Net Operating Losses

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How Improving PA’s Treatment of Net Operating Losses
Will Attract Investment, Jobs

Net Operating Loss (NOL) carryforward is a tax provision that allows businesses having losses in a taxable year to carry those losses forward and deduct them from future years’ profits.

The ability to carry losses forward particularly benefits two types of businesses, both of which are critical to our economy:

  • Start-up firms (including those in technology or biosciences) often experience significant losses in early years that could be reinvested by reducing future tax liabilities if they become profitable.
  • Employers that operate in cyclical business cycles, such as manufacturers in the commodity markets like metals, chemicals, or pulp and paper, where profits and losses can fluctuate greatly. 

How Pennsylvania Compares

Pennsylvania currently caps a business’s NOL carryforward deduction at 40 percent of taxable income. We are one of only two states that cap NOL deductions below the federal limit of 80 percent of taxable income. There are 18 states that align with the federal rules, while 24 states have no deduction cap at all. Six states do not have a corporate net income tax.

Which State Would You Choose?

Consider a hypothetical start-up company that has a choice to do business in Pennsylvania or in another state that has the same tax rates as Pennsylvania. In its first year of operation (2023), the Company had significant start-up costs and recorded a $50 million loss. Once the business started generating sales, they earned a $75 million profit in 2024.

Under Pennsylvania’s uncompetitive NOL rules, the company is limited to reducing their taxable liability in 2024 to 40 percent of their taxable income ($75M x 40% = $30M).  Unable to deduct the full amount of losses carried forward from the previous year, they end up paying $3.82 million in taxes, an effective tax rate of 15.28 percent!

In the other state, the company can deduct up to 80 percent of taxable income ($75 x 80% = $60). Because this amount is greater than the $50 million loss carried forward from the previous year, the company can deduct the full $50 million loss. This results in a total tax liability of $2.12 million, or an effective tax rate of 8.49 percent.

If you had the option between two states to start a company, would you choose Pennsylvania where you will pay $1.7 million more in taxes and an effective tax rate that is 80 percent higher?

Improving our Tax Climate

NOL deductions promote a fair tax system by reducing additional tax burdens on entrepreneurial risk, cyclical businesses, or those more susceptible to economic downturns. Pennsylvania is a national outlier in its harsh treatment of losses. Fixing this flaw will promote future growth, provide more stability as businesses make long-term investment and hiring decisions and make Pennsylvania more attractive to employers and entrepreneurs.

 

What Employers Are Saying

 

“Astrobotic is proud to be a Pennsylvania Company leading America back to the Moon but is deeply concerned about PA’s uncompetitive tax environment.  As we go heads-up against other space companies around the country, it is painful to see significant funding be siphoned away from our research and development projects to pay higher than usual state taxes.  Space is a capital-itensive industry that requires long-term re-investment.  High [business] taxes are preventing us from hiring more workers, and ultimately causing us to face headwinds that our competitors are not.”

 

“Since 2017, Cannon Boiler Works has paid over six and a half times the amount of state corporate income tax as they have federal corporate income tax, due to Pennsylvania’s low cap on Net Operating Loss deductions.  The company experienced considerable losses in 2020 and 2021, which will take longer to recover at a 40% cap on Net Operating Loss deductions.”

 

“Because Pennsylvania caps Net Operating Losses (NOLs) at 40%, companies are forced to pay exponentially higher effective tax rates more rapidly and are unable to recoup initial outlays and investments in a timely manner.  If Pennsylvania’s NOL cap was increased to 80% or consistent with the federal limit, [our subsidiary] would be able to recover its investments more quickly, continue funding innovation for new product offerings, and increase job growth, all of which would benefit Pennsylvania.”

 

“Pennsylvania’s current statutory NOL limitation is the most stringent in the United States.  Many states have no limitation and other states allow an 80% NOL deduction in comparison to Pennsylvania’s 40% NOL deduction.  If the limitation was amended or rescinded, O-I Glass Inc. would be able to take the funds allocated for the additional Pennsylvania income tax burden and reinvest in new technologies, recycling infrastructure and new machinery & equipment that would help secure the long-term viability of O-I’s manufacturing facilities here in the Commonwealth.”

 

“As an emerging company currently based in Canada, Flashfood may search in the future for an ideal state in which to relocate our business headquarters.  Unfortunately, Pennsylvania’s tax structure makes it unlikely to be a serious candidate for us.  By capping carryforward deductions at half the federal rate, Pennsylvania has effectively implemented a tax on startups that is nonexistent in 48 other states.  The Commonwealth’s harsh treatment of NOLs remains a deterrent keeping companies like ours from making their home in Pennsylvania.”