IRS details wage and apprenticeship requirements

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.

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.

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. 

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.

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. 

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. 

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.

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