The Next Horizon for Digital Advertising Taxes Around the Country

I wrote in the fall about the growing trend of ad-supported streaming and its potential impact on state tax revenue. As new methods of taxation continue to arise, it’s important to monitor how state and local authorities attempt to step in to gain tax revenue. As we’ve seen recently, major updates to digital advertising taxes are playing out across the country, principally with the latest developments in Maryland.

The nation’s first tax on digital advertising gross revenue was meant to fund the state’s education reforms. It taxes annual gross revenue derived from digital advertising services in Maryland by businesses with at least $100 million in global annual gross revenues and ranges from 2.5% to 10%, depending on the global annual gross revenues of the business. As a result, companies meeting that threshold owed a tax on the portion of those revenues derived specifically from digital advertising services in the Old Line State.

Opponents were quick to file suit against—both in federal and state courts—with plaintiffs in both cases arguing violations of the Commerce Clause, Due Process Clause, and Internet Tax Freedom Act (ITFA). Two major opponents, Verizon Communications Inc. and Comcast Corp., challenged the statutory tax on digital ads as unconstitutional and in violation of federal law.

In October, they prevailed, with Anne Arundel County Circuit Court Judge Alison L. Asti striking down the tax, saying it violates the US Constitution’s prohibition on state interference with interstate commerce and discriminates against certain companies, essentially picking winners and losers who have to fork over taxes on revenue.

If we look to a couple of the main reasons why Maryland’s statute was struck down— mainly that it was discriminatory, selectively applied, and a broad violation of IFTA—we can see why Asti would rule in the favor of the network companies.

Soon after the October ruling, Maryland Senate President Bill Ferguson signaled his confidence that the Maryland Attorney General would win an appeal in state courts to overturn the ruling. The Office of the Comptrollerfiled a direct appeal late last month with the state Supreme Court and a petition to allow the state to collect the tax while the matter is adjudicated. The federal lawsuit, spearheaded by the US Chamber of Commerce, was dismissed in early December.

But with the future of digital advertising taxes in Maryland upended by this ruling, state and local governments across the country will have to take into account some of the key aspects of the case as they look to tax digital advertising within their own jurisdictions.

Changing Dynamics Around the Country

Outside of Maryland, most attempts at removing advertising taxes have been aimed at First Amendment claims. For example, the Ohio Supreme Court struck down a Cincinnati tax on billboard sales as “selective taxation” that violates the First Amendment. While not specifically tied to digital advertising, this shows that an advertising tax that is both selective and discriminatory has and will face challenges before the judicial system.

But prior to the recent Maryland law, most states had already taxed in-state advertising, just through a different means—income. While not explicitly a tax on advertising, businesses in Maryland that earn net income from advertising, such as newspapers and other forms of media, have that income taxed.

Washington, D.C., explored imposing a digital advertising tax within its 2021 fiscal year budget but relinquished it after discovering a problem with its proposal. Other states—including Connecticut, Indiana, Massachusetts, Montana, New York, Texas, Washington, and West Virginia—all introduced digital advertising tax bills in 2021 but have yet to enact one. With the recent Maryland ruling, they may continue to pump the brakes.

What’s Next for Digital Advertising Taxes?

Advertising money is still way too big of a revenue opportunity for states to pass up—especially in the economic environment they find themselves in. So, does Maryland or some other state attempt to cure the defects found in its recent law?

States still need tax revenue. And due to the current economic conditions, it’s a difficult political environment to pass tax increases on other categories that are more easily felt by the average consumer. Taxing advertising revenue is normally attractive because it is largely invisible to consumers and is a transaction tax—a better revenue generating tool than a corporate income tax alone. And best of all, voters are not fond of ads in the first place.

The potential road map for states to do this effectively now is by trying to treat advertising as a broad class, without picking a particular form of advertising. Maryland failed because it wanted to protect traditional, local advertisers and discriminated against large, online companies. The obvious cure is to tax advertising—full stop—without specific parameters around gross revenue or other factors.

Does any state have the political will to move forward with a broader advertising tax? Or perhaps we’ll see more states adopt streaming taxes to ensure a revenue stream, as they pose less of a constitutional risk, and are less likely to breach ITFA. We’ll see how it plays out as the appeal process begins.

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

Toby Bargar is a senior communications tax strategist at Avalara. As part of Avalara’s Communications business unit, he has spent years assisting clients with complex transaction tax issues, particularly in the field of communications tax and regulatory cost surcharges.

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