the General Assembly consistently has opted to use a capped NLC deduction since 1994.” 

Finally, the court determined that the third prong “requires that we balance the equities, which clearly weigh in favor of prospective-only application of Nextel.” The court reasoned that “retroactive application of our decision in Nextel would require the Commonwealth to pay back millions of dollars in tax revenue that was collected and spent nearly a decade ago, in reliance on case law that this Court has since abandoned.”