Authored by Paulina Raymond, CPA | Manager & Sarah Reeves, CPA | Principal
As Maryland becomes an increasingly expensive tax state, Maryland individuals and business owners should be aware of recent tax law changes to optimize their tax planning strategies.
1. Maryland 2% Surtax on Net Capital Gains
Beginning in 2025, Maryland imposes an additional 2% tax on net capital gains for individuals with Federal Adjusted Gross Income (AGI) over $350,000. This brings Maryland’s effective tax rate on capital gain income up to a maximum of 11.8% for certain Marylanders in the top income and local tax brackets. The $350,000 threshold applies regardless of filing status. Trusts with Federal AGI over $350,000 are also subject to the 2% surcharge on undistributed capital gain income.
Prior to 2025, capital gains in Maryland were taxed at the same rate as ordinary income. While long-term capital gains receive preferential tax rates for federal income tax purposes, the Maryland tax rate on capital gain income is now higher than that on ordinary income for top earners.
Exceptions – 2% Surtax does not apply to capital gains attributable to:
- Sale of residential home – The home must be the taxpayer’s primary residence and be sold for less than $1,500,000. It must be a single-family home, townhome, row home, residential condominium unit, or residential cooperative unit.
- Assets held in retirement accounts – This includes employer sponsored 401(k), 403(b), and 457(b) plans, Individual Retirement Accounts (both traditional and Roth IRAs), defined contribution plans, defined benefit plans, or similar retirement savings plans.
- Qualifying farming/ranching livestock
- Land subject to a conservation, agricultural, or forest preservation easement
- Trade or business property deductible under IRC Sec. 179
- Affordable Housing owned by a nonprofit organization
How to plan ahead
Expecting to be just over the $350,000 Federal AGI threshold in a year with capital gain income?
- Consider tax planning opportunities to bring your income under that threshold with strategies such as harvesting capital losses, accelerating deductions, or deferring other income where appropriate. Careful year-end tax projections and planning with your tax advisor will be necessary to achieve this.
Not maxing out your retirement contributions yet?
- While retirement accounts are already a tax-efficient savings vehicle, the benefit for Marylanders can be even more substantial. Capital gain earnings in retirement accounts are not subject to the Maryland 2% surcharge. Contributions to certain retirement accounts also reduce taxable income which could help lower an individual’s tax bracket or get them below the $350,000 capital gain surtax threshold. Finally, for certain retirement accounts, it may be possible to manage timing of withdrawals in future retirement years to optimize tax brackets and thresholds.
Receiving capital gain income from a passthrough entity (PTE)?
- Additional estimated payments should be made at the individual level to cover the 2% surcharge and avoid underpayment. PTEs do not pay this additional 2% surcharge at the entity level.
Planning a business exit?
- Long-term planning is critical to achieve the most efficient tax structure on a future business exit. Timing an exit in an otherwise low-income year, timing recognition of losses on other investments in the same year as a sale, or spreading gains over multiple years may offer an effective strategy. Some business owners may also consider whether they will relocate to a lower-tax state for their future retirement home. This requires planning years in advance of a business exit.
Proactive planning is key to minimizing taxes and ensuring estimates are paid in to avoid an unwanted surprise tax bill.
2. Pass-Through Entity Tax Changes Now Delayed until 2027
Pass-through Entities (PTE) can elect to pay Maryland tax at the entity level, which allows them to reduce business income flowing through to the members. This provides a “work-around” the state and local tax (SALT) cap at the individual level and maximizes the federal tax benefit pass-through business owners receive for state taxes paid.
Currently, this PTE tax calculation is based on Maryland-sourced income. A significant change for the Maryland PTE tax initially in effect for 2026 would have calculated the PTE tax on resident members’ total income from the passthrough (not just the Maryland sourced income).
While the intention of this change is to allow a greater state and local tax deduction for Maryland residents, it causes some issues for PTEs with a mix of residents and non-residents as well as cash-flow concerns for multi-state business with only a small portion of their business in Maryland.
This change was delayed to 2027 and updated to provide more flexibility to the calculation. Beginning in 2027, PTEs will have the option to apply the PTE tax for Maryland residents to either their:
- Total distributive share of income from the passthrough or
- Distributive share of Maryland apportioned income
Nonresidents will continue to have PTE income taxed on their share of Maryland apportioned income.
Due to the timing of this postponement, businesses may need to re-visit their 2026 PTE tax estimates and potentially their election/non-election for the PTE tax.
Tax year 2026 will continue to base PTE tax on Maryland sourced income for Maryland residents, but this change could be a potentially advantageous consideration for 2027.
How PTEs and individual owners of PTEs can plan ahead
- Consider cash flow needs to determine which option makes the most sense. While Maryland residents could benefit from the increased deduction, for those with significant apportionment outside of Maryland, this means putting out more cash upfront at the entity level and waiting for a refund later at the individual level.
- Making it equitable for PTE partners can be complex when there is a mix of Maryland resident and nonresident partners as well as different types of partners such as corporations, partnerships (tiered structures), and trusts. Operating agreements and/or corporate governance documents should be reviewed and potentially updated to address.
- S Corporation risk should be carefully navigated to avoid any situations which may inadvertently create a second class of stock with disproportionate tax distributions or “true-up” payments tied to PTET outcomes which would jeopardize the S election.
Balancing all these considerations can be complex, and it is key to understand how the PTET benefit flows through and is utilized at the ultimate owner level.
Whether you’re managing a large capital gain, weighing your PTE election, or both, proactive planning now can help minimize the impact of these changes. Reach out to the SC&H Tax Team to discuss tax planning opportunities and navigate the Maryland PTE election options for your business.
