The Statutory and Administrative Treatment of Supplies for Qualified Research within the Maryland Research and Development Tax Credit Framework

Supplies for qualified research in the State of Maryland comprise tangible, non-depreciable property consumed directly during the performance of experimental activities that meet the technological innovation criteria established by federal and state law. To remain eligible for the Maryland Research and Development tax credit, these expenditures must be incurred for materials physically utilized within the state’s borders to eliminate technical uncertainty in the development of new or improved business components. 1

Theoretical and Legal Foundations of the Maryland Research and Development Tax Credit

The Maryland Research and Development (R&D) Tax Credit is a sophisticated fiscal instrument designed to foster a robust ecosystem of innovation by reducing the effective cost of high-stakes scientific and technological investigation. Established under the Maryland Tax-General Code Section 10-721 and further elucidated by the Code of Maryland Regulations (COMAR) 03.04.10, the credit serves as a primary driver for the state’s biotechnology, manufacturing, and information technology sectors. 1 By providing a direct offset against state income tax liability, Maryland incentivizes businesses to anchor their most intellectually demanding activities within the state, thereby generating high-value employment and long-term economic resilience. 1

The architecture of the Maryland credit is fundamentally “incremental,” meaning it is structured to reward companies that increase their research efforts over time relative to their historical performance. 1 Within this framework, the definition of “Qualified Research Expenses” (QREs) is paramount. These expenses are broadly categorized into internal costs—primarily wages and supplies—and external costs, such as contract research. 1 The focus on “supplies” as a distinct category of QREs represents a critical area of tax planning and compliance, as the materials consumed in the research process often constitute a substantial portion of the total investment for hardware-intensive and life-science-oriented firms. 6

Maryland’s statutory language explicitly incorporates the federal definitions found in Internal Revenue Code (IRC) Section 41. Section 10-721(a)(6) of the Maryland Tax-General Article states that “Maryland qualified research and development expenses” are those defined in § 41(b) of the IRC, provided they are incurred for research conducted in Maryland. 2 This direct linkage ensures that Maryland taxpayers benefit from a unified standard of eligibility, though they must simultaneously navigate state-specific administrative requirements and geographical nexus constraints that do not apply at the federal level. 8

The Meaning of Supplies in the Context of Qualified Research

To understand the meaning of supplies for the Maryland R&D credit, one must look to the federal interpretation adopted by the state. Under IRC § 41(b)(2)(C), the term “supplies” is defined as any tangible property, other than land or improvements to land and property of a character subject to the allowance for depreciation. 1 This definition creates a clear bifurcation in accounting treatment: for an item to qualify as a supply, it must be consumed or have a useful life of less than one year in the context of the research activity. 5

The exclusion of depreciable property is perhaps the most significant boundary in the definition of supplies. If a piece of equipment is purchased and intended for use over multiple years, it must be capitalized and depreciated, making the purchase price ineligible for the R&D credit. 1 However, the materials used to build a prototype—even if that prototype is a complex piece of machinery—may qualify as supplies if the prototype itself is not intended for long-term use or sale but is instead used as a testing vehicle to be eventually discarded or dismantled. 1

Tangibility and Direct Consumption

The requirement for property to be “tangible” excludes intangible assets such as patents, software licenses, or general utility services from the definition of supplies. 5 Furthermore, the property must be “used in the conduct of qualified research.” 1 This implies a degree of direct consumption. In a laboratory setting, this includes reagents, chemicals, biological cultures, and glassware that may be broken or rendered unusable during the experiment. 5 In a manufacturing or engineering context, it includes the raw materials—steel, plastic, electronic components—used to fabricate test models or “first-article” production units. 5

Administrative guidance from the Maryland Department of Commerce and the Office of the Comptroller emphasizes that the “direct consumption” standard is strictly enforced. 2 Materials used for general administrative functions, such as office paper or breakroom supplies, are ineligible even if they are used by research personnel. 1 The nexus between the supply and the “process of experimentation” must be demonstrable and documented. 6

Maryland Revenue Office Guidance and Administrative Framework

The administration of the Maryland R&D credit is a bifurcated process involving two distinct state agencies: the Maryland Department of Commerce and the Maryland Comptroller. 12 Each agency provides specific guidance that shapes how the law is applied to supply expenses.

The Department of Commerce: Certification and Eligibility

The Department of Commerce is the gatekeeper of the R&D credit. No business may claim the credit on a tax return without first obtaining a certification from the Department. 1 The administrative burden begins with a mandatory application, which must be submitted by November 15 of the calendar year following the tax year in which the expenses were incurred. 1

Guidance for the application process, found in Department manuals and instructional PDFs, requires the applicant to provide a granular breakdown of Maryland-based QREs. 1 Specifically, the Department asks for confirmation that:

1. All research activities were conducted within the State of Maryland. 8
2. All claimed supply expenses were for tangible property consumed in Maryland. 2
3. The applicant is in “Good Standing” with the State Department of Assessments and Taxation (SDAT). 16

The Department’s role is to verify the eligibility of the activities and the expenses before issuing a tax credit certificate by February 15 of the following year. 1 Because the program is subject to a strict $12 million annual cap, the Department is also responsible for the proration of credits if total applications exceed the available funds. 1

The Office of the Comptroller: Filing and Audit Standards

Once a business receives its certification from the Department of Commerce, it must interface with the Office of the Comptroller to claim the benefit. 1 The Comptroller provides guidance through Administrative Releases and tax booklets, such as the Corporate Income Tax Return (Form 500) instructions and Form 500CR instructions. 19

The Comptroller’s primary focus regarding supplies is “substantiation.” In the event of an audit, the Comptroller requires taxpayers to maintain detailed records that link each supply expense to a specific, qualified research project. 1 This alignment with federal substantiation standards means that taxpayers must be prepared to provide:

• Invoices and receipts that specify the nature of the property purchased. 6
• Project logs or lab notebooks that record when and where materials were used. 6
• A “nexus study” or similar documentation proving that the consumption occurred at a Maryland facility. 8

Furthermore, the Comptroller requires an “addition modification” for the amount of the credit claimed. 19 Since the expenses used to generate the credit (including supplies) were already likely deducted as business expenses on the federal return, Maryland law requires the taxpayer to add the amount of the state credit back to their Maryland taxable income to prevent an impermissible double benefit. 19

Geographic Nexus: The “Consumed in Maryland” Requirement

A distinguishing feature of the Maryland R&D credit is the requirement for geographic nexus. While the federal credit applies to research conducted anywhere in the United States, the Maryland credit is restricted to research performed “in the state.” 8 For wages, this typically depends on where the employee is physically located while working. For supplies, the standard is based on the “location where supplies used in research and development are consumed.” 2

Tax-General § 10-721(f)(2)(iii) authorizes the Department and the Comptroller to adopt regulations that prescribe standards for this determination. 2 This has significant implications for supply-chain management in R&D:

• Out-of-State Purchases: If a Maryland biotech firm orders specialized chemicals from a vendor in Germany and those chemicals are shipped to a lab in Baltimore and used in an experiment there, the expense is a Maryland QRE. The origin of the purchase is irrelevant; the location of consumption is the determining factor. 2
• In-State Purchases for Out-of-State Use: If the same firm buys materials from a Baltimore vendor but ships them to its subsidiary’s lab in North Carolina for use in research there, the expense is not a Maryland QRE. Even though the money left a Maryland bank account and went to a Maryland vendor, the consumption occurred outside the state. 2

Apportionment and Multi-State Entities

For large corporations operating in multiple jurisdictions, the Maryland nexus requirement necessitates a meticulous accounting of supply inventories. 2 If a company maintains a central repository of supplies that are distributed to various labs across the country, it must be able to track exactly which materials were sent to and used at its Maryland sites. Failure to maintain these records can lead to the disallowance of supply expenses during a Comptroller audit, as the “consumption in Maryland” cannot be verified. 1

Calculation Methodologies for the Maryland R&D Credit

Maryland utilizes an incremental credit model. While the state formerly offered two types of credits—the “Basic” and “Growth” credits—legislative changes have streamlined the program primarily toward the Growth model. 6

The Growth R&D Tax Credit

The Growth credit is equal to 10% of the Maryland QREs (including supplies) incurred during the taxable year that exceed a “Maryland Base Amount.” 1 The calculation of the base amount is a multi-step process that relies on historical financial data. 1

Steps in Calculation:

1. Identify Prior Years’ Data: Gather Maryland QREs and Maryland Gross Receipts for the four taxable years immediately preceding the credit year. 1
2. Compute the Fixed-Base Percentage: This is the ratio of total prior QREs to total prior Gross Receipts over those four years. 1
3. Calculate the Maryland Base Amount: Multiply the Fixed-Base Percentage by the company’s average Maryland Gross Receipts for the same four-year period. 1
4. Determine Excess QREs: Subtract the Maryland Base Amount from the current year’s Maryland QREs. 1
5. Apply the Credit Rate: Take 10% of the excess QREs. 1

If a business is new to Maryland or has never incurred R&D expenses in the state before, the Fixed-Base Percentage and the Base Amount are $0$. In this “startup” scenario, the company can claim 10% on the full amount of its qualified expenses, including all Maryland-consumed supplies. 1

Statutory Caps and Proration

The Maryland R&D credit is subject to a total statewide cap of $12 million per year. 1 This cap is divided into two pools: $8.5 million for larger corporations and $3.5 million set aside specifically for small businesses. 1

Because the demand for the credit consistently exceeds these caps, the Department of Commerce is required by law to prorate the credits. 1 This means that a company might apply for a $100,000 credit but only receive a certificate for a fraction of that amount. The proration factor is calculated by dividing the total pool of funds by the total amount of credits applied for by all eligible businesses in that category. 4

*Note: Historical data from 2019 shows the split as $5.5M Basic and $6.5M Growth, but recent legislative shifts and the $12M aggregate cap maintain the oversubscription pressure. 4

Small Business Provisions and the Importance of Refundability

For small businesses, the R&D credit is particularly valuable due to the refundability provision. While larger corporations can only carry unused credits forward for 7 years to offset future tax liability, certified small businesses may receive a direct cash refund if the credit exceeds their current year’s state income tax. 1

The Net Book Value Asset Test

Eligibility for the small business refund is determined by an asset-based test rather than a revenue-based test. Under Tax-General § 10-721(a)(8), a small business is a for-profit entity with “net book value assets” totaling less than $5 million at either the beginning or the end of the taxable year for which the credit is claimed. 1

The Department of Commerce defines “net book value assets” as the total value of all assets (tangible and intangible) as reported on the balance sheet, minus depreciation and amortization. 1 Crucially, liabilities are not deducted in this calculation. This means that a startup with $6 million in equipment and $4 million in debt would not qualify as a small business because its net book value of assets ($6 million) exceeds the $5 million threshold. This asset test is a critical consideration for manufacturers who may need to purchase significant amounts of supply-related machinery or maintain high inventories of raw materials, as these assets could inadvertently disqualify them from the refundability provision. 1

Identifying Qualified Research Activities (QRAs) for Supply Consumption

To remain eligible for the credit, the supplies must be consumed during activities that satisfy the IRS’s “four-part test.” This test ensures that the research is truly innovative and not merely routine product maintenance or cosmetic alteration. 6

1. The Permitted Purpose Test

The research must relate to a new or improved function, performance, reliability, or quality of a business component. 5 Supplies consumed in research that is purely aesthetic—such as testing different colors for a product’s exterior without changing its performance—do not qualify. 5 However, if a different material is tested to see if it reduces the weight of a drone while maintaining structural integrity, the cost of that material is a qualified supply. 6

2. Elimination of Uncertainty Test

The taxpayer must intend to discover information that would eliminate uncertainty regarding the capability, method, or appropriate design for developing or improving the business component. 6 Uncertainty exists if the information available to the taxpayer does not establish the best way to achieve the desired result at the outset of the research. 6 Supplies used in “validation” testing—where the design is already proven and the company is simply checking for manufacturing defects—generally do not qualify. 5

3. Process of Experimentation Test

Substantially all of the research activities must constitute a process of experimentation. This involves the systematic evaluation of one or more alternatives, often through modeling, simulation, or trial and error. 6 Materials consumed in “test batches” or “pilot runs” are prototypical qualified supplies, provided the purpose of the run is to refine the design or process rather than to produce units for sale. 5

4. Technological in Nature Test

The process of experimentation must fundamentally rely on principles of the “hard” sciences: engineering, computer science, biological science, or physical science. 6 Supplies used in behavioral studies, market research, or economic analysis are ineligible. 5

Industry-Specific Applications of the Supply Definition

The practical application of the definition of “supplies” varies significantly across Maryland’s diverse industrial landscape.

Biotechnology and Pharmaceuticals

In Maryland’s extensive “BioHealth Capital Region,” supply costs are often a major driver of R&D investment. Qualified supplies in this sector typically include:

• Reagents and Catalysts: Chemical agents used to trigger reactions or identify biological markers. 1
• Disposable Labware: Pipettes, petri dishes, and single-use bioreactor liners that are contaminated or consumed during a single experiment. 1
• Active Pharmaceutical Ingredients (APIs): Small quantities of medicinal compounds used in formulation trials or pre-clinical testing. 5

Manufacturing and Aerospace

For Maryland’s aerospace and defense contractors, supplies are often synonymous with prototype development. Qualified expenses include:

• Metals and Composites: Raw materials used to build structural test models. 1
• Electronic Components: Sensors, microchips, and breadboards used to develop new avionics or navigation systems. 1
• Consumable Tooling: Drills, abrasives, or 3D-printing resins that are consumed during the fabrication of a one-off experimental unit. 1

Software and Cloud Computing

While software development is primarily labor-intensive, certain supply-like costs have become increasingly important. Under federal and Maryland guidelines, the cost of “computer rental” or “leased time” on remote servers (cloud hosting) can be treated as a qualified research expense. 1

• Cloud Hosting for Development: Costs paid to providers like AWS or Azure to host a development/test environment for new software architectures. 1
• Data Consumption: Charges for high-volume data sets used to train machine learning models, provided the data is “consumed” or transformed as part of the experimentation process. 7

Case Study: “Chesapeake Avionics LLC”

To illustrate the interplay between state law, revenue office guidance, and supply definitions, consider a hypothetical Maryland-based company, Chesapeake Avionics LLC.

The Innovation Project

In 2024, the company undertook a project to develop a new, light-weight emergency landing system for small aircraft. The goal was to reduce the system’s total weight by 15% without compromising the deployment speed.

The Expenditures

The company tracked the following expenses related to the project:

1. Aluminum Alloy: $45,000 for specialized aircraft-grade aluminum used to build four different iterations of the landing gear housing. Three of these iterations failed stress tests and were scrapped. The fourth was retained for the certification prototype.
2. Sensors: $12,000 for 50 specialized pressure sensors. 45 sensors were destroyed during various “crash-test” simulations to determine the point of failure.
3. Simulation Software License: $8,000 for a one-year license for engineering simulation software.
4. Computer Workstation: $5,000 for a high-powered workstation purchased for the lead engineer.
5. Maryland Nexus: All aluminum and sensors were purchased from a vendor in Ohio but were delivered to and consumed at Chesapeake’s facility in Annapolis, Maryland.

Analysis of Eligibility for Supplies

• Aluminum Alloy ($45,000): This is a Qualified Supply. It is tangible property, not depreciable, and was consumed in a process of experimentation to solve a design uncertainty regarding weight vs. strength. Because it was physically used in Annapolis, it meets the Maryland nexus requirement. 1
• Sensors ($12,000): These are Qualified Supplies. Although the sensors themselves are finished products, they were “consumed” (destroyed) during the experimental process. Their cost is therefore an in-house supply QRE. 1
• Software License ($8,000): This is Not a Qualified Supply. Software licenses are intangible property. While software development costs may qualify for wages, the cost of purchasing or licensing software for use in R&D is generally not considered a “supply” under IRC § 41(b)(2)(C). 1
• Computer Workstation ($5,000): This is Not a Qualified Supply. This is a capital asset with a useful life of more than one year. It must be depreciated, and therefore the purchase price is ineligible for the R&D credit. 1

Calculating the Maryland Benefit

Assuming Chesapeake Avionics has a historical base amount of $40,000 and is certified as a “small business” ($3M in net book value assets):

1. Current Year Maryland QREs (Supplies Only): $45,000 + $12,000 = $57,000.
2. Excess QREs: $57,000 – $40,000 = $17,000.
3. Statutory Credit (10%): $17,000 * 0.10 = $1,700.
4. Impact of Proration: If the program is oversubscribed by 8x, the actual certified credit may be only $212.50.
5. Refundability: Since the company is a “small business,” this $212.50 can be received as a cash refund if the company has no tax liability. 1

Procedural Requirements for Claiming the Credit

To successfully secure the R&D credit in Maryland, a company must follow a rigorous administrative timeline. Failure to adhere to these deadlines or documentation standards will result in a disallowance of the claim. 1

The Certification Application

The application to the Department of Commerce is the foundation of the claim. Applicants must provide:

• Evidence of Maryland Nexus: A confirmation that all claimed expenses were incurred in the state. 8
• Federal Alignment: A copy of Federal Form 6765, if the company also claimed the federal credit. 17
• Historical Data: QRE and Gross Receipts data for the preceding four years to calculate the base amount. 1

Filing the Tax Return

After receiving the certification letter (typically by February 15 of the second year), the taxpayer must:

1. File an Amended Return: The R&D credit is technically for the prior tax year. To claim it, the taxpayer must file an amended Maryland income tax return for the year in which the expenses were incurred. 1
2. Attach Form 500CR: For corporations, the credit is reported on Form 500CR, Part K. 19
3. Include the Certification Letter: A copy of the letter from the Department of Commerce must be attached to the return. 1

Pass-Through Entities (PTEs)

For partnerships, S-corporations, and LLCs, the credit is calculated at the entity level but “passed through” to the individual members. 1

• Form 510: The PTE must file Maryland Form 510 and complete the Form 500CR section to establish the credit. 19
• Schedule K-1: The PTE must provide each member with a Maryland Schedule K-1, showing their proportionate share of the credit based on their ownership interest. 1
• Individual Filing: The members then claim the credit on their personal Maryland returns (Form 502) using Form 502CR. 6

Documentation and Substantiation for Supplies

Given the “consumption in Maryland” requirement and the IRC § 41 standards, documentation is the most frequent point of failure in R&D audits. The Maryland Comptroller recommends a “contemporaneous” approach to record-keeping. 1

Recommended Documentation for Supplies

Economic and Legislative Trends (2025 Outlook)

The Maryland R&D credit is a dynamic program that evolves with the state’s budget and legislative priorities. Several recent and upcoming changes are relevant for businesses planning their R&D investments. 1

Legislative Extensions

The program is currently authorized through June 30, 2027. 1 While the General Assembly has historically extended the credit, the expiration date serves as a reminder of the program’s reliance on legislative approval and the need for businesses to stay informed about potential policy shifts. 1

The Impact of Federal Tax Reform (OBBBA 2025)

The federal “One Big Beautiful Bill Act” (OBBBA) of 2025 has had a significant ripple effect on state R&D credits. 7

• Immediate Expensing (Section 174A): The OBBBA restored the ability for businesses to immediately deduct domestic R&D costs, including supplies, in the year they occur. This replaces the 5-year amortization requirement that had been in place since 2022. 7
• Retroactive Relief: Small businesses may have the opportunity to amend returns for 2022-2024 to claim immediate deductions for research costs that were previously capitalized. 7
• Interaction with Maryland Credit: Since Maryland adopts federal taxable income as the starting point for its own calculations, the restoration of immediate expensing simplifies the state tax return and increases current-year deductions for Maryland innovators. 7

The 2025 Income Tax Benefit Transfer Program

Beginning July 1, 2025, Maryland introduced a program that allows “eligible technology companies” with unused R&D credits to transfer those credits to other businesses. 22 This is a transformative development for startups that may have massive supply costs—such as those in hardware or medical device development—but lack the profitability to utilize the credit themselves. By selling the credit to a larger corporation, the startup can generate immediate working capital to reinvest in further research. 22

Summary Comparison of Supply Eligibility

The following table serves as a quick-reference guide for tax professionals and business owners to distinguish between qualifying and non-qualifying supply-related expenses.

Conclusion

The meaning of “supplies for qualified research” in Maryland is an exacting standard that requires a firm to demonstrate both technological innovation and a tangible physical connection to the state. By adopting the federal IRC § 41 definitions, Maryland ensures that its innovators are measured against a globally recognized standard of scientific inquiry. However, the state’s additional layers of administrative oversight—including the mandatory certification by the Department of Commerce, the geographic consumption requirement, and the asset-based test for small business refundability—make the Maryland R&D credit a complex but rewarding incentive.

For businesses operating in the state’s high-tech corridors, from the laboratories of Montgomery County to the manufacturing hubs of Baltimore, the strategic documentation of supply consumption is not merely a task for the accounting department; it is a fundamental component of the R&D funding strategy. As the state moves toward more flexible mechanisms like the 2025 credit transfer program and aligns with the federal restoration of immediate expensing, the Maryland R&D tax credit remains a vital tool for turning the “supplies” of today into the breakthroughs of tomorrow. 1

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