How Does the Pennsylvania NOL Limitation Work?

A net operating loss (NOL) happens when a company’s deductible expenses for tax purposes exceed its revenues in a given tax year. This results in negative taxable income, and the loss can be used as a deduction in subsequent, profitable years.

The ability to use an NOL allows a business to lower its taxable income in a future year. This mechanism helps to average out a company’s tax liability over time, acknowledging the cyclical nature of business. Pennsylvania permits this practice but imposes its own specific set of rules and limitations on how businesses can utilize these losses.

The Pennsylvania NOL Deduction Cap

Pennsylvania imposes a limit on the amount of net operating loss that a corporation can use to offset its income in a single tax year. For losses generated in tax years beginning before January 1, 2025, the deduction is capped at 40% of the company’s taxable income for the year.

Recent legislation introduced a change for future losses. For NOLs generated in tax years starting after December 31, 2024, the cap will increase incrementally. The previous 40% limitation will still apply to any NOLs that were generated in years prior to 2025.

The new cap will be phased in over several years as follows:

• For tax years beginning in 2025, the deduction is limited to 40% of taxable income.
• The cap will then increase to 50% in 2026.
• The cap will then increase to 60% in 2027.
• The cap will then increase to 70% in 2028.
• The cap will be permanently set at 80% for tax years beginning in 2029 and beyond.

Calculating the Allowable NOL Deduction

The method for calculating the maximum NOL deduction depends on when the losses were generated. If a company only uses losses from before 2025 or only from after 2024, the calculation is straightforward. However, if a company uses losses from both periods, the 40% cap is applied to the pre-2025 losses, while the new, higher cap applies to post-2024 losses, with the total combined deduction not exceeding the overall percentage limit for that tax year.

For example, consider a company with $500,000 in Pennsylvania taxable income for the 2025 tax year. The company has $800,000 in NOLs carried forward from a loss incurred in 2023. Since the loss was generated before 2025, the 40% cap applies. The calculation is $500,000 (taxable income) multiplied by 40% (NOL cap), which equals $200,000. The company can deduct $200,000 of its NOL, reducing its final taxable income to $300,000.

The starting point for this calculation is the “Pennsylvania Taxable Income before the NOL deduction,” a specific figure on the PA Corporate Tax Return (Form RCT-101). The remaining unused NOL from the example, which is $600,000, is not lost. This balance can be carried forward to subsequent tax years to offset future income.

NOL Carryforward and Application

After determining the amount of net operating loss that can be used in the current year, any remaining NOL is carried forward to future tax years. Pennsylvania law allows businesses to carry these losses forward for a period of 20 years from the year the loss was incurred. This provides a substantial period for a company to generate sufficient profits to absorb the losses.

The income-based percentage cap applies specifically to C-Corporations filing the Corporate Net Income Tax return. For pass-through entities, such as S-Corporations and Partnerships, the financial outcome is different. The net loss is not deducted at the company level but is instead passed through to the individual owners or partners, who report it on their personal income tax returns, where separate individual tax rules apply.