Comprehensive Analysis of the “Location Where Services Are Performed” Standard for the Maryland Research and Development Tax Credit

The “Location Where Services Are Performed” refers to the statutory requirement that all qualified research activities must be physically conducted within Maryland’s geographical borders to qualify for state-level tax credits. This standard mandates that the physical presence of personnel, the site of contracted development, and the consumption of research supplies must occur specifically in the State to be incorporated into the calculation of Maryland Qualified Research Expenses.

The determination of whether research and development is conducted in the State is a complex, multi-factor analysis overseen by the Maryland Department of Commerce and the Comptroller of Maryland.1 Under the Maryland Tax-General Article § 10-721, the state does not merely accept the federal designation of a qualified research expense; it layers a strict geographical nexus requirement that focuses on the physical site of service execution.2 This regulatory framework is designed to ensure that the fiscal incentives provided by the State are effectively recycled into the local economy, fostering the creation of high-tech job clusters and the maintenance of physical research infrastructure within Maryland.3 For corporate tax directors and small business owners, understanding this nuance is critical, as out-of-state labor or remote work performed by individuals residing beyond Maryland’s jurisdiction may result in a significant reduction of the certified credit amount, even if the activities are otherwise qualified under the Internal Revenue Code.5

Statutory Foundations of the Maryland R&D Tax Credit

The Maryland Research and Development Tax Credit is codified under § 10-721 of the Tax-General Article of the Annotated Code of Maryland.1 The statute establishes two primary forms of credit: a basic credit and a growth credit, although recent legislative alterations have shifted the primary incentive toward the growth-based model.8 The purpose of this program is explicitly stated in the law: to foster increased research activities and expenditures within the State.2

Integration with Federal Law

The Maryland credit is deeply rooted in Section 41 of the Internal Revenue Code (IRC). The state law adopts the federal definitions of “qualified research” from § 41(d) and “qualified research expenses” (QREs) from § 41(b).2 Consequently, for an activity to qualify in Maryland, it must first pass the federal four-part test: the activity must be intended to create a new or improved business component; it must be technological in nature; it must involve a process of experimentation; and it must eliminate a technical uncertainty.11 However, once an activity is deemed “qualified research” under federal standards, the Maryland statute imposes a further filter: the research must be “Maryland qualified research and development,” meaning it must be “conducted in this State”.2

Legislative Evolution and the Growth Credit Focus

The Maryland General Assembly has enacted several critical amendments to the R&D credit to maximize its economic impact. Senate Bill 196 (2021) represented a significant shift in the program’s architecture.8 This legislation effectively repealed the 3% basic credit in many contexts, focusing the state’s resources on a 10% credit for expenses that exceed the “Maryland base amount”.3 This shift reinforces the “Location Where Services Are Performed” standard by incentivizing companies not just to maintain a presence in the state, but to incrementally expand their physical research footprint.2

The Multi-Factor Test for Location Determination

In adopting regulations to define the “Location Where Services Are Performed,” the Maryland Department of Commerce and the Comptroller are authorized to consider a specific set of factors.1 These factors provide the analytical framework for determining whether the research expenses were truly “incurred for Maryland qualified research and development”.10

1. Physical Location Where Services are Executed

The primary factor is the actual physical site of the research activity.1 For laboratory-based research, this is straightforward: the work is performed where the lab is located. However, for software development and engineering design, the “site” is where the individual is physically located while coding or designing.5 If a Maryland-based company utilizes a software engineer who is physically located at a desk in Virginia or Delaware, those wages are generally excluded from the Maryland QRE calculation because the “services were performed” outside the state.5

2. Residence or Business Location of Personnel

The Department also considers the residence or business location of the persons performing the services.1 While an employee’s residence is a factor, the physical site of work often takes precedence. An employee who lives in Pennsylvania but commutes to a Maryland facility to perform research is generally viewed as performing services in Maryland.5 Conversely, the “business location” refers to the office or facility to which the employee is assigned and where they physically report.1 In the post-COVID era of remote work, this has become a point of contention; however, Maryland has largely returned to a “physical presence” standard, meaning remote work from an out-of-state home does not qualify for the credit.5

3. Location Where Supplies are Consumed

The location of supply consumption is the third statutory factor.1 This distinguishes between the point of purchase and the point of use. If a company buys specialized laboratory chemicals from a vendor in Massachusetts but uses them in a research facility in Rockville, Maryland, those supply costs qualify because the “consumption” occurred in Maryland.1 However, if the supplies are used in a satellite office outside Maryland, they are ineligible for the state credit, regardless of where the purchasing department is located.1

4. Other Relevant Factors

The statute provides the Department with the flexibility to consider any other factors deemed relevant for the determination.1 This may include the location of the cloud servers used for research, the site of prototype testing, or the location where clinical trials are managed.4 The Comptroller may also look at payroll withholding data to verify whether the company has been reporting the employees as Maryland-based workers for other tax purposes.11

State Revenue Office Guidance and Administrative Framework

The administration of the Maryland R&D tax credit is a joint effort between the Department of Commerce and the Comptroller’s Revenue Administration Division. Both offices provide critical guidance on how the location standard applies to the law.

Department of Commerce Oversight

The Department of Commerce is responsible for the certification of the credit.3 Before a taxpayer can claim the credit on a return, they must submit a formal application by November 15 of the year following the tax year in which the expenses were incurred.3 The application requires businesses to explicitly certify that their research was conducted in Maryland.

Specifically, the Department’s instructions require applicants to:

• Confirm that all eligible Maryland qualified R&D expenses, including those paid to 3rd party vendors, were incurred within Maryland.6
• Provide the physical address of the Maryland facility where the research occurred.6
• If multiple facilities are used, the applicant must attach a comprehensive list of all facility addresses to the application.6

Comptroller of Maryland and Form 500CR

Once the Department of Commerce issues a certification letter, the taxpayer must claim the credit on their Maryland income tax return using Form 500CR.19 The Comptroller’s instructions for Form 500CR emphasize that a copy of the certification letter must be attached to the return to substantiate the claim.11 For corporations, the return must be filed electronically if the R&D credit is being claimed.19 The Comptroller retains the authority to audit these claims to ensure that the “Location Where Services Are Performed” matches the payroll and facility data provided in the original application.10

Pass-Through Entities (PTEs) and Administrative Release 6

Maryland has unique rules for pass-through entities, such as S-corporations and LLCs, regarding how R&D credits are allocated and reported.21 According to Administrative Release 6, “Taxation of Pass-Through Entities,” and related technical bulletins, the R&D credit is typically calculated at the entity level and then passed through to the members or partners on their respective Maryland K-1s.21 If a PTE is doing business in Maryland, its nonresident members must report their distributive share of income allocable to Maryland, and they may use the R&D credit to offset the resulting tax liability.22

The Impact of Remote Work and Contractor Locations

The modern research environment often involves a mix of internal staff and external contractors, many of whom may work remotely. This presents significant challenges for meeting the Maryland location standard.

Wages for Remote and Commuting Employees

The physical presence of the employee is the “gold standard” for the Maryland R&D credit. Personnel who commute into Maryland from neighboring states (e.g., Virginia, DC, Pennsylvania) are eligible because their technical services are performed while they are physically located within a Maryland facility.1 However, the rise of telework has led to a stricter interpretation. If an employee resides and works from their home in Virginia, their wages are generally not “Maryland qualified research expenses” because the services are not performed in the State.5

Taxpayers must be prepared to demonstrate the physical nexus of their workforce. This is often accomplished through the maintenance of labor time sheets and location logs.11 If an employee splits their time between a Maryland office and an out-of-state home, only the portion of their wages attributable to the days spent physically in Maryland is eligible for the credit.6

3rd Party Vendor and Contractor Compliance

When a Maryland company outsources research to a 3rd party vendor or Contract Research Organization (CRO), the location standard still applies.12 For the expenses to qualify as Maryland QREs, the vendor must perform the research within Maryland.6 The applicant must verify this and check the “YES” box on the application confirming that vendor expenses were incurred in the state.6

Furthermore, a company may not include expenses paid to a contractor if the contractor is also claiming a Maryland R&D tax credit for those same expenses.6 This prevents the State from providing multiple incentives for the same activity. It is standard practice for Maryland businesses to include “location of performance” clauses in their R&D contracts to ensure that the work remains eligible for the state credit.12

Small Business Considerations and Asset Valuation

Maryland provides an enhanced version of the R&D credit for small businesses, including a unique refundability feature. However, to qualify for these benefits, the “Location Where Services Are Performed” must be paired with specific asset-based criteria.

Defining the “Small Business” for R&D Purposes

A “small business” is defined under § 10-721(a) as a for-profit corporation, LLC, partnership, or sole proprietorship with net book value assets totaling less than $5 million at the beginning or end of the taxable year.3 This calculation is distinct from revenue-based tests often used in other state programs.

$$\text{Net Book Value Assets} = \text{Total Assets (including intangibles)} – (\text{Depreciation} + \text{Amortization})$$

Notably, liabilities are not subtracted in this calculation.14 Small businesses must submit their balance sheet to the Department of Commerce as proof of their eligibility for the $3.5 million small business set-aside and the refundability of the credit.3

Refundability and Small Business Liquidity

For certified small businesses, the R&D tax credit is fully refundable.1 If the credit amount exceeds the business’s Maryland income tax liability for the year, the State will issue a refund for the excess.1 This is a powerful incentive for Maryland-based startups, as it provides non-dilutive capital even when the company is not yet profitable. However, the refund is still subject to the $12 million statewide cap and proration if the program is oversubscribed.3

Calculating the Credit: The Incremental Method

The Maryland R&D credit is calculated using an incremental method based on state-sourced data. This requires a precise determination of both Maryland QREs and Maryland Gross Receipts for the current year and the preceding four years.10

The Maryland Base Amount

The “Maryland base amount” is the threshold that current year expenses must exceed to qualify for the 10% growth credit.3 It is calculated by multiplying the “Maryland base percentage” by the average annual Maryland gross receipts for the four preceding years.10

$$\text{Maryland Base Percentage} = \frac{\text{Sum of Maryland QREs (Prior 4 Years)}}{\text{Sum of Maryland Gross Receipts (Prior 4 Years)}}$$

$$\text{Maryland Base Amount} = \text{Maryland Base Percentage} \times \text{Average Annual Maryland Gross Receipts}$$

If a business is in its first year of incurring R&D expenses in Maryland, the base amount is zero, allowing for a 10% credit on the entirety of their eligible Maryland expenses up to the cap.3

Proration and the Statewide Cap

Because the R&D tax credit program is consistently oversubscribed, the Department of Commerce often must prorate the awards.14 If the total amount of credits applied for by large businesses exceeds $8.5 million, or if the amount for small businesses exceeds $3.5 million, each applicant’s credit is reduced proportionally.3 This means that while a company may be “certified” for a certain amount based on its expenses, the actual credit it can claim on its tax return may be significantly lower.3

Practical Example: The Maryland Biotech Scenario

To understand how the “Location Where Services Are Performed” standard applies in practice, consider the case of Baltimore Bio-Innovations (BBI), a small startup.

1. Identifying the Workforce and Location

In 2024, BBI has ten researchers. Five work at their lab in East Baltimore. Three are residents of Virginia who commute to the Baltimore lab four days a week. Two are remote software developers who live and work full-time from their homes in North Carolina.

2. Categorizing Expenses

Under the “Location Where Services Are Performed” standard:

• The wages of the five lab researchers qualify as Maryland QREs.5
• The wages of the three Virginia commuters qualify because the research services are physically performed in Baltimore.1
• The wages of the two North Carolina remote developers are ineligible, as the services are not performed in Maryland.5

3. Supply and Asset Costs

BBI spent $50,000 on research supplies. $40,000 were consumed in the Baltimore lab. $10,000 were shipped to a partner facility in California for testing. Only the $40,000 consumed in Maryland qualifies.1

4. Calculating the Potential Credit

BBI’s total Maryland QREs are $800,000. Their calculated base amount is $300,000. The “Growth” amount is $500,000 ($800,000 – $300,000). The potential credit is 10% of $500,000, which equals $50,000.

5. Final Award After Proration

BBI submits its application by November 15, 2025. If the small business pool is oversubscribed by 20%, BBI’s final certified credit will be $40,000 ($50,000 x 0.80). Because BBI has net assets of $2 million, this $40,000 is fully refundable on its Maryland tax return.3

Compliance and Documentation Requirements

Meeting the “Location Where Services Are Performed” standard requires rigorous documentation to withstand audits by the Maryland Comptroller. The burden of proof lies with the taxpayer to show that the research was indeed conducted in the State.11

Essential Records for Substantiation

Companies should maintain the following records for at least four years:

• Facility Addresses and Leases: Evidence of the physical research site in Maryland.6
• Payroll Records and Time Sheets: Detailed logs indicating where employees were physically located when performing research tasks.11
• Contractor Invoices and Certificates: Invoices that specify the work location and certifications from vendors confirming they are not claiming the credit themselves.6
• Inventory and Consumption Logs: Records showing when and where research supplies were physically used or consumed.1
• Project Narrative Logs: Documentation (e.g., meeting minutes, Bugzilla reports, R&D logs) linking specific innovation activities to Maryland-based facilities.11

Risk of “Funded Research”

Maryland taxpayers must also be aware of the “funded research” trap under IRC § 41, which is adopted by Maryland. If a company performs research in Maryland but the work is funded by a client who retains all rights and bears all financial risk, the research may be ineligible for the credit.12 In Populous Holdings, Inc. v. Commissioner, the court found that fixed-price contracts often leave enough risk with the performing firm to allow them to claim the credit, provided they retain substantial rights to the research.12 Companies should ensure their Maryland-based research contracts are drafted with these federal and state incentives in mind.

Future Outlook and Emerging Legislation

The landscape of Maryland’s R&D incentives continues to evolve. Several recent legislative initiatives suggest that the state is doubling down on its commitment to location-based innovation.

The DECADE Act and Program Modernization

The Delivering Economic Competitiveness and Advancing Development Efforts (DECADE) Act (Senate Bill 427), effective July 1, 2025, aims to modernize Maryland’s economic development structures.25 While it streamlines many programs, it also expands potential funding for small businesses and technology companies, reinforcing the importance of the R&D credit as a primary tool for growth.25

Income Tax Benefit Transfer Program

A significant development is the Income Tax Benefit Transfer Program (House Bill 35), taking effect in July 2025.24 This bill will allow eligible technology companies to transfer unused R&D tax credits to other unaffiliated taxpayers in the State.24 This “sale” of credits provides a mechanism for companies that do not have enough tax liability to utilize their credits to still derive immediate financial value from their Maryland-based research activities. This program further emphasizes the need for a precise determination of the “Maryland apportionment factor” to value the transferrable credit.24

Conclusion

The “Location Where Services Are Performed” standard is the defining characteristic of the Maryland Research and Development Tax Credit. It transforms a broad federal incentive into a precise instrument of state economic policy, ensuring that Maryland tax dollars are used to support innovation that occurs within Maryland’s borders. For businesses, this requires a strategic approach to workforce management, supply chain logistics, and contractor relations.

By focusing on the physical site of labor and the consumption of supplies, the state creates a clear “in-state” mandate that rewards companies for investing in local talent and infrastructure. As the program enters a new era of refundability for small businesses and credit transferability for larger firms, the importance of maintaining rigorous documentation of the “Maryland-only” nature of research expenses has never been higher. For the innovative enterprise, the Maryland R&D tax credit offers a significant competitive advantage—provided they can prove that their research truly “takes place” in the State of Maryland.

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