Analysis of Maryland Qualified Research and Development Expenses and the State Tax Credit Framework

Maryland Qualified Research and Development Expenses (QREs) represent the dollar value of wages, supplies, and contract research costs incurred for innovative activities conducted within the state. These expenses form the base for a 10% income tax credit that incentivizes companies to invest in technological advancements and experimentation in Maryland.1

The technical meaning of Maryland Qualified Research and Development Expenses (QREs) is deeply rooted in the statutory alignment between the Maryland Tax-General Article and Section 41 of the Internal Revenue Code (IRC). For an expenditure to be classified as a Maryland QRE, it must satisfy a dual-layered requirement of meeting federal eligibility standards for research and development while maintaining a strict geographic nexus to the state of Maryland.2 Under the current legislative framework, defined primarily by Maryland Tax-General § 10-721 and supplemented by the Code of Maryland Regulations (COMAR) 03.04.10, these expenses are categorized as the tangible and intangible costs associated with “qualified research” conducted in the state.2 The state defines Maryland qualified research and development as activities that meet the criteria of IRC § 41(d)—specifically that the research is technological in nature, involves a process of experimentation, and is intended to eliminate uncertainty regarding the development or improvement of a business component—provided that the physical conduct of these activities occurs within Maryland borders.6 The financial components of these QREs are restricted to wages paid to employees for direct research or supervision, supplies consumed during the research process, and a defined percentage of payments made to third-party contractors for Maryland-based research services.6 This exhaustive definition ensures that the tax incentive specifically targets the high-wage, high-impact innovation sectors that drive the state’s economic growth, such as biotechnology, cybersecurity, and advanced manufacturing.1

Statutory Foundations and Federal Alignment

The legal architecture of the Maryland R&D tax credit is a hybrid system that incorporates federal definitions to ensure consistency with national accounting standards while exerting local control over fiscal impacts and geographic priorities. Maryland Tax-General Article § 10-721 explicitly adopts the federal definition of “qualified research expenses” as set forth in § 41(b) of the Internal Revenue Code.2 This alignment allows Maryland businesses to utilize their federal research credit calculations as a starting point for their state-level claims, provided they can isolate the portion of those expenses attributable to Maryland-based activities.4 The state’s reliance on IRC § 41(b) means that if an expense is disqualified at the federal level—for example, if it relates to routine data collection or social science research—it is automatically disqualified for the Maryland credit.7

The relationship between the state and federal definitions is not merely one of convenience; it is a structural necessity that allows the Maryland Department of Commerce to leverage decades of federal tax court precedents and Internal Revenue Service (IRS) guidance. By adopting § 41(b) and § 41(d), the Maryland General Assembly has ensured that the “Four-Part Test” remains the gold standard for determining activity eligibility.6 However, the state introduces a critical “sourcing” requirement that the federal government does not have to consider: the “conducted in this State” mandate.2 This means that a Maryland QRE is not simply an expense incurred by a Maryland company; it is an expense incurred for work actually performed in Maryland.4

The Three Pillars of Qualified Research and Development Expenses

To provide clarity for businesses, the Maryland Department of Commerce and the Comptroller of Maryland categorize QREs into three specific buckets, reflecting the federal structure of IRC § 41(b). Understanding the nuances within each pillar is essential for accurate credit calculation and successful certification.

In-House Research Wages

The most significant component of most QRE claims in Maryland is wages. According to state guidance and COMAR 03.04.10, “qualified wages” are the portion of an employee’s salary and wages paid for “qualified services”.5 For an employee’s wages to qualify, they must be engaged in one of three activities: (1) actually conducting the research, (2) providing direct supervision of the research, or (3) providing direct support for the research.6 In the context of Maryland law, the services must be performed at a facility located within the state.10 This is particularly relevant for companies with a mobile or remote workforce; the state revenue office may evaluate the physical location where the services are performed rather than the company’s headquarters location.1

A sophisticated interpretation of “direct supervision” and “direct support” is necessary for full compliance. Direct supervision includes the immediate oversight of researchers, but generally does not include high-level management that only receives periodic reports. Direct support includes the work of lab technicians who prepare research materials or computer programmers who develop code specifically for the experimentation process.6 However, wages for administrative staff, human resources, and maintenance personnel are strictly excluded, even if their work indirectly supports the research environment.6

Research Supplies

The second pillar consists of “supplies” used in the conduct of qualified research. Maryland follows the federal definition, which includes tangible property other than land or improvements to land and property of a character subject to the allowance for depreciation.6 In the innovative sectors typical of Maryland, such as biotechnology, these expenses often include reagents, chemicals, lab-grown cultures, and prototypes.1 The key requirement for a supply expense to be a Maryland QRE is that it must be “consumed” during the research process.2

One common area of confusion involves the distinction between a supply and a capital asset. If a company purchases a high-end microscope or a server for its Maryland lab, these are capital assets subject to depreciation and do not qualify as QRE supplies.6 However, the disposable components or materials used for a single experiment or to build a temporary prototype are qualifying supply expenses.6

Contract Research Expenses

The third pillar involves payments made to third parties for qualified research conducted on behalf of the Maryland taxpayer. Recognizing that companies often outsource specialized testing or technical analysis, Maryland law permits a portion of these costs to be included in the QRE total.6 To prevent the double-counting of overhead and profit margins, the state—aligning with federal standards—typically limits the qualifying portion of contract research to 65% of the total payment.6

For these expenses to qualify as “Maryland” expenses, the research must be performed within the state. If a Maryland-based biotechnology firm hires a university lab in Baltimore to conduct testing, those expenses qualify. If the same firm hires a lab in North Carolina, those expenses are excluded from the Maryland credit calculation, even though they might qualify for the federal credit.2 Furthermore, the business may not include expenses paid to a third-party vendor if that vendor is also claiming a credit for the same expenses, a rule designed to prevent state “over-incentivization” of a single activity.10

The Four-Part Test: The Qualitative Gateway to QREs

While the definition of an expense (wages, supplies, contractors) is quantitative, the qualification of the activity that generates the expense is qualitative. Maryland revenue office guidance mandates the use of the IRS Four-Part Test to validate the research activity.6

Permitted Purpose

The first part of the test requires that the activity be related to a new or improved “business component”.6 A business component can be a product, process, software, technique, formula, or invention that the taxpayer intends to hold for sale, lease, or license, or use in its own trade or business.6 The research must be aimed at improving the function, performance, reliability, or quality of that component.6 This excludes purely aesthetic improvements or market research designed to determine consumer preference.6

Elimination of Technological Uncertainty

The second part focuses on the intent of the researcher. At the outset of the project, there must be a technological uncertainty regarding the capability or method of achieving the result, or the appropriate design of the business component.6 If the solution is readily available through existing public knowledge or standard engineering practices, the activity does not qualify as research. The taxpayer must be attempting to discover information that is not already known to them in their specific context.6

Process of Experimentation

The third part requires a systematic “process of experimentation”.6 This typically involves the evaluation of alternatives through a structured trial-and-error methodology, modeling, simulation, or systematic testing.6 A simple “fix-it” approach to a bug does not qualify unless it involves a systematic evaluation of multiple hypotheses to solve a technological problem.6

Technological in Nature

Finally, the research must be “technological in nature”.6 This means the process of experimentation must fundamentally rely on the principles of physical or biological sciences, engineering, or computer science.6 Activities based on soft sciences, such as economics, management, or the social sciences, are expressly excluded.6

The Application and Certification Lifecycle

A unique feature of the Maryland R&D tax credit is its mandatory certification process. Unlike the federal credit, which is self-reported on Form 6765, the Maryland credit requires an affirmative award letter from the Maryland Department of Commerce before it can be claimed on a tax return.1

The Critical November 15 Deadline

The most important date for any Maryland innovator is November 15 of the calendar year following the tax year in which the expenses were incurred.1 For example, a business that incurred QREs during the 2024 tax year must submit its online application to the Department of Commerce no later than November 15, 2025.4 Missing this deadline is generally fatal to the claim, as the state needs all applications submitted by a single date to manage the statutory caps and proration.1

The Certification and Claim Process

Once the application window closes, the Department of Commerce reviews all submissions for eligibility and calculates the prorated awards. By February 15 of the following year, the Department issues a certification letter to each approved applicant.1

Because the certification occurs after the standard tax filing deadlines for the year the expenses were incurred, most taxpayers must file an amended Maryland income tax return to claim the credit.1 However, the law provides flexibility, allowing the credit to be claimed on an original return for any of the seven succeeding taxable years, provided the certification letter is attached.2

Calculating the Credit: The Incremental Growth Model

Maryland utilizes an incremental credit model, which is designed to incentivize increased R&D spending rather than simply rewarding a baseline level of investment. The core of this model is the “Maryland Base Amount”.1

Mathematical Determination of the Base Amount

The Maryland Base Amount is calculated using a four-year lookback period. According to COMAR 03.04.10 and Tax-General § 10-721, the base amount is the product of the “Maryland Base Percentage” and the “Average Annual Maryland Gross Receipts” for the preceding four years.1

The “Maryland Base Percentage” is determined by dividing the aggregate Maryland QREs for the four preceding years by the aggregate Maryland Gross Receipts for those same four years.1

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

The “Maryland Base Amount” is then determined as follows:

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

For a taxpayer to generate a credit, their current year Maryland QREs must exceed this Base Amount.1 The credit is then calculated as 10% of that excess.1

The 3% vs. 10% Historical Context

Prior to 2021, Maryland offered both a “Basic” credit (3% of QREs up to the base amount) and a “Growth” credit (10% of QREs in excess of the base amount).5 However, Senate Bill 196 (SB 196) significantly altered this structure by eliminating the 3% Basic Credit for tax years after 2020.13 Today, the program operates solely as a 10% Growth Credit program, focusing state resources on companies that are actively expanding their Maryland-based research footprints.7

Special Rules for Partial and Short Years

When a business entity has a “short taxable year” (a period of less than 12 months), the Maryland Base Amount must be adjusted to prevent the creation of an artificial surplus of credits.4 This “Maryland Adjusted Base Amount” is calculated by multiplying the standard base amount by a fraction, where the numerator is the number of days in the short year and the denominator is 365.4

$$\text{Adjusted Base Amount} = \text{Base Amount} \times \left( \frac{\text{Days in Short Year}}{365} \right)$$

Furthermore, the taxpayer only claims the Maryland QREs actually incurred during that short taxable year.5 This ensures that the base threshold and the qualifying expenses are measured against equivalent time periods.

Small Business Provisions and Refundability Mechanics

A defining characteristic of the Maryland R&D incentive is its prioritization of small businesses. The state recognizes that for many early-stage technology and biotechnology firms, a non-refundable tax credit is of limited value because the company has not yet achieved profitability and therefore has no tax liability.1

Definition of a Small Business

For R&D credit purposes, a “small business” is a for-profit entity (corporation, LLC, partnership, or sole proprietorship) with net book value assets of less than $5 million at the beginning or end of the taxable year for which the credit is claimed.1 “Net book value assets” are defined as total assets, including intangibles, minus depreciation and amortization, without the reduction of liabilities.1 To prove eligibility, small businesses must submit a balance sheet to the Department of Commerce during the application process.1

The $3.5 Million Set-Aside

Of the $12 million in total annual credits available, Maryland law mandates that $3.5 million be reserved for small businesses.1 If the total applications from small businesses exceed $3.5 million, the credits for each small business are prorated.1 Conversely, if the small business bucket is undersubscribed, the excess funds can be reallocated to the $8.5 million pool for larger businesses.2

Refundability for Small Businesses

Perhaps the most significant benefit for small businesses is refundability. While larger businesses can only carry forward unused credits for seven years, certified small businesses may claim a cash refund for the portion of the credit that exceeds their Maryland tax liability.2 This effectively turns the tax credit into a grant from the state, providing vital non-dilutive capital to support ongoing research operations.13

Revenue Office Guidance on Tax Compliance

Claiming the Maryland R&D credit involves more than just receiving a certificate; it requires careful integration into the taxpayer’s overall state tax return. The Maryland Comptroller provides specific administrative guidance to ensure that the credit is properly reported and that “double-dipping” is avoided.

The Addition Modification (§ 10-205)

Under Maryland Tax-General Article § 10-205(i), any taxpayer who claims the Maryland R&D credit must make an “addition modification” to their federal adjusted gross income when calculating their Maryland adjusted gross income.9 This addition modification must be equal to the total amount of the credit claimed.9

The logic behind this requirement is that R&D expenses are typically deductible at the federal level, which reduces the federal adjusted gross income that serves as the starting point for Maryland taxes. By requiring an addition modification, the state ensures that the taxpayer does not receive both a deduction and a credit for the same dollar of expenditure.9

Interaction with Net Operating Losses (NOLs)

The Comptroller’s Administrative Release No. 18 details the interaction between R&D credits and Maryland’s treatment of Net Operating Losses. While Maryland generally follows federal NOL rules, certain “decoupling” modifications may apply.21 For a business in a loss position, the addition modification required by the R&D credit may reduce the amount of the Maryland NOL that can be carried forward, as the addition modification increases the taxable income (or reduces the tax loss) for that specific year.14

Pass-Through Entity (PTE) Treatment

For partnerships, S-corporations, and LLCs, the R&D credit is generally calculated at the entity level but claimed at the individual member level.1 The entity must apply for and receive the certification from the Department of Commerce.1 The credit is then allocated among the partners or shareholders based on their pro-rata share of the entity’s income or expenses, typically reported on the Maryland Schedule K-1.1 Each member then reports their share of the credit and the corresponding addition modification on their individual Maryland tax return (Form 502 for residents, 505 for non-residents).6

Case Study: NovaTech Solutions’ R&D Investment

To demonstrate the application of Maryland’s QRE rules and credit calculation, consider “NovaTech Solutions,” a hypothetical Maryland-based cybersecurity firm.

Company Profile and Data

In 2024, NovaTech Solutions invests heavily in developing a new encryption protocol at its Baltimore headquarters.

• 2024 MD QREs: $2,500,000 (Wages for 10 Maryland engineers and $200,000 in supplies).
• Net Book Value Assets: $4,200,000 (Qualified as a Small Business).
• Historical MD QREs (2020-2023): $1,800,000, $2,000,000, $2,200,000, $2,400,000.
• Historical MD Gross Receipts (2020-2023): $20,000,000, $22,000,000, $25,000,000, $28,000,000.

Step 1: Base Percentage Calculation

The base percentage is the four-year aggregate QREs divided by the aggregate Gross Receipts 1:

$$\text{Base Percentage} = \frac{\$8,400,000}{\$95,000,000} \approx 0.0884 \text{ (or 8.84%)}$$

Step 2: Average Gross Receipts Calculation

$$\text{Avg. Gross Receipts} = \frac{\$95,000,000}{4} = \$23,750,000$$

Step 3: Base Amount Calculation

The Maryland Base Amount is the threshold NovaTech must exceed 1:

$$\text{Base Amount} = 0.0884 \times \$23,750,000 = \$2,099,500$$

Step 4: Tentative Credit Calculation

NovaTech’s 2024 QREs ($2,500,000) exceed its base amount ($2,099,500) 1:

$$\text{Excess QREs} = \$2,500,000 – \$2,099,500 = \$400,500$$

$$\text{Tentative Credit (10%)} = 0.10 \times \$400,500 = \$40,050$$

Step 5: Application and Final Award

NovaTech submits its application by November 15, 2025. Because the small business set-aside of $3.5 million is frequently oversubscribed, the final award may be prorated.1 If the proration factor is 90% (0.90), the final certified credit is:

$$\text{Certified Credit} = \$40,050 \times 0.90 = \$36,045$$

Step 6: Refund and Compliance

NovaTech receives its certification in February 2026. Because its assets are under $5 million, the company qualifies for a refund of the $36,045 credit to the extent it exceeds its 2024 Maryland tax liability.2 Simultaneously, NovaTech must file an amended 2024 return and include a $36,045 addition modification to its Maryland income.9

Statistical Insights into Program Utilization

The Maryland R&D tax credit is one of the most heavily used business incentives in the state. Analysis of annual reports from the Department of Commerce and the Comptroller reveals several key trends regarding the fiscal health and competitive impact of the program.

Program Oversubscription and Proration Trends

The $12 million annual cap is a point of constant pressure. Since the program’s inception, the total amount of credits applied for has consistently exceeded the statutory limit.1 In some years, the total “tentative” credits requested by all businesses have been more than double the available funds, leading to proration factors as low as 40% to 50% for non-small businesses.1

Sector-Specific Impact

The program is dominated by high-technology sectors. Biotechnology and life science companies account for a disproportionate share of the QREs reported in the state, driven by the high cost of laboratory research and the concentration of the NIH, FDA, and major research universities in the Baltimore-Washington corridor.1 The “Information” sector, which includes cybersecurity, data processing, and social media firms, also receives substantial awards, reflecting the state’s strategic focus on the digital economy.25

Small Business vs. Large Business Dynamics

The 2021 overhaul via SB 196 was specifically intended to prevent large corporations from capturing the majority of the credit.13 Prior to these changes, a few massive firms would often exhaust the majority of the “Basic” credit pool. By eliminating the Basic Credit and increasing the Growth Credit pool to $12 million with a $3.5 million set-aside for small firms, Maryland has shifted the benefit toward innovators who are actively growing their research spend.7 Small businesses now receive roughly 29% of the total state-wide allocation, a significant increase from the pre-2021 era.13

Strategic Considerations for Maryland Innovators

Businesses looking to maximize their Maryland R&D tax credit must look beyond simple calculation and focus on strategic documentation and timing.

Optimizing the Base Amount

Because the credit is based on growth over a four-year average, companies that experience sudden spikes in Maryland R&D spending generate the most significant credits.1 Strategic planners should be aware that “lumpy” R&D spending can be more tax-efficient than steady spending. For instance, concentrating a multi-year project’s most expensive phases into a single tax year can maximize the “excess” over the base amount, though this must be balanced against the $250,000 per-firm cap.1

Mergers, Acquisitions, and Credit Continuity

Maryland revenue office guidance provides specific rules for how credits and base amounts transfer during corporate reorganizations. In a stock purchase, the unused credits and the historical QRE data generally carry over to the surviving entity.1 However, in an asset purchase, the unused credits remain with the seller, as they are tied to the legal entity that incurred the expenses.1 If Company A acquires Company B, it must include Company B’s historical Maryland QREs and Gross Receipts in its own base amount calculation moving forward, a rule intended to prevent the artificial creation of “growth” through consolidation alone.4

Documentation as Audit Defense

As the program remains oversubscribed, the Department of Commerce and the Comptroller have increased their audit intensity. Businesses are advised to maintain “contemporaneous” records rather than relying on year-end estimates.1 Innovation logs, time-tracking software, and detailed project scopes for contractors are the primary defense in a state audit. The state may request proof that the research was actually “conducted in Maryland,” such as badge-swipe data for restricted lab areas or shipping manifests for supplies delivered to a Maryland facility.2

Comparative Analysis: Maryland vs. Other States

To understand Maryland’s competitive position, it is useful to compare its QRE-based credit with other regional and national innovation hubs.

• California: Offers a 15% credit on QREs over a base amount, but uses a different “Alternative Incremental Credit” (AIC) method and has much higher individual caps.26
• Delaware: Uses two methods: a 10% credit over a base amount or a 50% share of the federal Alternative Simplified Credit (ASC).27
• Florida: Similar 10% rate but limited to certain industries and has a very high $500,000 asset requirement for some applicants.27
• Arizona: Offers a much higher 24% credit on the first $2.5 million in QREs, making it one of the most aggressive incentives in the country.26

While Maryland’s total cap ($12 million) is lower than giants like California or New Jersey, its specific set-aside and refundability for small businesses make it a top-tier destination for early-stage startups that are still pre-revenue.1

The Future of Maryland QRE Incentives

As the program moves toward its scheduled June 30, 2027 termination date, several legislative and regulatory shifts are on the horizon.

The Income Tax Benefit Transfer Program (HB 35)

New legislative proposals, such as the “Income Tax Benefit Transfer Program,” aim to provide even more liquidity to Maryland’s tech sector.14 If passed, this program would allow “eligible technology companies” to sell their unused R&D tax credits and NOL modifications to other Maryland taxpayers.14 This would be a major shift, moving from a system of carryforwards and limited refundability to a transferable “credit marketplace”.14

Interaction with Federal Amortization Relief

The tax community in Maryland is also closely watching federal developments regarding IRC Section 174. The shift to mandatory five-year amortization for domestic R&D costs in 2022 significantly increased the effective tax rate for many innovators.25 If federal relief (such as a return to immediate expensing) is granted, Maryland businesses will likely see an increase in the “value” of their state R&D credit as a complementary tool for cash flow management.28

Conclusion

The Maryland Research and Development Tax Credit represents a highly calibrated fiscal tool designed to anchor the state’s most innovative industries. By grounding the definition of Qualified Research and Development Expenses in federal IRC § 41 standards, the state provides a predictable framework for businesses to identify and calculate their qualifying costs. However, the unique Maryland requirements—the strict geographic sourcing of research, the asset-based definition of small businesses, and the mandatory pre-certification by the Department of Commerce—demand a high level of administrative diligence.

The shift in 2021 toward a unified 10% Growth Credit system clarified the program’s intent: to reward companies that are expanding their footprint and pushing the boundaries of technology within the state. For small businesses, the refundability of the credit serves as an essential bridge toward profitability, while for larger firms, the seven-year carryforward provides a valuable mechanism for long-term tax planning. As the state moves toward the 2027 expiration of the current program, the focus will likely remain on maintaining Maryland’s status as a premier hub for biotechnology, cybersecurity, and advanced manufacturing by ensuring the R&D credit remains accessible, adequately funded, and responsive to the needs of the evolving innovation economy. Success in claiming the credit ultimately rests on the ability of a business to align its technical experimentation with the rigorous evidentiary and sourcing standards set forth by Maryland’s revenue office guidance and statutory law.

R&D Tax Credit Preparation Services

Swanson Reed is one of the only companies in the United States to exclusively focus on R&D tax credit preparation. Swanson Reed provides state and federal R&D tax credit preparation and audit services to all 50 states.

If you have any questions or need further assistance, please call or email our CEO, Damian Smyth on (800) 986-4725.
Feel free to book a quick teleconference with one of our national R&D tax credit specialists at a time that is convenient for you.

R&D Tax Credit Audit Advisory Services

creditARMOR is a sophisticated R&D tax credit insurance and AI-driven risk management platform. It mitigates audit exposure by covering defense expenses, including CPA, tax attorney, and specialist consultant fees—delivering robust, compliant support for R&D credit claims. Click here for more information about R&D tax credit management and implementation.

Our Fees

Swanson Reed offers R&D tax credit preparation and audit services at our hourly rates of between $195 – $395 per hour. We are also able offer fixed fees and success fees in special circumstances. Learn more at https://www.swansonreed.com/about-us/research-tax-credit-consulting/our-fees/