In October 2017, the Pennsylvania Supreme Court determined that the cap on Pennsylvania’s net loss deduction violated the Uniformity Clause of the Pennsylvania Constitution because it applied only to taxpayers with income greater than $3 million. Yet, that court refused to grant a refund to Nextel. Instead, the court simply articulated a severability analysis, hypothesizing what type of net loss carryover deduction the Pennsylvania legislature would have allowed if it had followed the Uniformity Clause. The court, thus, “sever[ed]…the $3 million flat deduction” from the statute. The court then reasoned that if that if a hypothetical regime in which only the percentage cap had been enacted applied from the beginning, the corporations that had paid zero tax as a result of the flat dollar cap would have paid more – hypothetically – because they would have, instead, been subject to the lower percentage cap. Because Nextel was already subject to the percentage cap, its actual tax was the same as the tax that would have been imposed in this hypothetical scenario.
The problem with this “hypothetical” equalization approach is that the United States Supreme Court has specifically rejected it as being contrary to due process. In McKesson, the state of Florida argued that its legislature “would have” taxed every taxpayer at the same level if it had legislated even-handedly.2 The Supreme Court roundly “rejected this line of reasoning” as “inconsistent with the nature of the State’s due process obligation.”3 Instead, what McKesson requires is “that the tax as actually imposed on petitioner and its competitors during the contested tax period” be equalized.
The Pennsylvania Supreme Court did not address McKesson or due process at all in its opinion, which leaves that as an open question. On this due process question, Nextel filed a petition for a writ of certiorari with the United States Supreme Court on May 3.
Now, the Pennsylvania Department of Revenue has determined that it will not enforce the Pennsylvania Supreme Court’s Nextel opinion for periods prior to 2017 – thus continuing to allow taxpayers to deduct the “greater of the flat dollar cap or the percentage cap as authorized by statute.” Although this determination avoids difficulties for some taxpayers, it, of course, perpetuates the underlying uniformity problem: taxpayers with income greater than $3 million will continue to be subject to a cap on the amount of net loss carryforwards that they can deduct, while those with income of $3 million or less are not subject to the cap. Thus, given that the Department has announced that it will not equalize the position of taxpayers through assessment, the only remaining remedy, consistent with federal due process, is to grant refunds to those taxpayers whose net loss carryover deductions were limited by a cap.