Taxpayers that are in a positive net operating loss carryover position, but that paid tax in any open year due to the statutory scheme, should file protective refund claims seeking a refund for any overpaid tax.

The Commonwealth Court of Pennsylvania, in its decision Nextel Communications of the Mid-Atlantic, Inc. v. Commonwealth, No. 98 F.R. 2012 (Pa. Commw. Ct. Nov. 23, 2015), determined that the statutory scheme for net operating losses (NOLs) for corporate net income (CNI) taxpayers violates the Uniformity Clause of the Pennsylvania Constitution.


The taxpayer, Nextel Communications of the Mid-Atlantic, Inc., challenged the denial of its refund claims for the 2007 tax year. The NOL provision of the Pennsylvania Tax Reform Code for 2007 limited the NOL deduction for corporate taxpayers to the greater of 12.5 percent of the taxpayer’s income or $3 million.1 Nextel reported taxable income of $45 million for 2007; however, the 12.5 percent limitation only allowed it to use $5.6 million of its $150 million available NOLs on its return. It promptly filed a petition for refund, alleging that the NOL provisions violated the Uniformity Clause.

The Uniformity Clause of the Pennsylvania Constitution provides, in pertinent part, that “[a]ll taxes shall be uniform, upon the same class of subjects, within the territorial limits of the authority levying the tax.”2 Nextel argued that the NOL provisions essentially created a graduated tax system that favored businesses with taxable income of $3 million or less.3 Businesses below this income threshold and in a positive NOL carryover position (those that have NOL carryovers in excess of taxable income in a particular year) would pay no tax, but taxpayers with taxable income of greater than $3 million and in a positive NOL carryover position would owe tax.

According to the stipulation of facts filed in the case, 19,357 taxpayers were in a positive NOL carryover position for 2007; 19,303 had taxable income below $3 million. The remaining 234 taxpayers, or 1.2 percent of the positive NOL carryover taxpayer pool, exceeded this threshold.

The Commonwealth disputed Nextel’s argument that the NOL scheme created an unconstitutional progressive tax system, noting that all taxpayers were uniformly subject to the pre-apportionment rate of 9.99 percent applicable to corporations during 2007. It also argued that Nextel’s effective rate was lower than this statutory rate, that it was able to use more NOLs ($5.6 million) than a smaller taxpayer would have been allowed, and that a smaller taxpayer that was not in a positive NOL carryover position could have paid a higher effective rate than Nextel did. According to the Commonwealth, the Uniformity Clause only requires “rough uniformity” and the NOL provisions were “nearly perfect” and therefore satisfied the rough uniformity requirement. It also argued that any resulting classifications were rationally related to the Commonwealth’s interest in sensible budgetary planning. Paradoxically, the Commonwealth blamed Nextel’s business model, which resulted in many unprofitable years, for preventing Nextel from recouping fully its NOL deductions.

The Commonwealth also argued that Nextel’s inability to use the losses in question during the 2007 tax year did not mean the losses disappeared, noting that the law permits a 20-year NOL carryover. Nextel refuted this argument by noting that many of its losses had expired as a result of the 20-year limitation on the carryover period.

Commonwealth Court’s Opinion

The Commonwealth Court noted that the legislature has wide discretion in matters of taxation and that a taxpayer challenging tax legislation bears a heavy burden. It stated that, while the Uniformity Clause does not require absolute, perfect uniformity and equality, the legislature cannot treat similarly situated taxpayers differently. The court concluded that the $3 million taxable income threshold created by the NOL provisions could not withstand scrutiny under the Uniformity Clause. In rendering its decision, it relied heavily on In re Cope’s Estate, 4 which held that an estate tax provision that exempted a low threshold of property from tax violated the Uniformity Clause. The court held that an arbitrary valuation threshold that exempted some property owners from estate tax was analogous to an arbitrary income threshold that exempted some CNI taxpayers from tax. It specifically dismissed the Commonwealth’s carryover argument by noting, “[a] taxpayer should not have to wait twenty years to get that taxpayer should not have to wait twenty years to get the same deduction that another taxpayer, because of a legislatively-imposed cap based solely on the value of the property to be taxed, can take in Year 1.”

In terms of remedies, the Commonwealth urged the court to strike the NOL provisions in their entirety. The court declined to do so, noting that the challenge to the statute was not a facial challenge, but rather an “as applied” challenge. The court noted that the remediation analysis under the Uniformity Clause is generally the same as under the Equal Protection Clause of the U.S. Constitution.5 It rejected the Commonwealth’s assertion that the remedy was essentially to disallow NOL deductions equally; rather, the appropriate remedy was to refund the excess tax collected from Nextel.6

Pepper Perspective

The mandate for taxpayers that are in a positive NOL carryover position, but that paid tax in any open year due to the NOL provisions in the Tax Reform Code, is clear. These taxpayers should immediately file protective refund claims seeking a refund for any overpaid tax. Taxpayers should also anticipate legislative action that will address the constitutional infirmity in the Tax Reform Code, most likely by striking the absolute dollar limitations in the statute.