Pennsylvania’s Net Operating Loss Pitch Hints at Budget Balance

Pennsylvania’s proposal to increase its limit on net operating losses, or NOLs, illustrates how budget status, politics, and other factors impact how a state reconciles the desire to attract businesses through its tax code with the obligation to pass a balanced budget.

Pennsylvania anticipates a $14 billion budget surplus and $7.2 billion rainy day fund. It can therefore propose to cut taxes while still balancing its budget—an enviable position. One way the state has proposed to cut taxes is to increase its current cap on NOLs. State Sen. Greg Rothman (R), the primary sponsor of one of the proposals, has called it a “startup penalty.”

Although a lower tax rate may attract business, it only affects taxpayers with taxable income. Startup companies—as well as mature businesses experiencing downturns—don’t pay tax in the years when their expenses exceed their taxable income and in which they accumulate losses, including NOLs. Startups would find it more attractive to invest when NOL use is less restricted.

Pennsylvania limits NOL use to 40% of current year taxable income. Let’s put that into context by assuming a taxpayer has a $10 million loss in 2024 and $10 million of taxable income for tax years 2025 through 2027.

The table below illustrates that Pennsylvania’s current NOL limitation wouldn’t allow that taxpayer to use all its $10 million of NOLs until 2027.

This table illustrates that current law requires a taxpayer with our hypothetical facts to pay $479,000 of tax in 2025 and $449,000 in 2026 before fully using its NOLs in 2027.

Pennsylvania’s NOL limitation, combined with its declining tax rate, causes this taxpayer to pay more tax, adding insult to the NOL limitation injury. The following table shows that enactment of SB 346, which would increase the limitation to be the same as the federal 80% limitation, would allow the taxpayer to use its NOLs sooner and cause a $169,800 cash tax reduction.

There is bipartisan support to increase Pennsylvania’s NOL limitation to 80% from its current 40%. This presents a stark contrast to California, where the legislature is sending Gov. Gavin Newsom (D) a bill to suspend for three years NOL deductions for businesses with more than $1 million in income. The bill also caps at $5 million business tax credits for 2024, 2025, and 2026.

Several factors could explain the diametrically opposed proposals coming from states on either side of the country. California has a deficit, while Pennsylvania has a multibillion-dollar budget surplus and rainy day fund.

California also has one-party control. By contrast, Pennsylvania Gov. Josh Shapiro is a Democrat, the commonwealth’s House of Representatives is controlled by a one-vote majority of Democrats while its Senate has been controlled by Republicans for 30 years.

Pennsylvania’s balance of power creates a need for compromise when balancing a budget with the desire to attract business. Shapiro is in his first term, and Newsom is in his second (and last) term, though both may have presidential aspirations. In terms of population size, California and Pennsylvania are the largest and fifth-largest states, but both populations have been declining.

Which state has the right answer for the appropriate way to balance its budget? The answer may depend on whether the state is more interested—by choice or necessity—in the longer- or shorter-term impact of its decision.

If Pennsylvania’s plan is enacted, we’ll have to see if it serves its desired purpose of attracting business. That said, common sense dictates that it’s imminently fair to allow a taxpayer to fully and quickly use its NOLs.

This article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.

Author Information

Mike Semes is of counsel at BakerHostetler and professor of practice at Villanova University School of Law’s graduate tax program.

Write for Us: Author Guidelines