The IRS has released proposed regulations (REG-100908-23) and frequently asked questions with extensive new guidance on how taxpayers can fulfill and document compliance with the new prevailing wage and apprenticeship requirements that taxpayers must meet to receive the full credit and deduction amounts for the energy incentives under the Inflation Reduction Act of 2022 (IRA).
Unlike the initial guidance provided in Notice 2022-61, the proposed regulations provide detailed substantiation and recordkeeping requirements. The new guidance also tightens the “good faith” exception for the apprenticeship rules and clarifies who is responsible for any penalties when the underlying credits are transferred.
The prevailing wage and apprenticeship rules will be crucial for most energy projects. Under the IRA, projects that fail to meet the requirements will generally only qualify for a credit rate of one-fifth of the full amount. The maximum $5-per-square-foot Section 179D deduction is also cut to one-fifth if the rules are not met. There are some exceptions for smaller projects and for projects that began construction before Jan. 29, 2023.
The rules generally require a minimum wage for certain workers on a project and a minimum percentage of hours to be performed by qualified apprentices. Similar rules have long been imposed on infrastructure projects receiving federal funding, but have never before been applied to tax credits. Like the initial guidance, the proposed regulations rely heavily on existing Department of Labor (DOL) rules. The regulations, however, provide critical clarifications on issues unique to the framework of the tax credits.
Grant Thornton Insight
Unless an exception applies, meeting the prevailing wage and apprenticeship rules will be critical to the economics of energy projects. Taxpayers will need to work with contractors and subcontractors to fulfill extensive new documentation and substantiation obligations. Taxpayers should also consider adding contractual compliance requirements with specific remedies for failures, as the penalties can be steep. Credit transfer agreements should also address the issue, as there can be exposure on both sides.
General application
The prevailing wage rules generally require taxpayers to ensure a minimum prevailing wage is paid to certain workers during the construction of the facility or property and in the alteration or repair of a facility or property for a specified period after the project is placed in service (PIS). The apprenticeship rules similarly require a minimum number of apprentices and apprenticeship hours during construction, alteration or repair work, though no specific time period for compliance is provided in the statute. The application and duration of the prevailing wage and apprenticeship rules varies slightly among the credits:
- Section 30C – Alternative fuel vehicle refueling property credit (during construction)
- Section 45 and 45Y – Production tax credits (PTCs) (during construction and 10 years after PIS)
- Section 48 and 48E – Investment tax credits (ITCs) (during construction and five years after PIS)
- Section 45Q – Credit for carbon oxide sequestration (during construction and 12 years after PIS)
- Section 45V – Credit for production of clean hydrogen (during construction and 10 years after PIS)
- Section 179D – Deduction for energy efficient commercial buildings (during installation)
- Section 48C – Advanced energy manufacturing credit, available only by application (while re-equipping, expanding, or establishing a facility)
- Section 45Z – Clean fuel production credit that will replace existing fuel credits in 2025 (during construction and for 10 years after PIS unless the facility is placed in service before Jan. 1, 2025, then only for tax years in which the credit is claimed)
- Section 45L – New energy-efficient home credit (during construction, alteration or repair)
- Section 45U – Zero-emission nuclear power credit (during any alteration or repair)
Sections 45L and 45U require only the prevailing wage rules, not the apprenticeship rules.
Exceptions
Projects that began construction before Jan. 29, 2023, are generally exempt from the wage and apprenticeship rules, except for the credits under Section 48C, 45Z, 45L, and 45U. Under Notice 2022-61, the determination of whether construction has begun will be made under existing IRS guidance in a long string of IRS notices (Notice 2013-29, Notice 2013-60, Notice 2014-46, Notice 2015-25, Notice 2016-31, Notice 2017-04, Notice 2018-59, 2019-43, Notice 2020-41, Notice 2021-5, and Notice 2021-41). Under this guidance, taxpayers can generally establish that construction has begun by either satisfying a test showing “physical work of a significant nature” has begun or by incurring 5% or more of the total cost of the facility under a safe harbor.
Projects under Section 45 and 48 (and their 2026 replacements under Section 45Y and 48E) are also exempt from the rules if the maximum net output is less than one megawatt or the capacity of electrical or equivalent thermal storage is less than one megawatt. The net output will be determined by “nameplate capacity,” defined as the maximum output on a steady-state basis during continuous operation under standard conditions.
Grant Thornton Insight
The one-megawatt threshold will exempt many smaller and non-utility-scale projects, particularly rooftop or onsite solar projects. The proposed regulations do not directly address how the threshold may or may not apply to qualifying property that has no storage or production output, such as electrochromic glass. Presumably, this property would qualify for the exception because it has a zero output or storage capacity.
Prevailing wage
The prevailing wage rules generally require taxpayers to ensure a minimum prevailing wage is paid to all laborers and mechanics employed by the taxpayer or any contractor or subcontractor in the construction, alteration or repair of the facility or property. The guidance relies heavily on DOL rules for prevailing wages for infrastructure projects, including in setting the wages and in defining terms such as “laborer,” “mechanic,” “employed,” and “construction, alteration, or repair.”
Laborer and mechanic are defined as individuals whose duties are manual in nature, and the definition includes anyone who devotes more than 20% of their time to laborer or mechanic duties. It would not include individuals whose duties are primarily administrative, executive or clerical, and persons employed in a bona fide executive, administrative or professional capacity. A laborer or mechanic is considered “employed by” the taxpayer, contractor or subcontractor regardless of whether the individual is characterized as an employee or independent contractor for other federal tax purposes.
“Construction, alteration, and repair” would be defined consistent with the DOL rules to include constructing, altering, remodeling, installing of items fabricated offsite; painting and decorating; and manufacturing or furnishing of materials, articles and supplies or equipment at the location of the facility. The rules could also capture offsite work if a significant portion of the construction, alteration, or repair of the facility occurs at a secondary side established specifically for the project or dedicated exclusively to the project for a specific period of time.
Grant Thornton Insight
The proposed regulations do not rely on rules elsewhere in the code to distinguish between alterations, repairs or maintenance. Instead, the IRS cribbed from DOL rules that provide that basic maintenance is not covered under the rules, including inspections, janitorial work, or replacing materials with limited lifespans. Work that improves a facility, adapts it to a different use, or restores function as a result of inoperability are covered. The IRS noted that the determinations of construction, alteration, repair, or maintenance for purposes of these rules do not apply to Section 162 or Section 263 determinations.
The prevailing wage itself would be determined under the general DOL rules. DOL publishes a list of prevailing wages based on the geographic area, labor classification, and type of construction on www.sam.gov. There are four general construction types, and the IRS said it expected most energy credit projects to be classified under the “building” or “heavy” categories. If no applicable published wage rate is available, taxpayers, contractors or subcontractors must request a supplemental wage determination.
Grant Thornton Insight
A DOL supplemental wage request is normally done by a contracting agency in coordination with a contractor. For tax credit projects, taxpayers, contractors and subcontractors will have to navigate this process themselves. This will include providing significant supporting material, including a description of the type of work to be performed, the geographic area, construction start date, labor classifications needed, and other pertinent wage information. The IRS said in the preamble it expects this process will be necessary only in a limited number of circumstances.
Apprenticeship
The apprenticeship rules require fulfilling three separate requirements in the construction, alteration, or repair of a qualified project:
- Minimum percentages of total labor hours must be performed by qualified apprentices:
- 10% for projects that begin construction before 2023
- 12.5% for projects that begin construction before 2024
- 15% for projects that begin construction in 2025 or later
- Taxpayers must satisfy any apprentice-to-journey-worker ratios of either the DOL or state agencies
- Any contractor, subcontractor, or taxpayers who employs four or more individuals on the project must employ at least one qualified apprentice.
The minimum percentage requirement would apply based on total hours for the project, while the ratio requirement would apply daily. The participation requirement would be a minimum threshold with no time requirement. Like the prevailing wage rules, the word “employ” in this context does not distinguish between employees and independent contractors.
Taxpayers can alternatively satisfy the general requirements by making a “good-faith effort,” which means requesting qualified apprentices from a registered program or programs that that can reasonably be expected to provide the necessary number of apprentices based on the location and type of work. The request must include proposed dates, occupations needed, location of the work, number of apprentices needed and the expected number of labor hours to be performed by the apprentices.
Taxpayers whose requests are denied or ignored would need to keep re-requesting every 120 days in order to continue qualifying for the good-faith exception. The proposed regulations include rules for partially relying on the good faith exception in circumstances where only some qualified requests go unfulfilled.
Grant Thornton Insight
The proposed regulations tighten the good-faith exception considerably compared to the initial guidance in Notice 2022-61, which only required taxpayers to “request qualified apprentices from a registered apprenticeship program in accordance with usual and customary business practice for registered apprenticeship programs in a particular industry.” The IRS noted that taxpayers and contractors may have to request apprentices from multiple programs because programs often train only in a single occupation.
Penalties
A lapse in compliance with the prevailing wage or apprenticeship rules will not automatically reduce the credit to rate to one-fifth of the full amount. Taxpayers will have the opportunity pay a penalty instead.
Taxpayers can cure a prevailing wage failure and retain the larger credit by paying the worker the difference in wages (multiplied by three for intentional disregard), plus the underpayment rate under Section 6621 (using 6% instead of 3%), and paying the IRS an additional $5,000 ($10,000 for intentional disregard) for each worker who was underpaid. Taxpayers can regain compliance with the apprenticeship requirements by paying $50 per labor hour ($500 for intentional disregard) to the IRS for hours the taxpayer fell below the required threshold. Taxpayers cannot voluntarily pay the IRS its penalty amounts until filing the return, and are required to pay the penalty within 180 days of notification if the IRS identifies the failure.
Failures for either requirement will be considered due to intentional disregard if it is knowing or willful, which will be determined based on facts and circumstance. The proposed regulations provide non-exhaustive lists of factors for this determination, including whether:
- The failure was part of a pattern including repeated or systematic failures
- The taxpayer promptly cured any failures
- The taxpayer paid a similar penalty in prior years
- The taxpayer included provisions in contracts requiring compliance with the rules
For prevailing wages, the IRS will also consider whether the taxpayer took steps to determine the proper classifications and prevailing wage amounts, posted applicable wages at the job site, undertook quarterly reviews, and put in place procedures for workers to report suspected failures. To encourage proactive corrections, the regulations create a rebuttable presumption that a failure will not be considered intentional disregard if the correction and penalty payments are made before a notice of examination is received.
The penalty payments may not be required if there is an applicable project labor agreement in place and any wage failures are remedied, which is generally defined as a pre-hire collective bargaining agreement with one or more labor organizations that establishes the terms and conditions of employment for a specific construction project.
Finally, the IRS will waive penalties for prevailing wage failures if the following conditions are met:
- Correction payments are made within 30 days after the taxpayer became aware of the error or claimed the credit.
- The wage failures occurred in not more than 10% of the pay period for the affected individual.
- The amount underpaid was less than 2.5% of the total required to be paid.
Taxpayers can alternatively satisfy the general requirements by making a “good-faith effort,” which means requesting qualified apprentices from a registered program or programs that that can reasonably be expected to provide the necessary number of apprentices based on the location and type of work. The request must include proposed dates, occupations needed, location of the work, number of apprentices needed and the expected number of labor hours to be performed by the apprentices.
Taxpayers whose requests are denied or ignored would need to keep re-requesting every 120 days in order to continue qualifying for the good-faith exception. The proposed regulations include rules for partially relying on the good faith exception in circumstances where only some qualified requests go unfulfilled.
Grant Thornton Insight
The penalties will be an important option to preserve the full credit upon any lapses. The IRS built some flexibility into the rules, but it will be crucial that taxpayers are documenting compliance efforts, implementing best practices, and monitoring compliance. The penalties can themselves prove costly, so taxpayers should consider building requirements and remedies into agreements with contractors, which can also be a factor in whether a failure is considered due to intentional disregard.
The IRS provided rules for who is liable for penalties when credits are transferred. The IRA created a novel monetization framework under new Section 6418 that allows taxpayers to sell the energy credit to an unrelated party for cash (see our prior story). The proposed regulations provide that it is the taxpayer that sells and transfers the credit that is liable for the penalties upon any failure, not the transferee buyer of the credit.
Grant Thornton Insight
This rule could create tension in transfer deals. The proposed rules under Section 6418 generally leave the buyer with the liability exposure for adjustments to credits either upon examination or for recapture from a disposition of the underlying property. It appears under these rules that the seller will be required to pay any penalty necessary to preserve the full credit rate, but it could be the buyer’s credit that is reduced by 80% if the seller fails to pay for a lapse discovered after the transfer. Strong contractual language may be needed to compel the seller to pay for any failures uncovered later.
Documentation and substantiation
The proposed regulations require taxpayers to maintain and preserve records sufficient to demonstrate compliance, which must include, at a minimum, payroll records for each laborer and mechanic (including each qualified apprentice) employed by the taxpayer, contractor or subcontractor in the construction, alteration or repair of the qualified facility. The rules then provide examples of documentation that “may” be included among records sufficient to demonstrate compliance, including:
- Full identifying information of all laborers and mechanics
- Labor classifications for all laborers and mechanics and documentation supporting the classifications
- Hourly rates paid, including bona fide fringe benefits and support for fringe benefit calculations
- Total hours worked per pay period
- Total wages paid each pay period
- Records to support wages paid to apprentices below the prevailing wage
- Records on timing and amount of any corrective payments
- Written requests for qualified apprentices
- Agreements entered into with qualified apprenticeship programs
- Total hours worked by apprentices
- Daily records reflecting the daily ratio of apprentices to journey workers
Grant Thornton Insight
The proposed regulations significantly expand the documentation requirements in the initial guidance. Notice 2022-61 had merely required taxpayers to comply with the general recordkeeping rules applicable to any item on a tax return under Treas. Reg. Sec. 1.6001-1. The proposed regulations provide helpful insight on the actual types of documentation that can be considered sufficient to substantiate compliance, but the recordkeeping could be onerous. Taxpayers will not need to submit certified payroll records required by the DOL for infrastructure projects, but they should make sure they have a process to track and monitor compliance and are building substantiation requirements into agreements with contractors and subcontractors.
Next steps
The regulations are proposed to apply to facilities, property, projects, or equipment for which construction or installation began after the date they are finalized, but taxpayers can generally rely on them now. The clarity provided by the rules should give taxpayers more confidence to pursue energy credit projects, as compliance is needed to receive the full credit amount. The requirements will, however, add costs and administrative burdens to projects. Taxpayers should consider adding compliance requirements into contracts and putting processes in place to substantiate their claims.
For more information, contact:
Tax professional standards statement
This content supports Grant Thornton LLP’s marketing of professional services and is not written tax advice directed at the particular facts and circumstances of any person. If you are interested in the topics presented herein, we encourage you to contact us or an independent tax professional to discuss their potential application to your particular situation. Nothing herein shall be construed as imposing a limitation on any person from disclosing the tax treatment or tax structure of any matter addressed herein. To the extent this content may be considered to contain written tax advice, any written advice contained in, forwarded with or attached to this content is not intended by Grant Thornton LLP to be used, and cannot be used, by any person for the purpose of avoiding penalties that may be imposed under the Internal Revenue Code.
The information contained herein is general in nature and is based on authorities that are subject to change. It is not, and should not be construed as, accounting, legal or tax advice provided by Grant Thornton LLP to the reader. This material may not be applicable to, or suitable for, the reader’s specific circumstances or needs and may require consideration of tax and nontax factors not described herein. Contact Grant Thornton LLP or other tax professionals prior to taking any action based upon this information. Changes in tax laws or other factors could affect, on a prospective or retroactive basis, the information contained herein; Grant Thornton LLP assumes no obligation to inform the reader of any such changes. All references to “§,” “Sec.,” or “§” refer to the Internal Revenue Code of 1986, as amended.
More flash
No Results Found. Please search again using different keywords and/or filters.