Structural Analysis of the Non-Small Business Category in the Maryland Research and Development Tax Credit

In the regulatory framework of Maryland’s innovation incentives, a Non-Small Business is defined as any for-profit entity that maintains net book value assets of $5 million or more at either the start or the end of the taxable year. This specific credit category governs the allocation of an $8.5 million aggregate funding pool, restricting such entities to non-refundable credits that must be carried forward against future tax liabilities rather than received as cash refunds.1

Defining the Non-Small Business Credit Category

The Maryland Research and Development (R&D) Tax Credit program, administered primarily by the Maryland Department of Commerce in coordination with the Comptroller of Maryland, establishes two primary tiers for applicants: Small Businesses and those that do not meet the small business criteria, colloquially and legally referred to as “Non-Small Businesses”.1 To understand the meaning of the Non-Small Business category, one must first isolate the statutory definition of a small business provided under Maryland Tax–General §10–721. A small business is characterized as a for-profit corporation, limited liability company, partnership, or sole proprietorship that possesses a net book value of assets totaling less than $5 million.4

The “net book value” is a critical accounting metric within this context, representing the total assets of the business—including intangible assets—minus accumulated depreciation and amortization.1 It is important to note that liabilities are not subtracted in this specific calculation, meaning a business with $6 million in assets and $2 million in debt is still categorized as a non-small business because its asset base exceeds the $5 million threshold.1 If an entity exceeds this asset limit at the beginning or the end of the tax year in which the expenses were incurred, it is automatically shifted into the non-small business credit category.3

This classification carries significant weight because it dictates the financial mechanism through which the business receives its benefit. While small businesses are eligible for fully refundable credits—allowing them to receive cash payments from the state even if they have no tax liability—non-small businesses are limited to non-refundable credits.1 For these larger entities, the credit serves as a reduction of state income tax liability. If the credit exceeds the tax owed in a given year, the non-small business cannot receive a check for the difference; instead, it must carry the excess credit forward to subsequent tax years.2

The Legal Foundation: Maryland Tax-General §10-721

The primary statutory authority for the R&D credit is found in §10–721 of the Tax–General Article of the Maryland Code. This section outlines the purpose of the program: to foster increased research activities and expenditures within the state.4 The law establishes a dual-cap system to manage the state’s fiscal exposure while ensuring that both small startups and established enterprises have access to incentives.

Statutory Caps and Reallocation

The Maryland legislature has authorized a total of $12 million in tax credits to be awarded annually.1 This total is divided into two distinct “buckets” based on the business classification. Under the current law, $3.5$ million is reserved specifically for small businesses, while $8.5$ million is allocated for non-small businesses.3

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The law includes a sophisticated mechanism for the reallocation of unused funds between these two categories. If the total amount of credits applied for by small businesses is less than the $3.5$ million set-aside, the remainder is automatically added to the $8.5$ million available for non-small businesses.3 Conversely, if non-small business applications do not reach $8.5$ million, the surplus is transferred to the small business pool.4 In the contemporary economic environment, however, the program is almost universally oversubscribed, particularly in the non-small business category, which frequently triggers proration.1

The Evolution of the Credit: Senate Bill 196

The current application of the law is largely defined by the changes enacted through Senate Bill 196 (Chapter 114 of the Acts of 2021). Prior to this legislation, Maryland maintained two separate credits: a “Basic” credit and a “Growth” credit.6 The Basic credit was equal to 3% of Maryland qualified research expenses (QREs) that did not exceed the state base amount, while the Growth credit was equal to 10% of the QREs that exceeded the base amount.10

Senate Bill 196 simplified this structure by repealing the 3% Basic credit entirely. For tax years beginning after December 31, 2020, all certified applicants—both small and non-small—are eligible for a single credit equal to 10% of the amount by which their Maryland QREs exceed their Maryland base amount.8 This shift transformed the credit into a purely incremental incentive, rewarding only those businesses that increase their research spending relative to their historical average.1

Administrative Guidance from the Department of Commerce

The Maryland Department of Commerce is the “gatekeeper” of the R&D tax credit. While the Comptroller handles the actual tax filings, the Department of Commerce must certify every dollar of credit before it can be claimed.1 For a non-small business, the guidance provided by the Department in its application instructions and regulatory releases is paramount to ensuring a successful claim.

Determining Qualified Research Expenses (QREs)

The Department of Commerce adheres strictly to the federal definition of “qualified research” and “qualified research expenses” as set forth in § 41(b) of the Internal Revenue Code (IRC).1 For an expense to be eligible for the Maryland credit, it must first meet the federal “Four-Part Test.” This test requires that the research be:

1. Technological in Nature: Relying on principles of the physical, biological, engineering, or computer sciences.2
2. For a Permitted Purpose: Directed at creating a new or improved business component’s function, performance, reliability, or quality.2
3. Eliminating Uncertainty: Intended to discover information that resolves uncertainty regarding the capability, method, or design of a product or process.10
4. A Process of Experimentation: Involving a systematic evaluation of alternatives through modeling, simulation, or trial and error.2

However, Maryland imposes a significant geographic restriction that is not present at the federal level. Only QREs incurred for research conducted within the State of Maryland are eligible for the credit.6 This includes wages paid to employees for work performed in Maryland, supplies consumed in Maryland research, and 65% of contract research costs where the services were rendered in-state.1 Non-small businesses with multi-state operations must carefully apportion their research costs to isolate Maryland-specific spending.1

The Role of the Maryland Base Amount

For a non-small business to receive any credit, its current-year spending must exceed its “Maryland Base Amount.” The calculation of this base amount is a multi-step process that relies on four years of historical financial data.1

The first step is determining the Fixed-Base Percentage. This is the ratio of the business’s aggregate Maryland QREs for the four taxable years preceding the credit year to its aggregate Maryland gross receipts for those same four years.1

$$\text{Fixed-Base Percentage} = \frac{\sum \text{Maryland QREs (Prior 4 Years)}}{\sum \text{Maryland Gross Receipts (Prior 4 Years)}}$$

The second step is calculating the Average Annual Maryland Gross Receipts for the four years preceding the credit year.7 The Maryland Base Amount is then the product of the Fixed-Base Percentage and the Average Annual Maryland Gross Receipts.1

$$\text{Maryland Base Amount} = \text{Fixed-Base Percentage} \times \text{Average Maryland Gross Receipts (Prior 4 Years)}$$

If a non-small business is a startup or did not have research expenses in the preceding four years, its base amount is zero, allowing it to claim the 10% credit on the full amount of its current-year research spending.1

Adjustments for Partial or Short Tax Years

Non-small businesses often undergo structural changes, such as fiscal year shifts or mid-year acquisitions, that result in a “short” tax year of less than 12 months. The Department of Commerce provides specific guidance for these scenarios to prevent the distortion of the base amount.7 In a short tax year, the business must calculate an Adjusted Base Amount by multiplying the standard base amount by a fraction representing the number of days in the short year divided by 365.3

Comptroller of Maryland Guidance and Filing Procedures

Once the Department of Commerce certifies the credit, the administrative responsibility shifts to the Comptroller of Maryland. For non-small businesses, the Comptroller’s guidance focuses on the mechanics of claiming the credit on corporate or individual income tax returns and the rules regarding carryforwards and controlled groups.

Claiming the Credit on Form 500CR

Non-small businesses must claim the certified credit using Maryland Form 500CR (Business Income Tax Credits). The credit is generally claimed for the tax year in which the expenses were incurred.14 However, because the Department of Commerce certification process takes several months—with applications due November 15 of the following year and certification issued by February 15 of the year after that—most non-small businesses must file an amended return to claim the credit.1

The Comptroller requires that a copy of the certification letter from the Department of Commerce be attached to the tax return.10 For non-small businesses that are structured as corporations, the return must be filed electronically if the entity plans to claim the R&D credit.15

Non-Refundability and the Carryforward Period

A defining feature of the non-small business category is the lack of refundability. If the certified credit exceeds the entity’s Maryland tax liability, the excess cannot be refunded.1 The Comptroller permits these businesses to carry the unused portion of the credit forward for up to seven taxable years.1 If the credit is not fully utilized within this seven-year window, the remaining balance expires and is lost.2

There is occasionally confusion regarding the carryforward period due to older regulations that allowed a 15-year window.7 However, current statutory guidance under §10–721(d) explicitly limits the carryforward for the R&D credit to seven years following the year the expenses were incurred.2

Controlled Groups and Aggregation Rules

Large enterprises often operate through multiple subsidiaries. The Comptroller’s guidance, mirroring federal law under IRC § 41(f), dictates that all members of a controlled group of corporations must be treated as a single taxpayer for the purposes of the R&D credit.1

The group calculates a single aggregate credit based on the combined Maryland QREs and gross receipts of all members. This total credit is then allocated among the individual members based on their proportionate share of the group’s total QREs.1 For non-small businesses, this means the $250,000 individual applicant cap applies to the entire group rather than each subsidiary, a significant limitation for large corporate families.1

Proration: The Reality of an Oversubscribed Program

One of the most critical pieces of guidance for non-small businesses is the explanation of the proration process. Because the $8.5$ million allocation for non-small businesses is a hard cap, the Department of Commerce must reduce individual awards if the total requested credits exceed this amount.1

The Proration Fraction is calculated by dividing the available $8.5$ million (plus any unused small business funds) by the total credits requested by all certified non-small business applicants.3

$$\text{Prorated Credit} = \text{Certified Credit Amount} \times \left( \frac{\$8,500,000}{\text{Total Credits Requested by Non-Small Businesses}} \right)$$

In recent years, the high volume of applications from Maryland’s thriving biotechnology and aerospace sectors has led to significant proration.1 For example, if non-small businesses collectively apply for $17$ million in credits, each individual applicant will only receive 50% of the amount they were technically eligible for based on their research spending.3

Practical Example: TechScale Solutions LLC

To illustrate the application of these rules, consider TechScale Solutions LLC, a hypothetical Maryland-based software engineering firm.

Company Profile and Categorization

• Financial Status: As of December 31, 2024, TechScale has a net book value of assets totaling $6.2$ million.1
• Classification: Because the assets exceed $5$ million, TechScale is classified as a Non-Small Business.4
• Implication: TechScale’s credit will be non-refundable and subject to the $8.5$ million pool.1

Step 1: Historical Data and Base Amount Calculation

TechScale must aggregate its Maryland-specific financials for the four preceding years (2020-2023).

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1. Fixed-Base Percentage: $\$2,000,000 / \$40,000,000 = 5\%$.1
2. Average Annual Gross Receipts: $\$40,000,000 / 4 = \$10,000,000$.7
3. Maryland Base Amount: $5\% \times \$10,000,000 = \$500,000$.1

Step 2: Current Year Calculation

In 2024, TechScale invests heavily in a new Maryland-based AI project, resulting in $1.5$ million in Maryland QREs.1

1. Incremental Spend: $\$1,500,000 – \$500,000 (\text{Base}) = \$1,000,000$.1
2. Statutory Credit Amount: $10\% \times \$1,000,000 = \$100,000$.3

Step 3: Application of Proration

TechScale submits its application by November 15, 2025. The Department of Commerce determines that for the 2024 tax year, non-small businesses requested a total of $12.75$ million in credits against the $8.5$ million allocation.3

1. Proration Factor: $\$8,500,000 / \$12,750,000 \approx 0.667$.3
2. Final Certified Credit: $\$100,000 \times 0.667 = \$66,700$.3

Step 4: Tax Utilization

TechScale receives its certification in February 2026. For the 2024 tax year, the company had a Maryland income tax liability of $50,000.1

1. Current Year Usage: TechScale applies $50,000 of the credit to eliminate its 2024 Maryland tax.1
2. Carryforward: The remaining $16,700 is carried forward to 2025.2 TechScale cannot receive this as a refund because it is a non-small business.1

Documentation and Audit Preparedness

For a non-small business, the risk of a tax audit is a significant consideration. The Comptroller of Maryland and the Department of Commerce emphasize that the burden of proof for “qualified research” lies entirely with the taxpayer.1

Substantiation Requirements

To defend a claim, a non-small business should maintain a robust documentation trail that mirrors federal standards under IRC § 41. Key documents include:

• Payroll Records: Detailed logs linking specific employees to research projects, including time-tracking data for those who supervise or support R&D.1
• Project Lists: Documentation of each research project’s objectives, the technological uncertainties involved, and the process of experimentation used to resolve them.10
• General Ledger Detail: Receipts and invoices for supplies consumed in the research process and payments made to third-party research contractors.1
• Consistency with Federal Filings: The Comptroller notes that while a business is not required to claim the federal R&D credit to qualify for the Maryland credit, the two filings should be consistent.10 If a business identifies an expense as R&D for the state but not the federal government, it must provide a clear justification for the discrepancy.13

Good Standing Requirement

A common but overlooked requirement is the “Good Standing” provision. To be approved for the credit, a business must be in good standing with the Maryland State Department of Assessments and Taxation (SDAT).13 This means the entity must have filed all necessary annual reports and paid all applicable business taxes.13 For a non-small business, a simple administrative lapse in SDAT filing can lead to the disqualification of a six-figure R&D tax credit.13

Strategic Considerations for Non-Small Businesses

The structure of the Maryland R&D credit imposes unique strategic constraints on businesses that fall into the non-small category. Understanding these nuances is essential for tax planning and capital allocation.

The Asset “Cliff”

The $5$ million net book value threshold creates a significant “cliff” effect. A rapidly growing startup that crosses this threshold mid-year immediately loses its right to a cash refund.1 For a cash-strapped tech company, the difference between a $100,000 refund and a $100,000 carryforward can be the difference between meeting payroll and needing to seek additional venture capital.1 Management must carefully monitor their balance sheet, as even non-cash items like the capitalization of software development costs can push the net book value over the $5$ million mark.1

The Ceiling on Large-Scale Research

The $250,000 individual applicant cap is a major factor for very large non-small businesses.1 A pharmaceutical giant investing $50$ million in Maryland-based clinical trials would technically be eligible for a $5$ million credit (10% of spend, assuming a zero base), but they are legally limited to receiving only $250,000.1 This cap ensures that the $12$ million state fund is distributed across a wide range of companies rather than being monopolized by a few large players, but it also reduces the relative incentive for mega-scale projects in the state.3

Pass-Through Entity Complications

Many non-small businesses are organized as Pass-Through Entities (PTEs), such as S-corporations, LLCs, or partnerships.1 In these cases, the business entity applies for and receives the certification, but the credit is actually claimed by the individual members or partners on their own Maryland tax returns.1

The Comptroller requires PTEs to file an electronic Form 510 and pass the credit through via a Maryland Schedule K-1.1 For non-small business PTEs, the members must be aware that the credit remains non-refundable at their individual level as well.1 If a partner’s share of the R&D credit exceeds their personal Maryland income tax, they must carry it forward on their individual return for the standard seven-year period.1

Impact of Mergers, Acquisitions, and Dispositions

In Maryland’s dynamic technology sector, acquisitions are frequent. The state provides specific guidance on how R&D credits and historical data are treated in these transactions.

Successor-in-Interest Rules

When one non-small business acquires another, the treatment of the R&D credit depends on the form of the transaction.1

• Stock Purchase or Merger: If the transaction is a merger or stock acquisition, the surviving entity generally steps into the shoes of the predecessor. This means the surviving company inherits the acquired entity’s unused R&D carryforwards.1 However, the survivor must also include the acquired entity’s historical Maryland QREs and gross receipts in its own base amount calculation, which can potentially increase the survivor’s “floor” and reduce future credits.1
• Asset Purchase: In a pure asset sale, the unused R&D credits typically do not transfer. They remain with the legal entity that originally incurred the expenses.1 The purchaser cannot use the seller’s historical credits, but the purchaser also does not have to include the seller’s historical data in its base amount calculation.1

Statistical Overview and Program Performance

The Maryland R&D tax credit is one of the state’s most popular incentives. Reviewing the statistics of the program provides insight into the competitive environment for non-small business applicants.

Participation Trends

The program is consistently oversubscribed, with the non-small business bucket typically seeing the highest demand.1 In 2024 evaluations, the Department of Legislative Services noted that the credit is a primary driver for investment in Maryland’s “Big Three” industries: Biotechnology, Information Technology, and Aerospace.1

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While the $12$ million cap has remained static, the total amount of R&D investment in Maryland has grown, leading to a steady decrease in the effective credit percentage received by non-small businesses after proration.1

Future Outlook and Legislative Risks

The Maryland R&D tax credit is not permanent; it is subject to a “sunset” provision. Under current law, the program is scheduled to remain in effect until June 30, 2027.1 For a non-small business planning long-term research cycles, this expiration date is a critical risk factor.

Potential for Expansion or Reform

There is ongoing debate in the Maryland General Assembly regarding the effectiveness of the $12$ million cap.20 Business advocacy groups often argue that the cap should be increased to $20$ million or more to reflect the growth of Maryland’s tech economy and to reduce the volatility caused by proration.20 Conversely, some policymakers suggest that the credit should be more narrowly targeted toward specific emerging industries like green energy or quantum computing.21

In 2024, the Department of Legislative Services conducted a formal evaluation of the program.19 This report will likely serve as the basis for any legislative extensions or modifications introduced in the 2025 or 2026 sessions. Non-small businesses should monitor these developments closely, as changes to the $5$ million threshold or the $8.5$ million set-aside would have immediate impacts on their tax strategies.21

Conclusion: Strategic Value for the Non-Small Business

The Non-Small Business category within the Maryland R&D tax credit framework is a sophisticated regulatory tool designed to foster innovation while maintaining strict control over the state’s budget. For entities with more than $5$ million in assets, the credit is an incremental growth incentive that requires a deep understanding of historical state-sourced data and a commitment to meticulous documentation.

While the lack of refundability and the impact of proration present hurdles, the 10% credit remains a substantial benefit for businesses committed to the Maryland research ecosystem. By successfully navigating the Department of Commerce certification and the Comptroller’s filing requirements, non-small businesses can significantly offset their state tax burden, effectively lowering the cost of discovery and ensuring Maryland remains a competitive hub for high-tech development. As the 2027 sunset approaches, the strategic importance of maximizing these credits and advocating for the program’s modernization has never been greater for the state’s largest innovators.

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