Reforming Maryland’s R&D Tax Credit: Addressing the Base-Amount Penalty

Executive Summary

Maryland currently offers a research‐and‐development (R&D) tax credit equal to 10% of qualified R&D expenses above a “base amount”, defined by federal §41(c) over the prior four years.¹ By design, only incremental R&D spending generates a credit. Small and midsize businesses (SMBs) with steady or flat R&D budgets therefore receive little or no benefit, even if they incur substantial R&D costs. This “base‐amount” approach deviates from simpler flat-credit models in peer states and can discourage ongoing R&D investment by established firms. If unaddressed, it risks reducing Maryland’s competitiveness and innovation output.

This whitepaper examines Maryland’s current R&D tax credit framework and this base‐penalty issue. It reviews how other states structure R&D credits to support SMBs and identifies two practical reform options: (1) introduce an alternative credit or flat‐credit for SMBs; and (2) modify the base‐amount calculation or allow a simplified credit election. For each option, we outline implementation approaches, safeguard measures (to prevent fraud or waste), and cost implications. We also present a brief fiscal analysis, framing upfront revenue costs against longer-term economic gains. Finally, we highlight the importance of reform and the adverse consequences if the base‐penalty remains.

1. Maryland’s Current R&D Credit Framework

Maryland’s R&D tax credit is administered by the Department of Commerce. In its current form, the credit equals 10% of qualified Maryland R&D expenses (QREs) in excess of the “Maryland base amount,” subject to caps.¹ (A small 3% credit for expenses up to the base amount used to exist but was repealed in 2021.^2,3) Thus today only incremental spending earns credit. The base amount is calculated per federal §41(c) rules: it’s essentially the product of a firm’s average R&D intensity over the last four years times its average Maryland receipts.⁴ Put simply, if a company’s current R&D spending equals its historical average (so that “excess” is zero), it gets no credit on that spending.

Key features of the Maryland R&D credit include:

• Incremental structure: Credit = 10% of (current‐year QREs – base amount).¹ Expenses up to the base amount yield no credit (apart from the repealed 3% credit).
• Caps and limits: Total R&D credits per year are capped at $12 million (with a $3.5 million set-aside for small businesses).^5,6 Credits per firm are limited to $250,000 each year (equivalent to 10% of the first $2.5 million of incremental R&D).⁷ If applications exceed the cap, credits are prorated proportionally.
• SMB definition: A “small business” is a for-profit entity with net book assets under $5 million.⁸ Approved credits for SMBs (those with <$5 million assets) are refundable if they exceed income tax liability.⁹

Maryland follows federal definitions of R&D and qualified expenses,¹⁰ and businesses must apply by November 15 each year for the preceding tax year’s expenses.¹¹ Applications require documentation of QREs and asset value (for SMB status). After certification, taxpayers can carry unused credits forward up to seven years.¹²

2. The Base‐Amount Penalty and Its Impact

Under this system, an established Maryland firm that consistently budgets the same amount for R&D year after year effectively has a “moving target.” Its base amount (roughly its historical average R&D) rises along with its spending, so only spending above that high baseline yields credit. For example, a company with $1 million of R&D every year (for 4+ years) would have a base of $1 million, so in year five its excess is $0 and it earns no credit, despite spending $1 million. By contrast, a startup or high-growth company with low past spending can reap a larger credit on its new R&D.

This design can penalize stable SMBs. Such firms do not see rewards for maintaining R&D; in effect the credit encourages increases rather than ongoing investment. A recent Maryland legislative report notes that the current structure “generates disparities in the credit rates” received by firms with different growth levels.¹³ Many Maryland businesses with incremental R&D above $2.5 million (the cap threshold) end up with a prorated credit far below the statutory 10% rate.^14,15 This complexity and unpredictability can discourage R&D planning and undermines the program’s goal “to foster increased research activities”.¹⁶

Peer-State Benchmarking

Peer-state comparisons underscore the issue: Several other states either provide baseline credits or alternate methods so that even non-growing R&D earns benefits.

• South Carolina: Allows a flat 5% credit on all qualified R&D spending (with a 50% liability cap).^17,18
• Delaware: Permits taxpayers to elect either the incremental 10% method or an alternate 50% of the federal research credit.¹⁹
• Virginia: Offers an optional simplified method: a 10% credit on current R&D minus 50% of the 3-year prior average (or 5% of R&D if no history).²⁰
• Pennsylvania: Provides a 20% credit to “qualified small businesses” (defined similarly by assets).²¹

These approaches acknowledge that strict base‐only rules may unduly limit SMB benefit.

If Maryland’s base-amount rule is not reformed, negative consequences may ensue. SMBs may shift or reduce their R&D activity, knowing they receive little incentive to maintain a flat budget. This could slow innovation in key sectors (e.g. biotech, cybersecurity, etc.) and ultimately weaken the State’s economic growth. Moreover, Maryland risks falling behind peer states in attracting R&D-intensive companies. In short, without change, the tax credit’s impact will remain concentrated among companies aggressively ramping up R&D, while steady performers see scant reward.

3. Policy Reform Options

To address this imbalance, Maryland policymakers could amend the R&D credit law in several practical ways. Below are two broad solutions (with variations) that could be enacted. Each aims to reward SMB R&D more fairly while retaining necessary oversight.

Option 1: Alternative or Flat Credit for SMBs

Proposal: Create a special R&D credit for small businesses that bypasses (or relaxes) the base‐amount rule. For example, Maryland could allow an SMB to claim a fixed percentage of all its qualified R&D expenditures (with appropriate limits), rather than only spending above the base. Alternatively, the State could let SMBs choose a simpler formula (such as Delaware’s Method B or a flat-rate credit).

• South Carolina Style: Offer SMBs a flat 5% (or higher) credit on all Maryland R&D spending,¹⁷ up to a liability limit. This ensures even stable SMBs earn a credit. To parallel MD’s refundable SMB policy, the flat credit could also be made refundable (or with a low carry-forward cap).
• Enhanced SMB Rate: Increase the credit rate for small businesses’ incremental R&D. For instance, raise the 10% to 15–20% for firms under $5 million assets (similar to Pennsylvania’s 20% rate for SMBs).²¹ The base amount would still apply, but SMBs would get a larger share of their excess spending back.

Implementation: The Maryland General Assembly would amend Tax‑General §10‑721 to define a new SMB credit. For example, add a subsection: “Notwithstanding the base amount rules, a qualified small business may claim an R&D credit equal to X% of all Maryland qualified R&D expenses incurred during the tax year.” Qualifying criteria (e.g. asset or revenue limits) could mirror the existing $5 million net-assets test. Commerce would issue guidance on documentation (likely similar to current rules) to verify the expenses.

Cost & Benefits: This change would cost the State additional revenue upfront (the flat credit on base-year spending is new spending). However, the scale is modest given the program’s $12 million annual cap. For instance, if every small business used $1 million of R&D, a 5% flat credit would yield $50,000 per firm. Even if ten firms did so, that’s $500,000/year—small relative to Maryland’s budget, and still under the small-business $3.5 million set-aside. Long-term, encouraging consistent R&D should boost innovation: more new products, patents, and high-paying jobs in Maryland. Economic studies find that lowering the “user cost” of R&D spurs firms to invest more.²² Those investments expand payrolls and profits, generating future income and sales taxes that help recoup the initial outlay.

Safeguards: To prevent abuse, the flat SMB credit would use the same strict definitions and application process as the existing credit. Commerce would verify that claimed expenses meet the federal R&D criteria.¹⁰ The overall program caps (including the $12 million total and $250k per-firm limits ^5,7) would still apply. In practice, the flat credit means no one can claim more than the statutory per-firm cap. Further oversight can include random audits by the Comptroller’s Office of certified credits (as is common for tax incentives). Because SMBs can get refunds if credits exceed their tax, Maryland should require any refund applicants to submit documentation and possibly affidavit of QREs. The Department should continue publishing annual reports on credit use (as now) to track utilization.

Option 2: Modify the Base‐Calculation (Alternative Method)

Proposal: Allow taxpayers to use a simplified or reduced base amount when computing the credit. In practice, this means lowering the hurdle before a credit accrues. Two approaches:

• Federal‐ASC Style: Permit an election for an Alternative Simplified Credit as in IRC §41(c)(5). For example, Maryland could let firms compute their credit as “10% of QREs minus 50% of the average of the prior 3 years of QRE” ²⁰ (mirroring Virginia’s existing option), or even adopt a 14% ASC method. In effect, this gives credit on half of a firm’s historical spending, so even flat budgets generate a 5%–10% credit on total R&D.
• “New Base” Formula: For small businesses, define the base amount as a fraction (e.g. 50–75%) of the standard calculation. For instance, the law could state that SMBs’ base amount is only 75% of the §41(c) base, lowering the threshold for credit.

Example – Virginia’s Option: Virginia allows taxpayers (for tax years ≥2016) to elect a credit equal to 10% of current VA R&D minus 50% of the 3-year prior average.²⁰ If a firm had $100k R&D each year previously, its base is $50k, so a current year of $100k yields $5k credit (10% of $50k). Crucially, even if the firm repeats $100k again, it still gets credit because its base is only half the average. Maryland could adopt a similar optional rule statewide or specifically for SMBs.

Implementation: Amend §10‑721 to add an alternative computation clause. For example: “A taxpayer may elect to compute its credit as X% of (Maryland R&D expenses – Y% of the average of the last 3 taxable years).” Clear definitions of “election” (once per tax year) and carryforward should be provided. Existing regulations would need updating (currently they only describe the fixed base method ³). Commerce could issue a simplified worksheet (like other states do) to help compute the new method.

Cost & Benefits: Switching to an ASC‐type method would shift some credits to firms with steady R&D. The immediate revenue effect is similar to increasing the credit rate: more firms would qualify and possibly at higher amounts. But again, the total program limit bounds the fiscal cost. Over time, this change encourages firms not to fear tax “cliffs” if they maintain R&D spending. Studies indicate that making R&D cheaper (even for constant spending) raises innovation output and economic growth.²² Because the credit remains incremental (just with a smaller baseline), Maryland gets innovation returns on additional R&D, improving tax receipts eventually.

Safeguards: As with Option 1, strict documentation is key. Firms electing the simplified method would still submit the same QRE records and undergo Commerce certification. The alternative method itself can include caps. For example, Virginia’s version caps the alternate credit at $45k (or $60k with university collaboration) per firm per year.²³ Maryland could mirror that with a per-firm cap to limit exposure. All current statutory caps ($12 million total, $3.5 million SMB carve-out, $250k per firm ^5,7) would remain. Audits should verify that the reduced base was correctly applied and that prior-year data are accurate. Commerce might require a statement that the taxpayer’s average 3-year history is correct, subject to review.

4. Implementation and Oversight

Implementing either solution would require legislative change and updated administration procedures. For Option 1 (flat SMB credit), the General Assembly must amend Tax‑General §10‑721 to define the new credit and its eligibility. For Option 2 (alternative base method), the law must explicitly allow the election and specify the formula. In both cases, Commerce (in coordination with the Comptroller) would issue new regulations and guidance. Importantly, these changes align with the program’s purpose: as enacted, the credit’s purpose is to “foster increased research activities and expenditures in Maryland”.¹⁶ Any reform should be framed as enhancing that goal.

To prevent fraud and waste, Maryland should leverage existing controls and add modest new safeguards:

• Strict Definitions and Documentation: Continue requiring that only expenditures meeting the federal §41 criteria count as QRE.¹⁰ Applicants already must certify expenses and assets under penalty of perjury. Commerce should keep thorough records of approved projects (as now) and coordinate with the Comptroller’s audits of tax returns claiming the credit.
• Caps and Proration: Maintain the overall $12 million cap and $250k per-firm limit.^5,7 These cap provisions inherently limit exposure. (The $250k cap ensures no taxpayer gets more than 10% of $2.5m incremental R&D.⁷) If credits are oversubscribed, prorating equitably reduces everyone’s benefit, which already happens under current law.
• Periodic Audits and Reviews: The State can periodically audit awardees. For example, the Comptroller could select a sample of certified firms each year to verify that expenses truly qualified and that the claimed amounts match the approved certificate. Findings (and any recapture) should be reported to the legislature. This oversight mechanism is common for tax credits.
• Data Transparency: Commerce should continue publishing an annual report (as required) showing the number of awards, total credits granted, and average credit sizes. Enhanced reporting (e.g. breakdown by firm size, industry) would help legislators assess whether the reformed credit is reaching intended SMBs. (Indeed, DLS has recommended that Commerce collect more detailed data.^24,25)
• Coordination with Federal Filings: Since the base calculation still relies on past R&D and receipts, Commerce may verify those figures against federal returns or audited financials. Requiring submission of a federal R&D tax form (Form 6765) or equivalent project documentation is one method. Delaware’s forms, for instance, ask for an attached Form 6765.²⁶ Maryland could similarly require proof of federally‐claimed R&D expenditures and base percentage.

5. Fiscal Considerations and Long-Term ROI

Any enhancement to the credit increases fiscal cost in the short term. However, it is important to frame this cost as an investment that yields greater economic activity and tax revenues later.

• Scale of Initial Cost: The R&D credit program already has a predictable annual cost of up to $12 million.⁶ Permitting more firms to claim credits or a higher percentage will push actual awards closer to the cap (if not already), but will not exceed it unless the cap is raised. For example, if currently $12 million is fully subscribed, widening eligibility simply redistributes existing awards. If the program is not fully subscribed, there is some fiscal headroom.
• Economic Multiplier: R&D is highly innovative; investments today often yield disproportionately large returns. Academic studies find that reducing the effective cost of R&D induces firms to spend more. One study cited by Maryland’s analysts found a 10% reduction in the “user cost” of R&D prompted a 19.8% short-run increase in R&D intensity.²² More R&D leads to new products, patents, and businesses. These successes expand corporate profits and wages, thereby broadening the State’s tax base. Over a multi-year horizon, some of the upfront tax credit “subsidies” effectively pay for themselves through this growth.
• Revenue Recapture: New R&D activity generates future tax collections. For instance, commercialization of new technologies produces sales and income subject to state tax. Even during the development phase, payroll and purchases associated with R&D (e.g. lab equipment, services) generate sales tax and corporate tax from suppliers. These indirect gains help offset the initial credit cost.
• Return on Investment: While precise ROI is hard to estimate without a dynamic model, many states use analyses showing R&D credits stimulate innovation clusters (e.g. Maryland’s life sciences corridor). Given that Maryland offers other R&D incentives (like a sales tax exemption ²⁷), improving the income tax credit enhances those clusters’ viability. Over time, a more attractive R&D climate can attract new firms (increasing corporate income tax revenue) and encourage spin-offs (bolstering the local tech economy).

6. Consequences of Inaction

Maintaining the status quo carries risks for Maryland’s innovation ecosystem. Key negatives include:

• Competitive Disadvantage: Maryland firms would continue to face a relative disincentive to sustain R&D. Competing states (PA, VA, DE, SC, etc.) offer more generous or simpler credits, so Maryland could lose investment. Tech companies, for instance, often compare state incentives; a rigid incremental-only credit may tilt decisions away from Baltimore/DC area.
• Slowed Innovation: Without a credit for steady R&D spending, companies may cut back on projects that do not promise “ramp-ups.” For example, product improvement or maintenance research could be deferred. Over years, this can stifle incremental innovation that keeps Maryland businesses competitive, leading to flatter productivity growth.
• Inequity and Perceptions: Small businesses that have historically invested in R&D will rightly view the policy as unfair. This could create political pressure or calls for carve-outs anyway. More damaging, if many SMBs simply do not apply for the credit (as seems implied by DLS’s note on underutilization ²⁸), the program fails its purpose.
• Fiscal Inflexibility: Ironically, a poorly designed credit can actually cost more due to complexity. Prorations and appeals (as noted by Commerce’s cumbersome allocation process ¹⁴) waste administrative resources. A simpler, more predictable credit would be easier to budget and manage.

In summary, leaving the base-amount rule unchanged means Maryland will continue to subsidize growth in R&D but not continuation of R&D, which undercuts the stated aim of fostering innovation. Reforming the credit restores alignment with that aim and signals support for all innovators, not just the fastest growing.

Conclusion

Updating Maryland’s R&D tax credit rules is essential to rewarding steady, high-value research alongside rapid growth. By establishing an Alternative Flat Credit for SMBs or adopting a Virginia-style Alternative Simplified Credit (ASC) method, Maryland can level the playing field for established local innovators, boost regional competitiveness, and ensure that every dollar of research investment contributes to long-term economic prosperity.

Works Cited

1. Evaluation of the Research and Development Tax Credit, accessed July 31, 2026, https://dls.maryland.gov/pubs/prod/TaxFiscalPlan/Evaluation-of-the-Research-and-Development-Tax-Credit-2024.pdf
2. Evaluation of the Research and Development Tax Credit, accessed July 31, 2026, https://dls.maryland.gov/pubs/prod/TaxFiscalPlan/Evaluation-of-the-Research-and-Development-Tax-Credit-2024.pdf
3. Research and Development Tax Credit Regulations 1-03, accessed July 31, 2026, https://commerce.maryland.gov/Documents/FinanceDocument/RDTC-%20Regulation.pdf
4. Evaluation of the Research and Development Tax Credit, accessed July 31, 2026, https://dls.maryland.gov/pubs/prod/TaxFiscalPlan/Evaluation-of-the-Research-and-Development-Tax-Credit-2024.pdf
5. Business Tax Credits | Research and Development | Maryland Department of Commerce, accessed July 31, 2026, https://commerce.maryland.gov/fund/programs-for-businesses/research-and-development-tax-credit
6. Evaluation of the Research and Development Tax Credit, accessed July 31, 2026, https://dls.maryland.gov/pubs/prod/TaxFiscalPlan/Evaluation-of-the-Research-and-Development-Tax-Credit-2024.pdf
7. Evaluation of the Research and Development Tax Credit, accessed July 31, 2026, https://dls.maryland.gov/pubs/prod/TaxFiscalPlan/Evaluation-of-the-Research-and-Development-Tax-Credit-2024.pdf
8. Maryland Department of Commerce, commerce.maryland.gov, accessed July 31, 2026, https://commerce.maryland.gov/Documents/Tax%20General%2010%20721.pdf
9. Business Tax Credits | Research and Development | Maryland Department of Commerce, accessed July 31, 2026, https://commerce.maryland.gov/fund/programs-for-businesses/research-and-development-tax-credit
10. Business Tax Credits | Research and Development | Maryland Department of Commerce, accessed July 31, 2026, https://commerce.maryland.gov/fund/programs-for-businesses/research-and-development-tax-credit
11. Business Tax Credits | Research and Development | Maryland Department of Commerce, accessed July 31, 2026, https://commerce.maryland.gov/fund/programs-for-businesses/research-and-development-tax-credit
12. Evaluation of the Research and Development Tax Credit, accessed July 31, 2026, https://dls.maryland.gov/pubs/prod/TaxFiscalPlan/Evaluation-of-the-Research-and-Development-Tax-Credit-2024.pdf
13. Evaluation of the Research and Development Tax Credit, accessed July 31, 2026, https://dls.maryland.gov/pubs/prod/TaxFiscalPlan/Evaluation-of-the-Research-and-Development-Tax-Credit-2024.pdf
14. Evaluation of the Research and Development Tax Credit, accessed July 31, 2026, https://dls.maryland.gov/pubs/prod/TaxFiscalPlan/Evaluation-of-the-Research-and-Development-Tax-Credit-2024.pdf
15. Evaluation of the Research and Development Tax Credit, accessed July 31, 2026, https://dls.maryland.gov/pubs/prod/TaxFiscalPlan/Evaluation-of-the-Research-and-Development-Tax-Credit-2024.pdf
16. Maryland Department of Commerce, commerce.maryland.gov, accessed July 31, 2026, https://commerce.maryland.gov/Documents/Tax%20General%2010%20721.pdf
17. South Carolina Department of Revenue TC-18 Form, dor.sc.gov, accessed July 31, 2026, https://dor.sc.gov/sites/dor/files/forms/TC18.pdf
18. South Carolina Department of Revenue TC-18 Form, dor.sc.gov, accessed July 31, 2026, https://dor.sc.gov/sites/dor/files/forms/TC18.pdf
19. Delaware Division of Revenue BUS-RDC Form, revenuefiles.delaware.gov, accessed July 31, 2026, https://revenuefiles.delaware.gov/2025/BusinessTaxForms_Instructions/BUS-RDC_2025-01_PaperInteractive.pdf
20. § 58.1-439.12:08. Research and development expenses tax credit – Virginia Law, accessed July 31, 2026, https://law.lis.virginia.gov/vacode/title58.1/chapter3/section58.1-439.12:08/
21. Are R&D Tax Credits Available in Pennsylvania? | See if You Qualify – KBKG, accessed July 31, 2026, https://www.kbkg.com/research-tax-credit/pennsylvania-rd-tax-credit
22. Evaluation of the Research and Development Tax Credit, accessed July 31, 2026, https://dls.maryland.gov/pubs/prod/TaxFiscalPlan/Evaluation-of-the-Research-and-Development-Tax-Credit-2024.pdf
23. § 58.1-439.12:08. Research and development expenses tax credit – Virginia Law, accessed July 31, 2026, https://law.lis.virginia.gov/vacode/title58.1/chapter3/section58.1-439.12:08/
24. Evaluation of the Research and Development Tax Credit, accessed July 31, 2026, https://dls.maryland.gov/pubs/prod/TaxFiscalPlan/Evaluation-of-the-Research-and-Development-Tax-Credit-2024.pdf
25. Evaluation of the Research and Development Tax Credit, accessed July 31, 2026, https://dls.maryland.gov/pubs/prod/TaxFiscalPlan/Evaluation-of-the-Research-and-Development-Tax-Credit-2024.pdf
26. Delaware Division of Revenue BUS-RDC Form, revenuefiles.delaware.gov, accessed July 31, 2026, https://revenuefiles.delaware.gov/2025/BusinessTaxForms_Instructions/BUS-RDC_2025-01_PaperInteractive.pdf
27. Evaluation of the Research and Development Tax Credit, accessed July 31, 2026, https://dls.maryland.gov/pubs/prod/TaxFiscalPlan/Evaluation-of-the-Research-and-Development-Tax-Credit-2024.pdf
28. Evaluation of the Research and Development Tax Credit, accessed July 31, 2026, https://dls.maryland.gov/pubs/prod/TaxFiscalPlan/Evaluation-of-the-Research-and-Development-Tax-Credit-2024.pdf