Thanks to a recent court ruling, the commonwealth of Pennsylvania could be on the hook for more than $100 million in tax refunds to businesses.
- The ruling came in a case that arose over provisions outlining how companies can use past losses to lower their tax bills.
- Some corporate taxpayers have claimed, successfully, that provisions that have since been dropped violated the state constitution.
- Now, state courts are dealing with how to handle tax payments that were made when those unconstitutional provisions were in effect.
- In the most recent case, decided on Dec. 28, the Commonwealth Court of Pennsylvania said the state must refund about $2 million in corporate net income taxes paid by Alcatel-Lucent, a telecom company based in France.
Why: The answer starts with understanding how companies use old losses to offset their taxes.
- Under current law, companies can deduct past losses – if they have any – to reduce up to 40% of their taxable net income, according to Michael Bannasch, state and local tax practice leader at Lancaster-based accounting and consulting firm RKL LLP.
- Thus, a company with profits of $10 million can deduct up to $4 million in past losses — even if it is carrying more losses than that on its books.
- Under previous versions of the tax code, companies could deduct either a percentage of their income — as in current law — or a flat-dollar amount, whichever was greater.
- Courts, however, ruled that the flat-dollar amount violated the state constitution.
- It allowed some smaller companies to completely avoid taxation, while larger companies could not.
How: In 2014, the year at issue in the Alcatel case, the state allowed a flat dollar deduction was $4 million, according to the court ruling.
- A company that had taxable net income below $4 million could effectively wipe out its tax liability.
- But that was not the situation for Alcatel. The company had taxable net income in 2014 of roughly $27.3 million in Pennsylvania, according to the court ruling.
- Alcatel had to use the percentage formula, enabling it to deduct net losses totaling 25% of its taxable net income, or about $6.8 million, according to the ruling.
- That left the company with income of $20.5 million and a tax bill of just over $2 million.
- At the time, however, Alcatel had enough past losses to completely offset its taxable income, according to the ruling. It was just limited in how much it could use.
- The question for the courts has been how to make it up to Alcatel and other larger companies.
What’s the answer: It has not been ‘go back and collect taxes from companies that didn’t owe any under the flat-dollar provisions deemed unconstitutional.’
- Instead, Pennsylvania courts have ruled in two cases — in Alcatel and another involving General Motors — that the taxpaying companies should get refunds.
- “The taxpayer thinks the court got it right and is anxious for these matters to come to a final resolution,” said Kyle Sollie, a Philadelphia-based partner in the state tax group at law firm Reed Smith.
- Sollie, who represented both Alcatel and GM, declined to comment further.
How is it $100 million: In short, other taxpayers have similar claims pending and thus could also be eligible for refunds.
- Attorneys for the state cited the $100 million-plus figure in a brief they filed in the Alcatel case, noting that an adverse ruling would have “devastating fiscal repercussions.”
- In a 2016 bond disclosure, the state estimated that the potential liability from tax appeals related to net losses ranged from $4 million to $500 million or more.
- A spokesperson for the Pennsylvania Department of Revenue said the agency is reviewing the Dec. 28 decision.
Can it get more complicated: Of course.
- In 2017, before its 2021 decision ordering a refund for GM, the Pennsylvania Supreme Court decided against a roughly $4 million refund in a case involving tech company Nextel.
- The Alcatel case followed the logic of the GM decision, said Richard Botwright, co-chair of the state and local tax group at Reading law firm Stevens & Lee.
- However, the 2014 tax provisions at issue in the Alcatel case are closer to the 2007 provisions at issue in the Nextel case, he said.
- GM was complaining about a 2001 version of the law that contained only a flat-dollar deduction for past losses — and capped the deduction at a certain amount. The company’s tax bill for the year was about $739,000.
- Alcatel and Nextel challenged laws that contained both the flat-dollar deduction and the percentage deduction.
- “These decisions are hard to reconcile,” Botwright said.
What’s next: The state has until late January to appeal the Alcatel decision to the state’s highest court, an outcome that outside attorneys deemed likely.
- “It’s definitely going to be appealed because the dollars are just astronomical,” said Paul R. Morcom, a member and chair of the state and local tax group at Harrisburg law firm McNees Wallace & Nurick.
Do I get a refund: Unless you have filed an appeal, it is too late.
- The legislature eliminated the flat-dollar cap in 2017 and there is a three-year statute of limitations on demanding a refund, attorneys said.
- The refund also applies only to companies that pay the corporate net income tax, not to pass-through entities whose profits are taxed as personal income of their owners.
