New Pending Rules for Corporate Net Loss Carryover Deductions in Pennsylvania

December 18, 2017
Aaron S. Marines

The Pennsylvania Supreme Court and General Assembly have created new rules on the amount of net loss carryover (NLC) a corporation can deduct.  This is an interesting instance where the Pennsylvania General Assembly has drafted a law trying to predict the Pennsylvania Supreme Court’s decision in the Nextel Communications case.  The General Assembly correctly predicted the outcome of the case, and so the new NLC provisions will become part of the new law.

The question is how much of a corporation’s loss may be carried over from prior years as a deduction against taxable income.  At the time of the case, the Pennsylvania Revenue Code provided that a corporation could carry over losses as deductions equal to the greater of 12.5%  of the corporation’s taxable income or $3 million (now those limits are $5 million or 30% of net income).  This produced a result where corporations with less than $3 million in net income could deduct all of their losses up to that $3 million cap.  Corporations with net income over $3 million could only deduct 12.5% of their net operating loss. The effect is that many corporations with income under $3 million paid no corporate taxes, while bigger corporations paid quite a bit.  The Supreme Court’s decision stated that 98.8% of Pennsylvania corporations did not pay Pennsylvania corporate income tax.  The Court decided that this was unconstitutional, as a violation of the Uniformity Clause that requires all taxes on the same class of subjects to be uniform. 

The practical and interesting part of the case comes from the remedy applied by the Pennsylvania Supreme Court.  The Court decided it would simply eliminate or “sever” the flat dollar figure — $5 million today — cap.  As a result, the effect of the ruling in Nextel Communications would be that all Pennsylvania corporations today would be limited to a net loss carryover of 30% of their taxable income.  This would have a huge effect on Pennsylvania corporations.  Now those 98.8% of corporations with taxable income under the flat dollar amount  would be greatly limited on the amount of prior years’ losses they could deduct.  This would be a huge shift in Pennsylvania tax policy and would affect a great number of small corporations.

The Pennsylvania General Assembly tried to get in front of this. House Bill 542  provides that, if the Pennsylvania Supreme Court ruled the net loss deduction unconstitutional – which it did — then new percentage rates for NLC would take effect.  HB 542 provides that the NLC deduction will be up to 35% of a corporation’s taxable income for the 2018 tax year, and increasing to 40% of a corporation’s taxable income for 2019 and beyond.  These percentages will be in place regardless of the size of the corporation. In addition, the Pennsylvania Department of Revenue has announced that they will not allow the $5 million figure to be used.  That means for the 2017 tax year, corporations will be limited to a net loss carryover of no more than 30% of their income.

This change in the law means that many small corporations will not be able to deduct carried-forward operating losses from their taxable income.  This could, of course, have further impact on the decisions these businesses make with respect to when to recognize income or losses, when to reinvest into the business, and many other big events. Pennsylvania corporations, especially ones with taxable income under $5 million, should consult with their tax professionals to see how this affects them.

Aaron Marines is an attorney at Russell, Krafft & Gruber, LLP, in Lancaster, Pennsylvania. He received his law degree from Widener University and practices in a variety of areas including Commercial Real EstateLand Use, Land Planning and Zoning matters.