Increased NOL Deduction
On July 11, 2024, Governor Josh Shapiro signed a tax bill (S.B. 654) that increased the state’s net operating loss (NOL) deduction (https://tinyurl.com/229d53zy). Under the new law, NOL deductions will be doubled to 80% of corporate taxable income for tax years beginning on or after January 1, 2026.
Pennsylvania previously limited the NOL deduction to 40% of taxable income and was one of only two states to cap the NOL deduction below the federal limit (80% of taxable income). By increasing the cap on NOL deductions, Pennsylvania is trying to become a more attractive location for start-up businesses and businesses with major fluctuations in profits and losses.
For tax years beginning after December 31, 2018, the limitation on the total NOL deduction allowed in any tax year has been 40% of taxable income. Under the recently passed leg-islation, this percentage limitation is increased by 10% each year until it reaches 80%, as follows:
- ▪ 40% for tax years beginning in 2025,
- ▪ 50% for tax years beginning in 2026,
- ▪ 60% for tax years beginning in 2027,
- ▪ 70% for tax years beginning in 2028, and
- ▪ 80% for tax years beginning in 2029 and thereafter.
To account for losses carried forward from prior limitation years, the legislation computes the allowable NOL deduction in each year according to the following method:
- ▪ For a net loss incurred in a tax year beginning prior to January 1, 2025, deduct 40% of taxable income; and
- ▪ For a net loss incurred in a tax year beginning on or after January 1, 2025, deduct the applicable percentage for the tax year specified above, minus “the actual percentage of taxable income deducted” above, multiplied by taxable income for the tax year.
Other Changes
Additional deductions are available for medical cannabis businesses that were disallowed for federal income tax purposes that would otherwise be eligible under IRC section 162 to the extent the business meets the “Medical Cannabis Deduction” definition pursuant to state’s Medical Marijuana Act.
For tax years after January 1, 2023, S.B.654 provides an annual corporate net income tax return election (applicable to C corporations only) to exclude intangible expenses/costs or interest expenses/costs paid to an affiliate when determining the affiliate’s Pennsylvania taxable income. In such a case, the payor “shall not be entitled to receive any credit” under the “subject to tax” exception to the state’s related party addback rule. The election must be made by the affiliated entity with the filing of its original return. The legislation provides that this election does not “otherwise impact nexus or apportionment of the taxpayer or the affiliated entity.” While the election could result in a significant reduction of intangible or interest income for the affiliate, it will not impact that affiliate’s Pennsylvania apportionment or nexus determination under the state’s bright-line test.
The Pennsylvania legislation represents some significant changes that will impact corporate taxpayers doing business in Pennsylvania. CPAs should review the Pennsylvania law changes and consider the implications on affected businesses.
