MAY 2025 – Maryland’s new 3 percent sales tax on certain Information Technology services has members of the business community questioning how it is going to impact the viability of federal contractors and the ability of the state to serve as America’s cyber hub.
Part of the 2026 Budget Reconciliation and Financing Act (House Bill 352), the new tax would come into effect on July 1, 2025 and apply to services provided under four NAICS codes: 518, 519, 5415 and 5132. Those services include data processing, web hosting, web search portals, online archives, online search and retrieval services, website operations, computer systems design and related services, and software design, documentation, installation and support. Under NAICS code 5415, the ‘defense contractor code,’ they also include planning, designing and managing hardware, software and communications technologies.
However, a lot is still unknown about how the new tax will be applied.
According to the legislation, services provided directly to the federal government are generally exempt, although prime contractors would have to obtain a Maryland Sales and Use Tax Exemption Certificate. Services provided in Maryland to a prime contractor serving the federal government could be subject to the tax, but services provided to an out-of-state prime might not be taxed.
“Other big questions we have right now are whether or not this tax applies to services provided as part of pre-existing contracts,” said Grason Wiggins, Vice President, Government Affairs for the Maryland Chamber of Commerce. “Also with larger contract packages, does that work get itemized so that only certain services are taxed or does the whole package get taxed?”
The new tax and the questions about it have left many contractors trying to decipher how it will impact their businesses.
Nearly 100 percent of RealmOne’s work is for the federal government, including 70 percent as a prime contractor.
“As a prime contractor for the federal government, there will likely be no sales tax. We just have to get the sales tax exemption certificate,” said Pearce Lantzy, Chief Financial Officer. “But the jury’s still out on what happens with subcontract work.”
Although Lantzy believes there is a strong case to be made for exempting subcontractor work as well, failure to get that exemption could put a lot of companies in a financial bind.
Subs could try to pass that added expense onto their primes and, subsequently, their federal clients, “but I find it very difficult to believe that those clients are going to accept those additional expenses,” Lantzy said.
The uncertainty about how the tax applies to subtractors is concerning to Quentin Smith, Chief Operating Officer at Set of X. The company’s workload is entirely subcontracted work for the National Security Agency.
“We run a pretty lean company,” Smith said, adding that his profit margin on many contracts is 5 percent. “If I have to eat the cost of a 3 percent tax, that’s going to be a significant hit to our margin.”
Companies could build the new tax into future contract bids in order to restore solid profit margins. However, that added expense would put Maryland companies at a competitive disadvantage.
“This tax makes Maryland companies 3 percent more expensive than companies operating outside of the state,” he said.
That disadvantage could convince some companies to relocate to other states and convince federal agencies to shift some contracting to other locations.
“Our main customer is NSA which has a presence in Georgia, Texas, Colorado, Hawaii and Utah. They could start moving more work to those locations,” Smith said.
The new tax arrangement could also shrink the amount of work going to subcontractors.
“If subcontractors’ costs go up by 3 percent, that’s going to incentivize primes to subcontract less work and try to do more of it themselves,” Smith said. “Many of those primes are not Maryland-based companies, so that work, those profits and the high-end executive jobs will not be contributing to Maryland’s tax base.”
Ultimately, that trend could shrink the ecosystem of small contractors in the state.
“Usually, innovation comes from small businesses,” Smith said. “If you are squeezing small businesses out and constraining the attractiveness of doing a startup, then you are going to lose innovation and competitiveness in Maryland.”
The Comptroller of Maryland is currently working out the details of how the new tax will be implemented. Business leaders are pressing the Comptroller to resolve outstanding questions soon. They’re also urging businesses and legislators to speak out about how the new tax would impact them.
“We are encouraging businesses to reach out to their legislators and provide substantive information on the impact this tax will have on their businesses,” Wiggins said. “Once we have a full picture of the impact of this bill, we’re going to re-engage with the General Assembly and see if there are opportunities to make changes to the law that will be helpful to the business community.”
