Maryland enacts major tax hikes to address budget shortfall

On May 20, 2025, Gov. Wes Moore signed the Maryland Budget Reconciliation and Financing Act, designed to address a very challenging fiscal environment. The budget bill markedly increases personal income tax rates, adopts a capital gains tax surcharge, and expands the sales tax base to additional services.¹

Personal income tax increases²

Maryland historically has subjected taxpayers to a progressive state-level tax with 5.75% as the highest tax rate applicable to Maryland taxable income of more than $250,000 ($300,000 for joint filers, surviving spouses, and heads of households), along with a flat local-level tax that varies by county and ranges from 2.25% to 3.2% of Maryland taxable income.

Effective for the 2025 tax year and beyond, two additional tax rate brackets are added to the state-level tax. A 6.25% tax bracket is now applicable to Maryland taxable income of $500,001 through $1 million ($600,001 through $1.2 million for joint filers, heads of households and surviving spouses). In addition, a 6.5% tax bracket is now applicable to Maryland taxable income over $1 million ($1.2 million for joint filers, heads of households and surviving spouses). In addition, for purposes of the local-level tax, counties will now be authorized to impose a local-level tax of up to 3.3%, with the ability to change from a flat tax to a progressive tax if done in a revenue-neutral manner.

In addition to the adoption of two new state tax rate brackets, the legislation makes changes to the standard and itemized deduction regimes. The maximum standard deduction has been raised from $5,600 to $6,700 for joint filers, heads of household, and qualified surviving spouses (the increase is from $2,800 to $3,350 for other taxpayers). At the same time, a restriction on the itemized deduction available to taxpayers has been enacted, under which taxpayers that have more than a threshold amount of federal adjusted gross income are required to reduce their itemized deductions by 7.5% of the excess threshold amount. This amount is $200,000 for most taxpayers ($100,000 if married filing separately).

Maryland has also adopted a capital gains tax surcharge of 2%. This surcharge is applicable to all net capital gains as defined and determined by the Internal Revenue Code (IRC) recognized by individuals reporting federal adjusted gross income (AGI) of more than $350,000. There are several exemptions to the surcharge. Capital gains from primary residences sold for less than $1.5 million are exempt, along with assets held in a variety of retirement accounts. In addition, exemptions are available for livestock sales made by farmers or ranchers, land sales subject to conservation, agricultural or forest preservation easements, sales of property used in a trade or business, the cost of which is deductible under IRC Sec. 179, and sales of affordable housing owned by nonprofits. 

Sales tax base expansion³

Historically, the Maryland sales and use tax base has included a limited number of services when compared to other states. Recognizing advancements in technology and the need to broaden the tax base in light of financial difficulties, effective July 1, 2025, the legislation expands the Maryland sales and use tax base to include sales of data or information technology services (described under the 2022 North American Industrial Classification System (NAICS) Sector 518, 519, or 5415) and system software or application software publishing services (described under NAICS Sector 5132).⁴ The Maryland tax rate applied to these newly taxable services is 3%, a preferential tax rate when compared to the normal 6% tax rate imposed by the state. However, the normal 6% tax rate is applied if the taxable item is already subject to tax under the existing Maryland sales and use tax provisions. In line with the inclusion of additional taxable services, a rule that had broadly exempted sales of custom computerized software from the Maryland sales and use tax has been stricken.

The legislation applies existing sourcing rules to determine the operation of the Maryland sales and use tax. The legislation adopts a presumption under which a retail sale of a digital code or product or sales of data or information technology services is made in the state in which the customer tax address is located. Determining the customer tax address requires a review of a series of cascading provisions which, depending upon what is known about the sales transaction, could be the business location of the vendor in the case where the customer receives the service, the primary use location of the service, or potentially the physical location or billing address of the customer. Figuring out the primary use location of the service likewise becomes complicated but is a necessary step in determining how to source these service-based transactions.

Finally, the legislation extends the potential for purchasers of taxable digital items or information technology or software publishing services to obtain “multiple points of use” certificates so that they can effectively apportion the amount of sales to Maryland based on the use of the applicable product or service. To utilize this relief, the purchaser must know that such item will be available for use in more than one taxing jurisdiction or resold in its original form to a related entity of the purchaser.

Sales tax rate increases⁵

In addition to tax base expansion, the Maryland legislation provides for several tax rate increases on specific items, all of which become effective on July 1, 2025:

• Increase to the sales and use tax rate for cannabis from 9% to 12%.
• Repeal of the sales and use tax exemption for vending machine snack food sales.
• Imposition of sales tax on precious metal bullion or coins with a sales price over $1,000 unless the sale is made at the Baltimore Convention Center.
• Repeal of the sales and use tax exemption for sales of photographic and artistic material used in publications.
• Increase in the vehicle excise tax rate to 6.5%, and repeal in the vehicle excise tax exemption for short-term rental vehicles (on which a 3.5% tax will become applicable).
• Increase to the mobile sports wagering tax rate imposed on licensees from 15% to 20%.

Pass-through entity tax regime adjustments⁶

The Maryland pass-through entity (PTE) regime, in which a member of an electing PTE may transform a tax imposed on an individual to a tax imposed on the PTE itself, resulting in circumvention of the $10,000 federal SALT cap, has been beset with complexity since its enactment. Part of the complexity stems from the fact that the PTE tax regime was grafted on top of a previous PTE tax regime that primarily served a withholding function to ensure owners of the PTE paid personal income tax to the state. Effective for the 2026 tax year and thereafter, the legislation makes clarifications in the state’s PTE tax regime so that the PTE’s taxable income is defined for resident members as being equal to the member’s distributive or pro rata share of the PTE (fully apportioned to Maryland). For nonresident members, the PTE’s taxable income is the amount derived from or attributable to the trade or business of the PTE in Maryland.

Commentary

The changes to the personal income tax regime in Maryland will result in a substantial tax increase that mainly will fall on high-income taxpayers. Given that the tax increases were enacted in the middle of the year but are effective for the entire year, many taxpayers that are required to make estimated payments will be underpaid. It should be noted that to the extent taxpayers do not make sufficient estimated payments to Maryland because of these changes, the Comptroller is required to waive interest and penalties that would otherwise be imposed for such underpayments.⁷

The imposition of a special state-level capital gains tax runs counter to the preferential treatment that a long-term capital gain typically receives for federal income tax purposes. In a prior incarnation of this provision, the capital gains tax surcharge was only planned to be enacted for a four-year period beginning in 2026, at a rate of 1% of Maryland taxable income. The enacted legislation doubles this proposed tax rate and makes it permanent.

The structure of the capital gains tax regime has several distinct components that require careful consideration. The tax does not account for differences in filing status, so jointly filing taxpayers generally will reach the $350,000 federal AGI threshold that subjects capital gains to the 2% tax more quickly than an individual taxpayer. Further, taxpayers with relatively similar amounts of income may not be treated similarly with respect to the capital gains tax. For example, a taxpayer that has $350,000 in federal AGI ($50,000 of which is net capital gain) would owe $1,000 in Maryland capital gains tax. In contrast, a taxpayer that has $345,000 in federal AGI, all of which is net capital gain, would not be subject to the net capital gain surcharge. But if the taxpayer with $345,000 in federal AGI earned an additional $5,000 in net capital gain includible in federal AGI, the Maryland capital gains tax would jump to $7,000. Finally, as this provision is effective for the 2025 tax year and beyond, taxpayers who exceed the $350,000 federal AGI threshold and have recognized these types of gains since the beginning of the year, whether due to a planned or unplanned recognition event, would be subject to the capital gains tax.

While the Comptroller must waive interest and penalties on estimated underpayments of the capital gains tax, this tax still must be paid by April 15, 2026, the original due date of the Maryland personal income tax return. Ultimately, that date could be critical for impacted taxpayers, at which time the full amount of the 2025 tax (state, county, and capital gains), along with 2026 first-quarter estimated payments (if applicable) would be due. At that point, the increased taxes may become real, as a high-income taxpayer that recognizes a capital gain on a transaction could be subject to a marginal tax rate of nearly 12% when factoring in the highest state, county and capital gains tax surcharge rates. This level of taxation may call into question whether affected Maryland taxpayers will consider moving to other states with more competitive state tax rates, which could have long-term adverse effects on the housing market and the state’s overall economy.

With respect to the sales tax base expansion, Maryland’s approach is distinctive in that the new services and items subject to tax do not have specific statutory definitions and rely upon NAICS code designations. Perhaps in light of this approach, and the knowledge that these provisions were likely to become law well in advance of Gov. Moore’s signature, the Comptroller has already acted to implement and interpret the newly revised sales tax statute through proposed regulations.⁸ The proposed regulation sets forth significant detail regarding the tax treatment of taxable services when coupled with personal, professional or insurance services (that independently would not be taxable). The Comptroller provides an example in the proposed regulation in which a web design service sold by a graphic design company independently from the sale of a nontaxable logo design service would be taxable, ostensibly to the extent the web design service is taxable. This treatment makes it even more important to separately state charges for taxable items versus nontaxable service charges on invoices.

To accommodate the expansion of the sales tax to numerous technological forms of services through NAICS code references, the Comptroller provides detailed guidance in the proposed regulations regarding applicable NAICS codes that drive the taxability of such items. It should be noted that according to the Comptroller, the NAICS business activity descriptions define the types of services that are now classified as taxable services, rather than looking to the taxpayer’s primary business activity code on their business reports.⁹ Taxpayers selling products and services related to data or information technology, software publishing, or adjacent commercial ventures should be forewarned in that the list of NAICS codes and products is very long. A comprehensive review of what a business is selling in this area would be warranted, as the tax will become effective in three weeks. The Comptroller anticipates adoption of the proposed sales and use tax regulations on July 1, 2025, with publication in the Maryland Register soon thereafter.