Maryland’s Digital Ad Tax Suffers Emphatic Defeat in Tax Court
Even before Maryland took the plunge with the nation’s first attempt to impose a special, discriminatory tax on digital advertising, NTUF was warning that it would not survive the legal process. Throughout the protracted tour of the state and federal court system that this doomed tax has been on, NTUF has noted that it rather obviously violates the federal Internet Tax Freedom Act (ITFA), as well as the dormant Commerce and Due Process Clauses of the U.S. Constitution.
Imagine our surprise, therefore, when last week the Maryland Tax Court struck down the tax under . . . ITFA, the dormant Commerce Clause, and the Due Process Clause. In a decision covering cases brought by Apple, Peacock, and Google, the court held that Maryland must refund the taxes collected, with interest.
The tax at issue was a gross receipts tax on the sale of digital advertising services, passed over then-Governor Larry Hogan’s veto in 2021. It applied to all sales of digital advertising services to Maryland customers, with rates ranging from 2.5% to 10% depending on global digital advertising revenue.
It didn’t take a lawyer to see that this tax wouldn’t stand up in court. ITFA, which expressly prohibits states from imposing taxes that discriminate against digital products, was the most obvious stumbling block. In other words, ITFA says that states cannot tax digital goods differently from traditional counterparts. The Maryland tax applied to digital advertising services, while traditional advertising (i.e. billboards) was exempt. It doesn’t get much more straightforwardly discriminatory than that.
But Maryland’s lawyers faced an uphill battle on other issues, as well. The dormant Commerce Clause prohibits states from taxing income that is not “fairly apportioned” to the taxing state, but two businesses with the same amount of activity in Maryland faced significantly different tax rates depending on their level of activity outside Maryland—a wrinkle clearly intended to maximize tax rates on businesses based in other states or countries. The court ruled that this same flaw violated the taxpayers’ due process rights.
Maryland is likely to appeal the ruling, but it faces even more of an uphill battle to overturn what was a clear ruling in favor of the plaintiffs. And should this ruling stand, Maryland will have no one to blame but itself for the budget problems it faces when it has to refund all its ill-gotten gains with interest.
A Clear Sign for Other States
Most states considering similar digital advertising tax legislation have watched developments in this case carefully before following suit. But a few haven’t bothered to wait.
The most recent example of this is Illinois, which passed a new digital advertising tax (along with taxes on nearly everything else internet-based) a couple of months back. Utah and Washington have also passed similar taxes into law in recent years.
Each of these states taxes digital advertising while exempting traditional advertising. Utah and Washington each attempted to pretend to be doing otherwise (Washington by applying the tax to all forms of advertising, then specifically exempting specific forms of advertising; Utah by defining “advertising” in such a way as to apply exclusively to digital advertising), while Illinois hardly bothered.
Last week’s decision should be a warning that there’s not One Simple TrickTM that will let states avoid legal consequences for invalid taxes. Not only did the court affirm ITFA’s validity and leave little space for wiggle room, but it also demonstrated that limboing past ITFA will not be enough to save a tax that targets out-of-state businesses.
States that have considered going down a similar path should keep this in mind. It’s a huge waste of taxpayer dollars to pass, enforce, administer, and litigate a tax that most observers knew the whole time would never be allowed to stand.