April 18, 2025

Executive Summary

The Maryland (“MD”) legislature gave final approval to a series of important MD tax changes contained in the Budget Reconciliation and Financing Act, H.B. 352. The key tax changes involve MD personal income tax rate increases, a limitation on itemized deductions and a new 2% capital gains surcharge. For sales and use tax purposes, the legislation expands the state’s tax base to include certain information technology (“IT”) and data services in conjunction with providing additional related clarifications and exemptions. Finally, the legislation also modifies the calculation of MD’s elective pass-through entity tax to benefit businesses with owners who are MD residents.

Personal Income Tax Changes

The new MD tax law provides for a host of changes to the state’s personal income tax (“PIT”) all set to take effect for tax years beginning after December 31, 2024. The specific changes include:

• Creating two new PIT brackets for taxpayers with taxable income exceeding $500,000 annually to be taxed at 6.25%, and taxpayers with taxable income exceeding $1 million to be taxed at 6.5%. For joint filers, the new brackets are taxable income of $600,001 through $1.2 million and taxable income exceeding $1.2 million.
• Imposing a new 2% surtax on capital gains for taxpayers earning more than $350,000 in federal adjusted gross income.
• Increasing the standard deduction for individuals to $3,350 and for joint filers/head of households to $6,700.
• Reducing the amount of otherwise allowable itemized deductions by 7.5% of the taxpayer’s federal adjusted gross income exceeding $200,000.
• Raising the maximum income tax rate that each county may set by ordinance or resolution, from 3.20% to 3.30%.

The 2% capital gains surtax should not apply to gains from the sale of a primary residence with a sales price less than $1 million, assets held in retirement accounts, defined contribution plans, deferred compensation plans, and property used in a trade or business of which the cost is deductible under Internal Revenue Code section 179.

Elective Pass-Through Entity Tax Changes

Under current law, the state’s elective pass-through entity tax (“PTE Tax”) base is comprised of income derived from MD sources, i.e. business income apportioned to the state using a receipts factor formula for most types of businesses. The new law would modify the PTE Tax base for resident members or owners of electing PTEs to include all income earned from the electing PTE regardless of source. This change takes effect for tax years beginning after December 31, 2025.

It is very possible that this provision is revisited in subsequent legislation to only allow S corporations with shareholders who are all residents of MD to pay elective PTE Tax on all income regardless of source. This change would fix a potential problem associated with the creation of a second class of stock for making all shareholders economically whole when an electing S corporation has MD resident and nonresident shareholders and pays tax on all income regardless of source that is attributable to the resident shareholders.

Sales & Use Tax Changes

Effective July 1, 2025—the legislation calls for broadening the MD sales and use tax base to impose a 3% tax on IT and data services described under NAICS Sectors 518, 519, or 5415, as well as system software or application software publishing services described under NAICS Sector 5132. These definitions can capture a broad array of data and IT services, such as computing infrastructure, data processing, internet hosting and information retrieval, computer system design, and software publishing.

Since the legislation did not alter the definitions and exemptions associated with digital products, many business-to-business sales of software-as-a-service (“SaaS”) that are currently exempt under the enterprise software exclusion should be subject to the new 3% sales tax.

Pursuant to the 2022 U.S. NAICS manual referenced in the legislation, the potential taxable categories include the following:

• NAICS Sector 518 - Computing Infrastructure Providers, Data Processing, Web Hosting, and Related Services: The Computing Infrastructure Providers, Data Processing, Web Hosting, and Related Services subsector groups establishments that provide computing infrastructure, data processing services, web hosting services (except software publishing), and related services, including streaming support services (except streaming distribution services).
• NAICS Sector 519 - Web Search Portals, Libraries, Archives, and Other Information Services: Industries in the Web Search Portals, Libraries, Archives, and Other Information Services subsector group establishments supplying information, storing and providing access to information, searching and retrieving information, and operating web sites that use search engines to allow for searching information on the internet. The main components of the subsector are libraries, archives, and web search portals.
• NAICS Sector 5415 - Computer Systems Design and Related Services: This industry comprises establishments primarily engaged in providing expertise in the field of information technologies through one or more of the following activities: (1) writing, modifying, testing, and supporting software to meet the needs of a particular customer; (2) planning and designing computer systems that integrate computer hardware, software, and communication technologies; (3) on-site management and operation of clients' computer systems and/or data processing facilities; and (4) other professional and technical computer related advice and services.
• NAICS Sector 5132 – Software Publishers: This industry comprises establishments primarily engaged in software publishing. Establishments in this industry carry out operations necessary for producing and distributing computer software, such as designing, providing documentation, assisting in installation, and providing support services to software purchasers. These establishments may design, develop, and publish, or publish only. These establishments may publish and distribute software through subscriptions and/or downloads.

The legislation provides that if a different rate could be applied to a sale or use of tangible personal property, a digital code, a digital product, or a taxable service, the higher rate should apply to the sale. Additionally, the exemption for custom software and related custom software services is eliminated under the new law.

The new sales tax regime provides an exemption for sales of cloud computing to a cybersecurity business purchasing taxable IT and data services. For purposes of this exemption, cloud computing is defined to mean:

• A service that enables on-demand, self-service network access to a shared pool of configurable computer resources, including data storage, analytics, commerce, streaming, e-mail, document sharing, and document editing.

The law also provides an exemption for sales of IT and data services by or to a company located in the University of MD’s Discovery District based in Prince George’s County that has a contract with the University’s Applied Research Laboratory for Intelligence and Security to “develop systems and technologies to advance the use of quantum computers.”

Finally, the legislation provides a set of sourcing rules for the newly taxable IT and data services that matches the rules applicable to digital products, which generally look to the location of primary use of the taxable product. Accordingly, the law allows a buyer to present the vendor with a certificate indicating multiple points of use of a digital code, digital product, or a newly taxable IT or data service if the buyer knows at the time of purchase that the product or service will be: (1) concurrently available for use by the buyer in more than one taxing jurisdiction; or (2) resold in its original form to a member of an affiliated group or a related pass–through entity of which the buyer is also a member. This relieves the seller from collecting the applicable tax for MD and shifts the responsibility on the purchaser to pay tax on the taxable product or service based on location of primary use. If multiple points of use is claimed by the purchaser, it must use any reasonable but consistent and uniform method of apportionment that is supported by its records existing at the time of the sale and accurately reflects the location of primary use.

Additional Tax Impositions & Increases

The budget legislation also calls for the following tax changes to take effect July 1, 2025:

• Imposing a 3.5% excise tax on short-term rentals of vehicles.
• Increasing the vehicle excise tax from 6 to 6.5%
• Increasing the sports wagering tax from 15 to 20%.
• Increasing the sales and use tax on cannabis from 9 to 12%.

Conclusion

The MD tax changes ushered into law via the enactment of H.B. 352 will have significant ramifications for individual taxpayers filing in MD and companies conducting business activities in the state. Due to the magnitude and complexity of these changes, we recommend reviewing with your tax advisor for planning and compliance purposes. Please reach out to Jaime Reichardt or another member of Citrin Cooperman’s State and Local Tax leadership team.