The Future of Digital Advertising Taxes Amidst Court Challenges

Although digital products and services have been around for decades, states are still playing catch up on how (or if) sales tax may apply. One area of interest in this new frontier of sales tax is the revenue that websites, social media companies, and others receive from selling advertising space on their digital platforms. Maryland became the first state to enact this type of tax through HB 732 (amended in 2021 through SB 787).

However, two separate lawsuits – Comcast et al. v. Comptrollerand U.S. Chamber of Commerce et al. v. Franchot– seek to void Maryland’s digital advertising tax as unconstitutional and in violation of federal law. The outcome of this litigation is likely to have a great impact on the future of similar digital taxes and that is why we want to explain in more detail below what these taxes are and where the litigation in Maryland currently stands. We also recap what other states are planning in the realm of digital advertising service taxes to help prepare the businesses this new tax regime may impact.

An Explanation of Digital Advertising Taxes

Digital advertising taxes are a tax on the gross receipts that a company receives from selling advertising space to other businesses on their platforms. For example, the ads you might find on a webpage or the ads you scroll past while on your favorite social media app. The rationale behind the tax is simple. States want to capture the massive revenue from companies that don’t necessarily have a physical location in the state but affect local commerce and politics through interactions with constituents over the internet.

These new regimes are effectively a tax on large tech companies that leverage the power of their user data to garner advertising interest from other businesses and organizations. Maryland’s enacted HB 732, for instance, only places reporting obligations on entities with $1 million or more in Maryland digital ad revenue per year and limits tax obligations to only those with $100 million or more in global annual gross revenue. Some of these bills, like Maryland’s, establish a unique tax as opposed to others that simply incorporate gross receipts from digital advertising into existing sales tax laws.

Are Digital Advertising Taxes the Same as a Social Media Tax or a Data Mining Tax?

Digital ad tax proposals in other states closely resemble Maryland’s enacted law but also contain twists on how tax applies, which is giving rise to other terms such as a social media tax or a data mining tax. With a social media tax, the key difference is that the number of account holders a social media company has will determine tax liability. For example, see Arkansas’ SB 558, which would add a $1 tax for the average number of Arkansas account holders that exist during a calendar year if enacted.

A data mining tax is another proposal that would place an excise or severance tax on companies (i.e., data collectors) that collect consumer data. Like the social media tax, the data mining excise tax would apply based on the number of consumers a company collected data from such as a name, email address, phone number, etc. To illustrate, New York’s proposed SB 4959 – at its highest rate – would impose a 50 cents per consumer tax and would apply to companies that collect data on over 10 million New York consumers as part of their business activities.

Why Are Internet Companies and Others Challenging Digital Ad Taxes?

The validity of digital advertising service taxes has been in question over issues of constitutionality in addition to conflict with other federal and state laws. The complaint against Maryland’s digital ad tax in the U.S. Chamber of Commerce et al. v. Franchot alleges that the law violates the U.S. commerce clause because it burdens out of state conduct. The lawsuit also claims the Internet Tax Freedom Act, which prohibits states from imposing discriminatory taxes on electronic commerce, preempts the digital ad tax.

Legality aside, these taxes also raise questions over the practicality of enforcement and how a company must show compliance. If upheld in the court system, reporting burdens could exist for both the big tech companies liable for the tax as well as the businesses that purchase digital ad services from them.

The Current State of Litigation over Maryland’s Digital Ad Tax

As mentioned, two separate lawsuits are at play over Maryland’s digital ad tax, one each in state and federal court. The state court case – Comcast et al. v. Comptroller – made recent news when the judge granted the plaintiff’s motion for summary judgment, determining Maryland’s tax conflicts with ITFA. This ruling effectively prevents the enforcement of Maryland’s tax in its current form. Moving forward, the Comptroller could appeal this decision to the Maryland Court of Special Appeals and subsequently to the Maryland Court of Appeals.

The federal case, spearheaded by the U.S. Chamber of Commerce, is ongoing with the parties filing briefs over the past few months. Assuming its challenge to Maryland’s digital advertising tax is successful, it won’t necessarily be the end of the discussion. Rather, state legislatures will likely learn from the flaws of Maryland’s tax and be more creative in their drafting of similar social media or data mining taxes to circumvent conflicts with the U.S. Constitution and ITFA. We highlight most of those state initiatives below.

Beyond Maryland: Which States Have Introduced Digital Advertising, Social Media, or Data Mining Tax Bills?

Maryland is the only state to enact a digital advertising tax to date, but they are not the only state contemplating similar proposals. This table provides a quick summary of related tax bills and their status in state legislatures.

As commerce thrives in digital and online spaces, state and local governments will continue to explore methods of taxation on those sales. You or your client’s business must stay aware of fast-changing laws that may alter or add to your existing sales tax reporting and remittance obligations. If your company recently received notice of an audit, tax liability, or other communication from a state department of revenue, consider meeting with one of our sales tax professionals today.

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