Candice Horbacz
In a case that legislators across the country have watched with intense interest, the Maryland Tax Court recently struck down the state’s digital advertising tax and ordered that refunds be paid to taxpayers for five and a half years’ worth of collections under the unconstitutional tax. This will not be the end of the story—appeals will follow, with refunds likely stayed pending those appeals—but after long years, it is the beginning of the end, and the Tax Court’s ruling, which represents a robust and comprehensive victory for the petitioners, should be regarded as a harbinger as lawmakers consider digital advertising taxes in other states. The Maryland Tax Court decided the case for the plaintiffs on the grounds that it violated the Internet Tax Freedom Act (ITFA), the Commerce Clause, and the Due Process Clause, any one of which would have been sufficient to invalidate the tax.
Maryland’s Pioneering, Yet Contentious, Digital Ad Tax
Maryland made history in February 2021 by becoming the first state in the nation to enact a tax on digital advertising revenue. The legislation, House Bill 732, was designed to generate significant revenue, projected to be around $250 million annually once fully implemented, with initial estimates for the first full fiscal year hovering closer to $100 million. This revenue was earmarked primarily for the Blueprint for Maryland’s Future Fund, a comprehensive, multi-billion-dollar education reform plan often referred to as the Kirwan Commission recommendations. The state’s ambitious education funding goals necessitated new revenue streams, and the digital advertising tax was seen by its proponents as an innovative way to tap into the rapidly expanding digital economy, particularly targeting large, out-of-state technology companies.
However, from its inception, the tax was mired in controversy and faced fierce opposition from a broad coalition of industry groups and business associations. Governor Larry Hogan initially vetoed the bill in 2020, citing concerns about its legality, its potential to harm Maryland businesses, and its broad scope. Despite the veto, the Democratic-controlled General Assembly overrode it in February 2021, pushing the tax into law. This legislative override underscored the state’s determination to implement the tax, despite widespread warnings from legal experts and industry stakeholders that it was likely unconstitutional.
The tax applied a tiered rate structure on gross revenues derived from digital advertising services in Maryland, ranging from 2.5% for companies with global annual gross revenues of $100 million to 10% for those exceeding $15 billion. Critics immediately pounced on this structure, arguing that it disproportionately targeted large, often out-of-state, technology giants while potentially burdening smaller businesses that rely on digital advertising. The legal challenges began almost immediately after the override, with prominent tech and advertising industry players, including Verizon Media (now Yahoo!), Comcast, and the U.S. Chamber of Commerce, filing lawsuits in various courts. These challenges consistently raised the same constitutional arguments that ultimately proved successful in the Maryland Tax Court: violations of the Internet Tax Freedom Act, the Commerce Clause, and the Due Process Clause. The state began collecting the tax in July 2022, leading to the "five and a half years’ worth of collections" referenced in the court’s ruling, an amount that now represents a significant potential liability for the state’s budget.
Unpacking the Legal Victory: Three Pillars of Unconstitutionality
The Maryland Tax Court’s decision was a comprehensive rejection of the digital ad tax, finding it unconstitutional on three distinct and independent grounds. This multi-faceted ruling significantly strengthens the position of petitioners and sends a clear message to other states contemplating similar measures.
The Digital Ad Tax Violates the Internet Tax Freedom Act (ITFA)
Federal law, specifically the Internet Tax Freedom Act, prohibits discriminatory taxation of e-commerce. Enacted in 1998 and made permanent in 2016, ITFA aims to foster the growth of the internet by preventing states and localities from imposing taxes that single out internet access or discriminate against electronic commerce. Crucially, ITFA prohibits any tax that singles out e-commerce while not taxing “similar property, goods, services, or information” offline. Opponents of the digital ad tax have long argued that by taxing digital ads but not billboards, newspaper ads, television commercials, and other forms of advertising, the tax clearly violated ITFA’s anti-discrimination principle.
Maryland offered several counterarguments to this central claim, all of which the Tax Court systematically rejected. First, the state argued that digital advertising isn’t actually "similar" to other forms of advertising, as that term should be interpreted under ITFA. The state attempted to draw distinctions based on the interactive nature, data-targeting capabilities, and dynamic delivery of digital ads. However, the court rejected this argument, concluding that the fundamental purpose and effect of digital advertising—to promote goods, services, or ideas to a target audience—shared overwhelming similarities with traditional advertising methods. The mode of delivery, while different, did not negate the core similarity in function and intent. The court found that these similarities far outweighed the dissimilarities in the mode of delivery, making the tax discriminatory.
Second, the state tried to argue that ITFA itself does not provide a private remedy or create a cause of action allowing anyone other than the federal government to seek to enforce it. The state contended that individual taxpayers or businesses could not directly sue to invalidate a state tax based on ITFA. The court concluded that this legal point, while potentially true in a strict sense, was irrelevant in this context. The petitioners were not directly seeking to "enforce" the federal law; rather, they had standing to pursue a refund of taxes paid under a state law they contended was unconstitutional. ITFA merely served as a compelling justification for their refund claim, demonstrating why the state tax was unlawfully collected. This distinction is critical, as it allows private parties to challenge state taxes on ITFA grounds through refund actions, even if direct enforcement mechanisms are limited to the federal government.
And third, Maryland argued that ITFA itself is unconstitutional under anti-commandeering doctrines, pointing to a Supreme Court ruling that struck down a federal ban on gambling on college sports (Murphy v. NCAA). The state suggested that Congress was overstepping its bounds by dictating state tax policy. However, the court appropriately noted a fundamental difference: whereas Congress does not have plenary authority to regulate intercollegiate gaming, it does have a clear and established constitutional right to regulate interstate commerce under the Commerce Clause. ITFA, by regulating state taxation that impacts interstate commerce, falls squarely within Congress’s enumerated powers. This distinction highlights the robust constitutional basis for ITFA and undermines attempts to challenge its federal authority.
This decision is highly relevant to other states: no matter what the other details of a digital ad tax’s design, if it only (or almost exclusively) reaches digital advertising, it violates ITFA. That’s the Maryland Tax Court’s ruling, and while Maryland courts certainly do not bind other states’ courts, policymakers should recognize that other courts are likely to reach the same conclusion, given the clear intent and established legal precedent surrounding ITFA.
The Digital Ad Tax Violates the Commerce Clause
The U.S. Constitution’s Commerce Clause grants Congress the power to regulate interstate commerce and implicitly restricts states from enacting laws that unduly burden or discriminate against it. State taxes that impact interstate commerce are typically evaluated under the four-prong test established in Complete Auto Transit, Inc. v. Brady (1977): the tax must apply to an activity with a substantial nexus with the taxing state, be fairly apportioned, not discriminate against interstate commerce, and be fairly related to the services provided by the state. The Maryland Tax Court found that the digital ad tax failed on multiple prongs of this critical test.
Maryland’s digital ad tax has a graduated-rate structure that is not based on the amount of gross revenue generated in Maryland, but rather on the advertising platform’s gross revenue worldwide. This meant that a company’s tax rate in Maryland was determined by its global financial performance, irrespective of its specific activities or revenue within the state’s borders. The court held that these graduated rates on global revenues violate the Complete Auto test for Commerce Clause compliance because it is not fairly apportioned, and because it lacks external consistency since the tax is on activity entirely outside Maryland. A tax is fairly apportioned if it measures only the activity that occurs within the taxing state. By basing the rate on global revenues, Maryland was effectively reaching beyond its borders, taxing extraterritorial values, which is a classic Commerce Clause violation.
Furthermore, the tax’s thresholds were designed in such a way as to disproportionately (arguably exclusively) tax out-of-state commerce. The highest rates applied only to companies with very large global revenues, almost exclusively multinational corporations headquartered outside Maryland. This structure created a discriminatory effect, favoring smaller, in-state businesses over larger, interstate ones.
The court also held that the tax is not fairly related to services received, another critical requirement of Complete Auto. The "fairly related" prong requires that the tax be in proportion to the services provided by the state to the taxpayer. As the court wrote, “The economic reality is that the Tax in its everyday operation discriminates against more globally robust companies in interstate commerce to the advantage of the Maryland tax coffers. Global revenues have no relationship to in-state services under the Tax to those payors.” The amount of tax owed bore no reasonable relationship to the value of services or protections Maryland provided to these large, often out-of-state, digital advertising platforms. The tax thus violated three of the four prongs of Complete Auto, demonstrating a profound constitutional infirmity.
Notably, while some of this owes to the unique design of Maryland’s tax—other states could choose not to increase rates based on global revenue of the ad platform—others are inherent to any tax that discriminates by targeting large, out-of-state companies and imposing a tax on them that has no fair relationship to in-state services. The court’s findings here provide crucial guidance on how states must structure their tax systems to avoid running afoul of the Commerce Clause, particularly when attempting to tax the globalized digital economy.
The Digital Ad Tax Violates Due Process
The Due Process Clause of the Fourteenth Amendment has been held to impose two important requirements for taxes involving interstate commerce: (1) a minimal connection (or "nexus") between the interstate activities and the taxing state, and (2) a rational relationship between the income attributed to the state and the interstate values of the enterprise. These requirements ensure that a state only taxes activities over which it has legitimate jurisdiction and that the tax levied is proportional to the benefits or protections the state provides.
The court found that, for the same reasons that the tax violates the fair apportionment requirement under the Commerce Clause, it fails under the second Due Process requirement because the tax is discriminatory. The reliance on global revenues to determine the tax rate and the discriminatory effect against out-of-state businesses meant that the tax lacked a rational relationship to the value generated within Maryland. The state was attempting to tax values that were not rationally attributable to its jurisdiction, thereby violating the fundamental principles of due process. This intertwining of the Commerce Clause and Due Process Clause arguments highlights the interconnectedness of these constitutional protections against overreaching state taxation.
The Path Ahead: Appeals and Budgetary Implications
This is a robust win for the petitioners on all counts, providing a comprehensive legal basis for invalidating the tax. However, the Maryland Tax Court is an administrative tribunal, and its rulings are subject to judicial review. The state is highly likely to file for judicial review by the circuit court, which they must do within 30 days of the ruling.
Under today’s summary judgment, companies that paid the tax must receive refunds, though those refunds will presumably be stayed pending the circuit court’s review. This stay is a standard legal procedure to prevent immediate financial disruption while the appellate process unfolds. Review by the circuit court would not involve new hearings or the presentation of new evidence but would instead be based solely on the Maryland Tax Court’s administrative record. This means the circuit court will assess whether the Tax Court correctly applied the law to the facts presented.
Should Maryland lose at the circuit court level, the losing party then has the right to appeal to Maryland’s appellate court. The Maryland Supreme Court could also expedite the process by granting early certiorari and taking the case directly at that time, a move
