Maryland Enacts Much-Needed Research & Development Credit Overhaul

On April 13, 2021, Maryland’s Governor Larry Hogan signed Senate Bill 196 into law, which makes significant changes to the state’s Research and Development (R&D) Tax Credit and extends the program through tax year 2025.  Maryland’s R&D Tax Credit was established in 2000 as a means of fostering innovation and technology, but the original structure of the program left many qualifying companies with a tax credit of as little as $1.

The approved legislation is an attempt to increase the dollar amount of the R&D tax credits issued to small businesses in the state, as well as incentivize companies to expand their R&D activities.  The Maryland Department of Legislative Services (DLS) found that under the original structure of the program approximately one-third of the credit recipients were small businesses.  However, these companies were only awarded about 2% of the total certified credits.  This was largely due to Maryland’s R&D credit program including the “basic credit” and a “growth credit,” with the “basic credit” not requiring a company to expand its R&D activities.  Thus, rather than fostering growth in R&D activities in the state, DLS found the structure of the credit program created a “windfall” of credit for R&D activities that would have occurred even without the credit.  Although likely not anticipated when this structure was designed, the existence of the basic credit also resulted in a disproportionate amount of the program’s funds going to a few large companies.  The specific changes made by Senate Bill 196 to address this are as follows:

• The Basic R&D Tax credit has been eliminated
• The funding for the growth R&D Tax Credit will be increased to $12 million.  This growth credit is equal to 10% of the amount by which a company’s Maryland qualified R&D expenses incurred during the taxable year exceed a Maryland base amount.
• Of the $12 million in available credits, only $8.5 million can be issued to companies that are not small businesses.  In other words, $3.5 million of the total tax credits have been allocated to qualified small businesses.  A “small business” means a business with net book value assets totaling less than $5,000,000.
• The maximum credit value allowed for any single taxpayer will be limited to $250,000.

These key changes will not only provide tax credits for new R&D activities within the state, but it will also assist start-up businesses, which often struggle to access enough capital to sustain R&D.  In assessing the potential economic impact of the changes to Maryland’s R&D program, DLS referred to a recent study that found the introduction of a state R&D tax credit can be associated with approximately a 7% increase in the rate of net new business formation.

In order for Maryland to see a similar impact, entrepreneurs will have to be confident that the changes to Maryland’s program will significantly increase the potential credits than under the prior structure.  It seems, at first glance, that the new structure of the program should be viewed as a positive change by small businesses.  The elimination of the basic credit addresses the primary reason why many companies’ credit amounts have been significantly prorated in recent years.  Similarly, having a specific amount of funding set aside for small businesses and setting a maximum credit amount of $250,000 will prevent a disproportionate amount of credits being issued to a few large companies in the state.

In short, the certified credit amount issued to a small business will be larger as a result of the changes enacted by Senate Bill 196.  Thus, the key feature of Maryland’s R&D credit program as it applies to small businesses will now be a meaningful benefit – that the credit is refundable for a qualifying “small business” (as defined above).

The changes to Maryland’s R&D credit program apply to tax credits certified after February 15, 2021.  Based on Maryland’s current credit application and certification process, this means that for a calendar year taxpayers, tax year 2021 will be the first year for which the new credit structure will apply.