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Washington’s Digital Ad Tax Enacted: Is Litigation Now Inevitable?

On May 20, 2025, Washington Governor Bob Ferguson signed into law Senate Bill (SB) 5814, a sweeping tax bill that expands Washington’s retail sales and use tax to digital advertising services and a range of high-tech and IT services. The new law takes effect for sales occurring on and after October 1, 2025.

As we noted previously, this legislation marks a significant shift in Washington’s tax policy, extending sales tax to categories of traditionally exempt business-to-business services. With enactment, legal challenges – particularly under the federal Internet Tax Freedom Act (ITFA) – are ripe and appear inevitable.

WHAT THE LAW DOES

SB 5814 amends RCW 82.04.050 by redefining “sale at retail” to include “advertising services,” broadly covering both digital and nondigital forms of ad creation, planning, and execution. The law specifically includes:

  • Online referrals
  • Search engine marketing
  • Lead generation optimization
  • Web campaign planning
  • Digital ad placement
  • Website traffic analysis

However, the law expressly excludes services rendered in connection with:

  • Newspapers (RCW 82.04.214)
  • Printing or publishing (RCW 82.04.280)
  • Radio and television broadcasting
  • Out-of-home advertising (g., billboards, transit signage, event displays)

With these carve-outs, it is difficult to see how anything other than internet advertising remains subject to tax. The structure of the new tax facially discriminates against e-commerce and is barred by ITFA.

ITFA AND THE CERTAINTY OF A LEGAL CHALLENGE

ITFA prohibits states from imposing taxes that discriminate against digital services when comparable offline equivalents are exempt. While SB 5814 purports to cover both digital and nondigital advertising, the exclusions for nondigital forms of advertising cause it to target the digital side of the industry. For example, a digital banner ad will be taxed, whereas a banner towed by an airplane promoting the same product will not.

This distinction mirrors the structure of Maryland’s Digital Advertising Gross Revenues Tax, which has been tied up in litigation since its enactment in 2021. A Maryland trial court found that law facially violated ITFA and federal preemption principles. That litigation continues, and Washington now finds itself on a similar path.

HIGH-TECH AND IT SERVICES ARE NOW TAXABLE

In addition to digital advertising, SB 5814 extends the retail sales tax to high-tech services, including:

  • Custom website development
  • IT technical support and network operations
  • Data processing and data entry
  • In-person or live-virtual technical training

Like advertising, these intermediate services typically are purchased by businesses in support of operations rather than for end consumption. Taxing their sale introduces tax pyramiding and adds costs that will ultimately be passed on to consumers. For Washington’s tech-driven economy, this change will inflate prices and reduce competitiveness.

Local advertisers and businesses that rely on digital marketing and high-tech services will see these costs rise and lead to higher prices for consumers.

OUTLOOK

While SB 5814 is now law, its enforceability remains far from certain. Taxing digital advertising services while expressly excluding offline media places the new law on a collision course with ITFA. A legal challenge is all but guaranteed.

At the [...]

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Washington’s Digital Ad Tax: A Lawsuit Waiting To Happen?

On April 27, 2025, the Washington Legislature delivered to Governor Bob Ferguson’s desk Senate Bill (SB) 5814, a sweeping tax bill that, among other changes, would expand the state’s retail sales and use tax to sales of digital advertising services and a range of high-tech and IT services. The bill now awaits the governor’s signature, with a decision due by May 20, 2025.

If enacted, the changes would take effect October 1, 2025, marking a significant expansion of Washington’s tax base into areas that have long been exempt, particularly intermediate business services such as digital marketing, data processing, and custom software support.

WHAT THE BILL DOES

SB 5814 amends RCW 82.04.050 by redefining “sale at retail” to include a broad range of services previously excluded from the sales tax. Specifically, it adds “advertising services,” defined as:

All digital and nondigital services related to the creation, preparation, production, or dissemination of advertisements including, but not limited to: layout, art direction, graphic design, mechanical preparation, production supervision, placement, referrals, acquisition of advertising space, and rendering advice…

The definition also expressly includes:

  • Online referrals
  • Search engine marketing
  • Lead generation optimization
  • Web campaign planning
  • The acquisition of advertising space in the internet media
  • Website traffic analysis for determining the effectiveness of an advertising campaign.

However, the bill expressly excludes advertising services rendered in connection with newspapers (as defined in RCW 82.04.214); printing or publishing (RCW 82.04.280); radio and television broadcasting; and out-of-home advertising such as billboards, transit displays, and signage at events.

With that list of exclusions, it’s hard to imagine what advertising services other than internet advertising services are left to tax. This focus on internet advertising creates a prima facie discriminatory tax on electronic commerce barred by the federal Internet Tax Freedom Act (ITFA).

ITFA AND THE CERTAINTY OF A LEGAL CHALLENGE

ITFA prohibits states from imposing “discriminatory taxes on electronic commerce.” A tax is discriminatory if it applies to digital services but not similar offline equivalents.

While SB 5814 expressly includes both digital and non-digital advertising services, the carve-outs for traditional formats such as print, TV, and radio effectively leave out non-digital advertising. As the bill itself states, services connected to newspapers, publishing, and broadcast media are not taxable. This distinction creates a classic ITFA problem:

  • A digital banner ad campaign will be taxed.
  • A newspaper ad or radio spot promoting the same product will not.

This kind of structural bias has been challenged before. Maryland’s Digital Advertising Gross Revenues Tax (the first of its kind in the United States) was enacted in 2021 and quickly faced multiple lawsuits on ITFA and other grounds. In 2022, a Maryland trial court struck down the law as unconstitutional, citing ITFA violations and federal preemption (although the decision was later reversed on procedural grounds). That litigation continues while the stack of taxpayer refund claims on the Maryland Comptroller’s desk grows taller.

Washington faces a similar outcome. SB 5814’s facial discrimination against digital advertising is precisely the kind of unequal [...]

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Texas Comptroller Proposes Rule Changes Cementing Tax on 130% of Marketplace Sales

In a controversial move, the Texas Comptroller is poised to amend Rule 3.330, Data Processing Services, effectively rewriting the rules to favor the contentious stance it has adopted in recent audits and litigation. This proposed amendment, which aims to cement the aggressive stance the Comptroller has taken in audits and litigation that a marketplace provider’s commission-based earnings are taxable “data processing services,” represents a significant departure from long-standing practices and highlights a disturbing trend of what is effectively a retroactive regulatory adjustment.

A LOOK AT THE PROPOSED CHANGES

The crux of the proposed amendment is the addition of paragraph (b)(5) to Rule 3.330, which the Comptroller explains is being added “to clarify that marketplace providers provide data processing services to their customers as they enter, retrieve, search, manipulate, and store data or information in the course of their business.” New paragraph (b)(5) provides that:

Marketplace provider services may be included in taxable data processing services when they involve the computerized entry, retrieval, search, compilation, manipulation, or storage of data or information provided by the purchaser or the purchaser’s designee. For example, services to store product listings and photographs, maintain records of transactions, and to compile analytics are taxable data processing services.

This new paragraph specifically targets the commissions that marketplace providers charge for facilitating sales, taxing them separately from the underlying transactions themselves. This is not just an expansion of the tax base; it’s a redefinition of what constitutes a taxable service, applying it in ways that were never intended under previous interpretations of the law that considered such commissions nontaxable auctioneer/brokerage fees.

WHY THIS AMENDMENT IS PROBLEMATIC

The Comptroller’s approach is problematic for several reasons, including:

  1. Effective Retroactivity. The proposed amendment seeks to justify an aggressive (and questionable) agency position that the Comptroller has only recently begun to assert in audits and litigation after it quietly revoked a long-standing administrative ruling in 2020. The revocation of this ruling in 2020, without public notice or legislative approval, was a stark deviation from established practices. By changing the rules after the fact, the proposed amendment undermines the stability and predictability of the law.
  2. Double Taxation. If a marketplace facilitates a sale where a consumer pays $100 and the marketplace earns a $30 commission, the proposed amendment would not only tax the $100 transaction but also the $30 commission. This results in an effective tax on 130% of marketplace sales, with the additional 30% a double tax on the portion of the sales proceeds paid to the marketplace provider as a commission. Under this scheme, the Comptroller is demanding that marketplace providers pay tax on 130% of the sales price and charge the consumer for tax on the 100% and the seller for the 30%.
  3. Discriminatory Tax Under ITFA. The proposed amendment subjects commissions earned by online marketplace providers to taxation as data processing services while similar services provided offline, such as commissions earned by auctioneers of oil and gas leases, consignment stores, and real estate agents using [...]

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California Legislatively Overturns Recent Office of Tax Appeals Taxpayer Win

The California State Legislature overturned Microsoft’s recent win at the Office of Tax Appeals, which held that the gross amount of dividends received from foreign affiliates outside its water’s-edge group should be included in its sales factor denominator, regardless of the application of a dividends-received deduction excluding 75% of such dividends from its taxable base.

The legislation declares that FTB Legal Ruling 2006-1 “shall apply with respect to apportionment factors attributable to income exempt from income tax under the Corporation Tax Law,” and it claims that the declaration “does not constitute a change in, but is declaratory of, existing law.” Consistent with the FTB’s position in the Microsoft case, Legal Ruling 2006-1 would limit the sales factor denominator to the net dividends included in the tax base.




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Colorado Changes Rules for Determining Members of Combined Filing Group

Colorado Governor Jared Polis has signed legislation that would replace Colorado’s unique “3 of 6” rule for determining the members of a unitary group for combined reporting purposes and instead adopt what Legislative Council Staff has called “the Multistate Tax Commission’s standard” for determining the members of a combined filing group.

Under current law, a combined report may only contain those members of an affiliated group of corporations as to which three of the following six facts have been in existence in the tax return year and the two preceding years:

  1. Sales or leases between one affiliate and another constitute 50% or more of the gross operating receipts or cost of goods sold of the entity making the sales/leases
  2. Certain back-office services are provided by one affiliate for the benefit of another
  3. Twenty percent or more of the long-term debt of one affiliate is owed to or guaranteed by another affiliate
  4. One affiliate substantially uses certain intellectual property of another affiliate
  5. Fifty percent or more of the board of one affiliate are members of the board or are corporate officers of another affiliate
  6. Twenty-five percent or more of the 20 highest ranking officers of an affiliate are members of the board or are corporate officers of another affiliate.

Under the new law all members of a “unitary business” will be required to file a combined report. A “unitary business” is defined as an affiliated group of entities “that are sufficiently interdependent, integrated, and interrelated through their activities so as to provide a synergy and mutual benefit that produces a sharing or exchange of value among them and a significant flow of value to the separate parts.”

The new law keeps Colorado’s water’s-edge rule in place, but it’s notable that said rule provides an exception for any entity “incorporated in a foreign jurisdiction for the purpose of tax avoidance” while identifying a list of nations where a corporation will be presumed to be incorporated for tax avoidance purposes (including the Cayman Islands, Luxembourg, Monaco, etc.).

Presuming Colorado voters don’t file a referendum petition and get the legislation overturned in November, the new standard would go into effect for tax years beginning on or after January 1, 2026.




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California Legislator Considers Digital Advertising Tax

Senator Steven Glazer, chair of the California State Senate Revenue and Tax Committee, is treating data like the next gold rush and taking bold steps to mine this new vein of wealth with his proposed “Digital Data Extraction Tax Law.” While couched as a tax on “data extraction,” the base for the tax is digital advertising revenue. The draft proposal contains several gaps, including the tax rate and effective date, and we understand that Senator Glazer is not certain he will file it.

Senator Glazer modeled his proposed tax on Maryland’s digital advertising gross receipts (DAGR) tax approach but with a twist, aligning it with Tennessee’s digital barter tax proposal (House Bill 2234/Senate Bill 2065). While California’s bill attempts to cure the numerous legal infirmities present in Maryland’s DAGR tax, it suffers from many of the same fatal weaknesses.

LEGISLATIVE BACKGROUND

The bill’s stated intent is to tap into the supposedly “enormous economic rents” that the “largest” internet companies generate from the personal data they “extract” from their users. The draft bill would introduce a new tax on gross receipts from the sale of digital advertising services (digital ad tax). The digital ad tax would be imposed on persons engaged in “digital data extraction transactions,” defined as transactions where:

(i) a person sells advertisers information about or access to users of the person’s services, [and]

(ii) the person engages in a digital barter by providing services to a user in full or partial exchange for displaying advertisements to the user or collects data about the user.

Under the bill, persons with digital advertising revenue above a certain level would be deemed engaged in taxable activity. Additionally, the digital ad tax would only apply to persons with advertising revenue above a certain (currently unspecified) level but would provide a carve-out for news media entities. Revenue from the tax would be earmarked for a fund that supports local newspapers.

A troubling feature of the draft bill is its sourcing regime. The bill would require that those subject to the digital ad tax use personally identifiable information about those to whom the ads are served to source revenue from the advertising to either California or somewhere else. Specifically, the bill requires that sellers of digital advertising services capture and retain information, such as users’ GPS locations or IP addresses. A seller would be required to produce this information to tax authorities on audit. These requirements raise profound privacy issues.

Perhaps recognizing the myriad of legal challenges faced by Maryland’s DAGR tax, California’s bill attempts to limit its application to entities based on their revenue derived in the state. It also attempts to ward off challenges that the digital ad tax is a discriminatory tax on electronic commerce barred by the Internet Tax Freedom Act (ITFA) by adding a bare statement that the “Legislature finds and declares . . . . [t]hat digital advertising is not substantially similar to traditional print [...]

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Microsoft Scores Massive Win in California, Opens the Door for Others Nationwide

The Office of Tax Appeals (OTA) handed Microsoft an enormous win in its controversy with the California Franchise Tax Board (FTB) over the inclusion of qualifying dividends in the sales factor denominator for which it also claimed a dividends received deduction (DRD).

Microsoft filed a water’s-edge combined report for the years at issue and deducted 75% of qualifying dividends received from foreign affiliates outside its water’s-edge group. Initially, Microsoft only included the 25% net amount of dividends received in its sales factor denominator. Subsequently, Microsoft filed a refund claim asserting that the gross amount of dividends received should be included in the sales factor denominator, which would have resulted in a nearly $100 million refund.

The FTB argued that its own legal ruling (Ruling 2006-01) limiting the denominator to net dividends was dispositive of the issue. In its opinion, qualifying dividends should be excluded like eliminated intercompany dividends that were previously reported as income. The FTB also argued that a “matching principle” should apply to exclude the dividends like other items expressly excluded for allegedly not contributing to the tax base.

However, the OTA did not defer to FTB’s legal ruling because it was not a formal regulation. It was interpreting a statute, and its interpretation was inconsistent with the law. The OTA also disagreed with the comparison to eliminated intercompany dividends as there is no similar express exclusion in the DRD statute. Furthermore, the OTA found that “the legislative history” did not support the FTB’s “matching principle” because if the legislature intended the list of exclusions to be non-exhaustive, it would have used language like “such as” or “and other similar transactions.”

In its petition for rehearing, the FTB raised new arguments that the legislative history supported its interpretation and that qualifying dividends should be excluded from the denominator because they are qualitatively different from Microsoft’s main line of business. The OTA again rejected “the same or similar arguments that were considered and rejected in the Opinion” and stated that “new theories that could have been raised, but were not, is not one of the causes that permits a new hearing.” Accordingly, the OTA found that Microsoft was entitled to the nearly $100 million refund.

*          *          *

Corporate taxpayers should consider this decision as the basis for similar claims both in California and nationwide. While the Microsoft case involved dividends resulting from the Section 965 inclusion regime, it should apply to any type of dividend. The position is not conceptually different from including the factors of a unitary business entity that is in a loss while simultaneously using the loss for a net operating loss deduction. Therefore, in states where taxpayers are including only dividends in the denominator to the extent included in the base, there may be a position to instead include all dividends – even those subject to a deduction from the base. Depending on the statutory language in any given state, this could be true even if 100% of the dividends are deducted. [...]

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Vermont Considers Imposing Mandatory Worldwide Combined Reporting

The Vermont House Committee on Ways and Means is actively exploring a proposal to become the first state to enact mandatory worldwide combined reporting for corporate income tax purposes. While legislation has not been formally proposed, the Committee has examined a working draft that could be embedded into a broader tax legislation package.

In Committee testimony supporting the adoption of mandatory worldwide combined reporting, Don Griswold, a senior fellow at the Center on Budget and Policy Priorities, argued that multinational corporations “pay huge fees to sophisticated advisers to develop an endless variety of complex schemes that shift their profits offshore.” According to him, mandatory worldwide combined reporting would be “the complete solution” to stopping what he perceives as a “loophole for massive tax avoidance.” He also intimated that several companies are among those he believes are currently engaging in “tax avoidance,” even though he freely acknowledged that he worked in a “Big 4 accounting firm’s 600-person ‘state tax minimization’ group” for most of his career.

On the other hand, at least one representative from the Vermont Department of Taxes has suggested that worldwide mandatory combined reporting is not the panacea that Griswold claims it would be. In Committee testimony, Will Baker, assistant attorney general and general counsel at the Department of Taxes, pointed out that a corporation’s Vermont taxable income could increase or decrease under worldwide combined reporting depending on the profitability of the corporation’s domestic and overseas subsidiaries and the locations of the corporate unitary group’s sales throughout the world. Baker also suggested that the Department of Taxes would face practical challenges calculating the income of subsidiaries that are not part of a corporate filing at the US federal level. Finally, he added that “small states” should generally “have the same rules that other states have” to make it easier for taxpayers to comply with Vermont law.

The McDermott state & local tax team will be closely monitoring this legislative proposal to see whether the Vermont General Assembly takes heed of the advice of its own officials at the Department of Taxes.




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Following Maryland’s Lead? We Guess Everyone Wants to Go to Court. Icy Challenges to Nebraska’s Advertising Services Tax Act Start to Emerge

Nebraska Governor Jim Pillen’s ambitious plan to provide $2 billion in property tax relief via an increase in the sales tax rate and an expansion of the sales tax base is stirring significant debate. Part of his proposal is embodied in the newly introduced Legislative Bills 1310 and 1354, known as the “Advertising Services Tax Act” (the Act), which aims to finance this tax relief by imposing a 7.5% gross revenue tax on advertising services. However, this initiative faces a wall of voter opposition. A recent Battleground Connect survey revealed that 70% of likely voters disapproved of increasing the sales tax rate to offset property taxes. It should come as no surprise that Nebraska voters would not want to follow Maryland’s lead. What is surprising is that Nebraska legislators are willing to tie the fate of their new tax to a law that is currently being challenged in court in Maryland after the state adopted a similar tax in 2021.

The heart of the controversy lies in the new advertising tax’s specifics. The tax only targets firms with US gross advertising receipts exceeding $1 billion, a threshold that effectively discriminates against out-of-state advertising service providers and implicates constitutional and federal laws governing interstate commerce.

The proposed law specifically excludes “news media entities” and targets out-of-state digital advertising platforms. “Advertising services” incorporates a range of services, including digital advertising services, related to advertisement creation and dissemination. The term also includes “online referrals, search engine marketing and lead generation optimization, web campaign planning, the acquisition of advertising space in the Internet media, and the monitoring and evaluation of website traffic for purposes of determining the effectiveness of an advertising campaign.” Advertising services does not include services provided by entities “engaged primarily in the business of news gathering, reporting, or publishing articles or commentary about news, current events, culture, or other matters of public interest.” A news media entity does not include “an entity that is primarily an aggregator or republisher of third-party content.” Taxing publishers of one type of content and not taxing others raises profound First Amendment concerns.

While facially the Act applies to all advertising, its real focus is on digital and internet advertising and this targeting raises multiple legal and policy concerns:

  • Impact on Nebraska Businesses and Consumers. The tax, though imposed largely on out-of-state service providers, will be passed through directly to local businesses when they buy advertising. Much like a sales tax, service providers can and will add a line-item charge of 7.5% on each invoice to the local business placing the advertisement, driving up the cost of advertising services for Nebraska businesses. These higher costs will be reflected in the prices of goods and services sold to Nebraska consumers or the profits of local businesses.
  • Potential for Litigation. Drawing parallels with Maryland’s digital advertising tax, which faced legal challenges and has already once been ruled unconstitutional and barred by federal law, Nebraska’s legislation would also lead to costly and [...]

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As Minnesota Moves Toward GILTI Taxation, New Jersey May Be Moving Away from It

We previously reported that the Minnesota Legislature was considering imposing mandatory worldwide combined reporting through an omnibus tax bill. Subsequent to our report and in the face of numerous criticisms, Minnesota Senate leaders backed away from the proposal. But ominously, those same leaders said they would examine other tax increases to make up for the (potentially hypothetical) revenue left on the table by moving away from mandatory worldwide combined reporting.

After a series of negotiations, an updated omnibus tax bill (HF 1938) emerged from the Minnesota Legislature conference committee over the weekend, which has already been passed by both the Minnesota House and Senate. Most notably for corporate taxpayers, the legislation:

  • Recouples Minnesota with the Internal Revenue Code provision providing for the inclusion of global intangible low-taxed income (GILTI) (under IRC § 951A) in the corporate tax base while providing a 50% dividends received deduction (but no deduction under IRC § 250)
  • Reduces the dividends received deduction from 80% to 50% for corporations in which the recipient owns 20% or more of the stock and from 70% to 40% for corporations in which the recipient owns less than 20% of the stock and
  • Decreases a corporation’s maximum net operating loss deduction from 80% to 70% of taxable net income each year.

As no prior bills proposing these tax increases had been introduced in the Minnesota Legislature, these tax increases have been passed without any public hearing or public testimony. The rush to put these proposals together may explain why the legislation fails to address how income from GILTI must be accounted for in determining a taxpayer’s apportionment factor.

Minnesota’s move toward GILTI taxation is out of step with legislation introduced in New Jersey, which would increase the state’s GILTI deduction to 95% from 50%. The proposal, which is part of a broader legislative compromise package negotiated by New Jersey government officials and businesses, has the support of the chair of the New Jersey Senate Budget and Appropriations Committee and has been publicly called “win-win” legislation by a New Jersey Division of Taxation representative.

As litigation addressing the constitutionality of taxing GILTI is already percolating through administrative appeals in numerous states, it is likely that New Jersey’s potential move away from GILTI taxation will prove to be the more fiscally prudent way to go.




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