On March 4, 2022, a federal judge ruled that the federal Tax Injunction Act (“TIA”) bars a challenge to Maryland’s Digital Advertising Gross Revenues Tax (“Digital Ad Tax”) from proceeding in federal district court, but does not bar the plaintiffs from challenging Maryland’s prohibition on passing the tax to a customer “by means of a separate fee, surcharge, or line-item” (the “Pass-Through Prohibition”).  Chamber of Commerce of the United States of America v. Franchot, No. 21-cv-00410-LKG (D. Md. Mar. 4, 2022).  (See our prior coverage of the Digital Ad Tax: Maryland Passes Digital Advertising Gross Revenues Tax After Overriding Veto and Maryland Amends its Digital Advertising Gross Revenues Tax, Creating Additional Constitutional Infirmities.)

Industry groups, including the U.S. Chamber of Commerce and the Internet Association, previously filed a complaint in federal district court (District of Maryland) requesting the court to: 1) declare the Digital Ad Tax preempted by the Internet Tax Freedom Act and unconstitutional under the Due Process and Commerce Clauses of the United States Constitution; and 2) permanently enjoin Maryland from enforcing it.  The industry groups also challenged the Pass-Through Prohibition as violating the First Amendment and Commerce Clause of the United States Constitution.

The state moved to dismiss the plaintiffs’ challenge by arguing, inter alia, that the TIA bars the industry groups’ challenges from from proceeding in federal court.  The TIA provides that federal courts lack subject matter jurisdiction to enjoin the enforcement of a state tax if “a plain, speedy, and efficient remedy” is available in state courts.  28 U.S.C. § 1341.  In determining whether the TIA applies, courts must first determine whether the statute at issue is a “tax” or a “fee.”  If the statute is determined to be a “tax,” then a court will analyze whether a plain, speedy, and efficient remedy is available in state court.  The state argued that the Digital Ad Tax is a tax, not a fee, and a plain, speedy, and efficient remedy is available to challenge the tax in state court.

In the March 4, 2022 order, the federal judge agreed with the state that the Digital Ad Tax qualifies as a “tax” for TIA purposes and that a plain, speedy, and efficient remedy for the taxpayers’ challenge is availability in Maryland state court.  Accordingly, the challenge to the Digital Ad Tax cannot proceed in federal court.  However, the judge ruled that the plaintiffs’ challenge to the Pass-Through Prohibition may proceed in federal court because that provision does not concern the “assessment, levy, or collection” of a tax as required to invoke the TIA.

It is encouraging that the challenge to the Pass-Through Prohibition continues at the federal level.  Furthermore, as the case proceeds, we believe that the plaintiffs have strong arguments that the Pass-Through Prohibition is unconstitutional under the First Amendment, Dormant Commerce Clause, and potentially other grounds.  Under the First Amendment, the state should not be allowed to dictate to a seller how it can state charges on its invoices to customers.  Under the Dormant Commerce Clause, if the charge cannot be passed on to Maryland customers then it results in increased costs for non-Maryland customers which discriminates against out-of-state commerce. 

We know that other states, particularly Massachusetts, are watching the developments in the Maryland litigation.  These other states considering legislation similar to the Digital Ad Tax should be wary about enacting similar pass-through prohibitions as they are likely unconstitutional.

As for the plaintiffs’ Digital Ad Tax challenge in the federal case, it is unclear if the plaintiffs will ultimately appeal the judge’s dismissal or the federal litigation will be limited to the Pass-Through Prohibition challenge.  Furthermore, a separate challenge to the Digital Ad Tax remains pending in state court (Comcast of California/Maryland/Pennsylvania/Virginia/West Virginia LLC, et al. v. Comptroller of the Treasury of Maryland, Case No. C-02-CV-21-000509 (Md. Cir. Ct. Anne Arundel Cnty.).

Given that the judge did not enjoin enforcement of the Digital Ad Tax itself, taxpayers subject to the Digital Ad Tax are required to file their first estimated tax payments by April 15, 2022.  We are assisting many taxpayers with questions on how to comply with the Digital Ad Tax in light of the ongoing federal and state court litigation.

Contact the Authors: Maria Eberle, Ted Bots, Mark Yopp, Dmitrii Gabrielov, Ronald Beach