There has been a flurry of litigation in recent years involving taxpayer challenges to the constitutionality of Pennsylvania’s statutory cap on net loss carryover (“NOL”) deductions for tax years prior to 2017.  First came the Pennsylvania Supreme Court’s decision in Nextel Communications of the Mid-Atlantic, Inc., 171 A.3d 682 (Pa. 2017), in which the Court ruled that the Commonwealth’s 2007 NOL provision – which limited the NOL deduction to 12.5% of taxable income or $3 million, whichever was greater – violated the Uniformity Clause of the Pennsylvania Constitution.  The flat dollar cap was found to be unconstitutional because one class of corporate taxpayers (those with taxable income of $3 million or less) could employ the NOL deduction to reduce their taxable income (and tax) to zero.  However, corporate taxpayers with income over the NOL dollar cap were entitled to offset only a portion of their taxable income for a given year through the NOL deduction, regardless of the amount of unused losses incurred in prior years that were otherwise available to be carried forward for Corporate Net Income Tax (“CNI”) purposes.  The Court in Nextel remedied the Uniformity Clause violation by severing the flat dollar portion of the NOL cap, but retaining the percentage limitation.  The end result was that Nextel did not receive a refund.

In the most recent litigation development, in General Motors Corporation v. Commonwealth, No. 12 MAP 2020 (Dec. 22, 2021), the Pennsylvania Supreme Court considered an appeal filed by General Motors Corporation challenging the constitutionality of the NOL cap in place for tax year 2001.  Both General Motors and the Commonwealth agreed that the dollar-based cap on NOL deductions for tax year 2001 violated the Uniformity Clause.  However, they disagreed on whether Nextel should be applied retroactively and, if so, on the proper remedy to be applied.  Unlike the 2007 tax year at issue in Nextel, when the NOL cap had both a flat-dollar and a percentage limitation, there was only a flat-dollar cap of $2 million in place during the tax year at issue in General Motors. The Court rejected the Commonwealth’s argument that the Nextel decision should apply only on a prospective basis because it established a new principle of law.  Instead, the Court determined that Nextel “‘steadfastly adhered’ to a century of case law interpreting the Uniformity Clause to invalidate tax ‘classifications based solely upon the quantity or value of the property being taxed.’”  Having concluded that Nextel applies retroactively, the Court had to consider the proper remedy to be applied to cure the constitutional violation.

Since the Court did not have the option of severing the flat dollar cap and leaving the percentage limitation in place, as it did in Nextel, its options for addressing the Uniformity Clause violation in General Motors were limited to severing only the flat-dollar cap, resulting in unlimited NOL deductions for taxpayers, or severing the NOL deduction in its entirety, resulting in no NOL deductions.  The Court concluded that severance of the NOL deduction in its entirety was more consistent with legislative intent, as evidenced by the history of the NOL deduction provision.  Accordingly, the Court reversed the Commonwealth Court’s decision severing only the flat-dollar cap, and instead severed the NOL deduction for the 2001 tax year in its entirety.

Notwithstanding the Court’s decision to strike the NOL deduction for the 2001 tax year, it ultimately awarded relief to General Motors on the basis that the Due Process Clause of the U.S. Constitution requires the Commonwealth to provide “meaningful backward-looking relief” to rectify the inequality suffered by General Motors in comparison to corporate taxpayers that were permitted to use the NOL deduction to offset all of their taxable income for 2001.  It is too late for the Commonwealth to remedy that inequality by assessing corporate taxpayers that previously utilized the 2001 NOL deduction to fully offset their Pennsylvania taxable income.  The Court therefore determined that the only way to equalize the actual tax positions of corporate taxpayers for tax year 2001is to refund the tax paid by General Motors as a result of the cap on its NOL deduction.  The Court affirmed the order of the Commonwealth Court to the extent it remanded the case to the Board of Finance and Revenue to recalculate General Motors’ 2001 CNI without capping its NOL deduction and to issue a refund based upon that recalculation.

The deadline for the Commonwealth to request review of the Pennsylvania Supreme Court’s decision in General Motors by the United States Supreme Court has not yet expired, so it is unclear whether this is a final decision.  In any event, unanswered questions remain that likely will be addressed in future Pennsylvania court decisions.  For example, Pennsylvania’s courts will be tasked with determining whether the Due Process Clause of the U.S. Constitution requires that unlimited NOL deductions be granted to taxpayers with pending appeals for tax years when the NOL cap included both dollar-based and percentage-based limitations.  That precise issue likely will be addressed in Alcatel-Lucent USA Inc. v. Commonwealth, No. 803 F.R. 2017, which involves the 2014 NOL provision.  Like the year at issue in Nextel, the 2014 provision included both a flat dollar cap and a percentage limitation.  The Commonwealth Court issued a decision in September 2021 in Alcatel-Lucent, holding that the Department of Revenue’s policy of applying Nextel only prospectively did not violate the state and Federal constitutions.  The Commonwealth Court also rejected the taxpayer’s arguments that it was entitled to relief under the Due Process Clause of the U.S. Constitution.  The taxpayer filed Exceptions to the Commonwealth Court’s initial decision and briefing on those Exceptions is ongoing.

Based on the rationale of the Pennsylvania Supreme Court’s decision in General Motors, it appears that the Commonwealth Court will be required to reconsider the analysis in its initial decision in Alcatel-Lucent.  First, the Pennsylvania Supreme Court determined in General Motors that Nextel applies retroactively, which is inconsistent with the Commonwealth Court’s initial decision in Alcatel-Lucent.  It remains to be seen whether the courts will determine that the Due Process Clause of the U.S. Constitution requires that Alcatel-Lucent be granted an unlimited NOL deduction for tax year 2014.  However, in General Motors, the Pennsylvania Supreme Court observed in a footnote that “Nextel did not present this Court with a robust due process argument based upon McKesson . . ., as does GM in the case at bar.”  And, Justice Saylor, in a dissenting opinion in General Motors noted that “the majority’s present due process analysis, if applied in Nextel, would seem to require a different result in that matter.”

We will provide additional updates as new developments occur.  If you have questions regarding these cases, please contact Sharon Paxton, Esquire (717-237-5393), or any member of the McNees State and Local Tax team.