Maryland budget includes services tax, individual tax increases

In brief

What happened? 

Maryland budget support legislation (H.B. 352) passed by the legislature on April 7 expands the existing statutory list of “taxable services” to include certain technology-related North American Industry Classification System (NAICS) classifications and subjects those services to a 3% sales tax rate effective July 1, 2025. The legislation also increases the top individual income tax rates and imposes a capital gains surcharge, applicable to all tax years beginning after December 31, 2024. The legislation further amends the calculation of the pass-through entity (PTE) tax, among other changes.  

However, certain previously proposed measures are omitted from the bill, such as mandatory unitary combined reporting, income tax on insurance company income not subject to the premium tax, and a retail delivery fee.  

The legislation now goes to Governor Wes Moore (D) for his approval.  

Why does it matter? 

The new 3% sales tax imposition may apply to a broad range of business-to-business transactions and may impact both sellers with Maryland-sourced sales and purchasers with in-state uses of those services. The new income tax rates and capital gains tax could result in combined state and local tax rates up to 11.8%. 

Actions to consider 

Businesses should analyze the new sales tax imposition, its interaction with existing sales tax laws, and relevant exemptions and sourcing rules to evaluate the impact on their sales and purchases and plan for compliance beginning July 1. Businesses also should consider the potential impact of the individual income tax increases and PTE calculation changes on their tax liability.

Observation: Prior to passage, the legislation was amended to drop a proposed 3% sales tax on the licensing of certain media or software rights and other intellectual property. While removing these provisions addressed concerns over what would have been a novel and broad tax imposition, the legislation still potentially applies to a broad array of business-to-business services as described in the specified NAICS codes. These codes are provided for business classification purposes and will require significant analysis to apply to various sales made by businesses.   

The legislation removes an existing exemption for sales of photographic material for use in the production of an item that is used in composition or printing or the production of another item used in printing. 

The legislation also removes the custom computer software exemption found in Md. Code Ann. Tax-Gen. Section 11-219 (“Services, generally”). Currently, that provision states that sales and use tax does not apply to a sale of custom computer software, regardless of the method transferred or accessed, or a service relating to custom computer software as described.  

The legislation would leave in place exclusions for: 

• a personal, professional, or insurance service that is not a taxable service and involves a sale as an inconsequential element for which no separate charge is made and 
• the sale of an optional computer software maintenance contract if the buyer does not have a right, as part of the contract, to receive at no additional cost software products that are separately priced and marketed by the vendor. 

Observation: The legislation also would not amend the definition of a “digital product” or the digital product exclusions in current law (such as the “enterprise software” exclusion). The practical effect of this will be to subject many business-to-business software-related transactions (such as SaaS) that are currently exempt from the 6% sales and use tax to a new 3% sales and use tax levy. 

The legislation generally applies sourcing provisions in existing law for digital products and codes to the newly taxable services. Further, the legislation provides that a buyer may present to the vendor a certificate indicating multiple points of use of a digital code, digital product, or a newly taxable service if the buyer knows at the time of purchase that it will be: 

• concurrently available for use by the buyer in more than one taxing jurisdiction or 
• 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. 

The legislation provides that the buyer delivering the multiple points of use certificate may use any reasonable but consistent and uniform method of apportionment that is supported by the buyer’s records as they exist at the time of the sale and accurately reflects the primary use location of “end-users” of the services in the state. 

Observation: Determining the location of multiple points of use of information technology and services requires understanding where use occurs across the purchaser’s enterprise, which may vary by contract and may change along with the nature of the technology and services provided. While the legislation only requires that the method of apportionment be “reasonable,” it is challenging to maintain “consistent and uniform” methods to “accurately” reflect the purchaser’s primary use location, especially when these methods must be supported by records existing “at the time of the sale.”