The IRS’s final regulations on the new prevailing wage and apprenticeship requirements (TD 9998) relax some key rules but will require most taxpayers with energy projects to perform significant monitoring and documentation to establish compliance.
The prevailing wage and apprenticeship (PWA) rules will be crucial for most energy projects. Under the Inflation Reduction Act, 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 exceptions for projects with less than one megawatt of capacity and projects that began construction before Jan. 29, 2023.
The PWA rules generally require a minimum wage be paid to certain workers and a minimum percentage of hours be performed by qualified apprentices. Similar rules have long been imposed under the Davis-Bacon Act (DBA) on infrastructure projects receiving federal funding, but these have never before been applied to tax credits. The IRS released initial guidance in Notice 2022-61 and then proposed regulations in 2023 (REG-100908-23). The final regulations were published on June 25.
Like the previous guidance, the final regulations rely heavily on existing Department of Labor (DOL) rules under the DBA, although the final rules also make several important changes:
- The IRS confirmed that taxpayers are required to apply the rules only with respect to energy property, not with regard to any non-energy aspects of a larger project.
- The apprenticeship rules will not be imposed after the project is placed in service.
- The IRS relaxed restrictions for using the “good-faith exception” to establish compliance with the apprenticeship requirements.
- Many taxpayers will need to collect substantial information and perform monitoring and reviews to satisfy documentation and substantiation rules.
Grant Thornton Insight:
While the IRS declined to require taxpayers to submit certified payrolls before a project is placed in service, it is clear from the documentation requirements and penalty rules that most taxpayers should collect and retain equivalent information and perform monitoring on a quarterly or even more frequent basis. The IRS has indicated that payroll records will not be enough and this area will be an enforcement target for the agency. Taxpayers should also consider including deliberate contractual PWA language in agreements with contractors and subcontractors, including provisions that address both the type and frequency of documentation needed and remedies for any failures. Credit transfer agreements should also address the issue, as there can be risk 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 application and duration of the prevailing wage 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)
The apprenticeship rules similarly require a minimum number of apprentices and apprenticeship hours during construction, alteration or repair work, though the statutory language is more ambiguous on the specific time period for compliance. The final regulations provide that the apprenticeship requirements will not apply once the property is placed in service. Importantly, Sections 45L and 45U require only the prevailing wage rules, not the apprenticeship rules.
Grant Thornton Insight:
The final regulations helpfully clarify that the PWA rules only apply to the portion of a construction activity that is creditable or deductible. For instance, a taxpayer would only have to meet the PWA requirements with respect to the energy efficiency property actually qualifying under Section 179D, not for the entire building project. Taxpayers installing Section 48 property on a building, such as solar panels, energy storage or electrochromic glass on a building, would only have to meet the PWA requirements with respect the installation of the qualifying property.
Exceptions
Beginning of construction
Projects that began construction before Jan. 29, 2023, are generally exempt from the PWA rules, except for the credits under Section 48C, 45Z, 45L, and 45U.
Notice 2022-61 provides that the determination of when construction begins is 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 2020-12, 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.
The final regulations provide that until the IRS issued further guidance, taxpayers can continue to rely on the beginning of construction guidance in Notice 2022-61 and the other related notices. In addition, the IRS acknowledged that earlier guidance created some confusion around this rule and provided a transition rule. Taxpayers do not need to meet the PWA requirements on any work done before Jan. 29, 2023, even if the taxpayer did not “begin construction” before that date for purposes of the overall exception.
Grant Thornton Insight:
The preamble to the final regulations also acknowledged some taxpayer confusion over the definition of “beginning of construction” for purposes of the exception above and the definition used to mark the start of the obligation to comply with the general PWA rules. The final regulations rely on the DBA rules to define when construction commences for applying the PWA rules generally, so that once an activity constitutes “construction” under the DOL rules for the DBA (discussed more below), the taxpayer must comply with the PWA requirements. This will not necessarily mark the beginning of construction for the exception above or for other purposes of the code, which will continue to rely on the IRS notices.
One megawatt limit
Projects under Section 45 and 48 (and under Section 45Y and 48E for projects beginning after 2024) are also exempt from the PWA 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 final regulations provide a general rule that net output will be determined by “nameplate capacity,” defined as the maximum output on a steady-state basis during continuous operation under standard conditions.
The final regulations do not offer much additional guidance on how this determination is made for various types of property and facilities. The IRS instead said guidance addressing each specific type of property would be provided under the rules for each credit.
Grant Thornton Insight:
The one-megawatt threshold could potentially exempt many smaller and non-utility-scale projects, particularly rooftop or onsite solar projects, though the lack of guidance in this area is frustrating. The preamble said that the determination of what is included in the scope of a facility or property for purposes of these rules (and any aggregation principles) should be made under underlying guidance for each credit. Proposed regulations under Section 48 would provide that qualifying property that has no storage or production output, such as electrochromic glass or microgrid controllers, cannot qualify for the exception at all. The proposed regulations under Sections 45Y and 48E did not offer much guidance in this area, and the preamble to those rules said guidance would be provided separately.
Prevailing wage rules
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. Like earlier guidance, the final rules rely 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.”
Workers
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
“Construction, alteration, and repair” is 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. This definition excludes “maintenance” after the property has been placed in service, and the final regulations clarify this term by distilling two separate sets of DOL guidance and adding more specific criteria. Under the guidance, “maintenance” is defined as work that is routinely scheduled and continuous or recurring and does not do the following:
- Improve the facility by fixing something that is not functioning or improving upon the existing condition
- Involve correcting individual problems or defects that are isolated and not recurring
- Improve the structural strength, stability, safety, capacity, efficiency or usefulness
Grant Thornton Insight:
The regulations do not rely on rules elsewhere in the code to distinguish between alterations, repairs, or maintenance, and provide that the PWA rules will not apply to any Section 162 or Section 263 determinations. The IRS noted in the preamble that the determination will be highly fact-specific, and it removed an example from the proposed regulations.
Offsite work
The definition of “construction” can also include offsite work if a significant portion of the construction, alteration, or repair of the facility occurs at a secondary site established specifically for the project or dedicated exclusively to the project for a specific period of time. The final regulations clarify that this does not include unrelated third-party manufacturers who produce materials, supplies, equipment, and prefabricated components for multiple customers or the general public.
Wage determination
The prevailing wage itself would be determined under the general DOL rules. Under the final regulations, the prevailing wage is determined at the time a contract is executed by the taxpayer, rather than when construction begins. This can provide more cost certainty during planning, but could also mean that different contractors use different prevailing wages if they enter into contracts at different times. The prevailing wage for any given contractor will generally remain unchanged unless the contract is entered into for an indefinite period, updated annually based on the contract execution date, or is amended to extend it or to include substantial additional construction, alteration, or repair work not within the scope of the original contract.
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-eligible 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 has said it expects this process will be necessary only in a limited number of circumstances.
Apprenticeship rules
The apprenticeship rules require fulfilling three separate requirements in the construction, alteration, or repair of a qualified project before property it is placed in service:
- Minimum percentages of total labor hours must be performed by qualified apprentices:
- 10% for projects that began construction before 2023
- 12.5% for projects that began construction in 2023
- 15% for projects that began or will begin construction in 2024 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.
Under the final regulations, the minimum percentage requirement applies based on total hours for the project across all contractors, while the ratio requirement applies daily across all contractors. The participation requirement would be a minimum threshold for each separate contractor or subcontractor with no time requirement. Like the prevailing wage rules, the word “employ” in this context does not distinguish between employees and independent contractors.
Good-faith effort
Taxpayers can alternatively satisfy the general apprenticeship requirements by making a “good-faith effort,” which means requesting qualified apprentices from a registered program or programs that covers the location of the facility, trains apprentices in the occupations needed with respect to the facility, and has a usual and customary business practice of entering into apprenticeship agreements with employers. The request must be made in writing and 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. Reasonable estimates are allowed.
Taxpayers whose requests are denied or ignored would need to keep re-requesting every 365 days (366 in a leap year) to continue qualifying for the good-faith exception, which is relaxed from the 120-day period in the proposed regulations. The final regulations retain rules for partially relying on the good-faith exception in circumstances where only some qualified requests go unfulfilled.
Grant Thornton Insight:
The final regulations relax the apprenticeships both by exempting all work after a facility or property is placed in service, and by expanding the good-faith exception. Documenting eligibility for the exception or actual compliance will remain important. Taxpayers should work with their contractors to understand the specific steps that were taken to identify and recruit apprentices.
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.
Grant Thornton Insight:
The IRS noted that this 180-day period is statutorily enforced from the notification point and is not suspended by going to IRS Appeals or taking the dispute to court. Taxpayers have the option of appealing any reduction in a claimed credit based on the determination of a failure, but if the failure is sustained, they will have lost their ability to cure it by paying a penalty if they are beyond the 180-day period.
Intentional disregard
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 final regulations expand the non-exhaustive lists of factors for this determination, including whether:
- The taxpayer took steps to determine the proper classification
- Prevailing wage amounts were posted at the job site
- The taxpayer undertook a quarterly or more frequent reviews of wages
- The taxpayer put in place procedures for workers to report suspected failures
- The taxpayer investigated complaints or reports of retaliation
- Pay stubs or payroll records were provided to laborers or mechanics
- 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
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.
Grant Thornton Insight:
The penalties will be an important option to preserve the full credit upon any lapses, but can be very costly. It will be critical to frequently monitor and document compliance in order to minimize penalties and ensure failures are not due to intentional disregard. Many of the factors will be up to contractors and subcontractors, so taxpayers should consider implementing deliberate contractual requirements and remedies into agreements (which is itself a factor), and implementing an effective review and monitoring process.
De minimis rule
The final regulations expand a de minimis rule that will waive penalties for prevailing wage failures if the following conditions are met:
- Correction payments are made within one month after the quarter in which the failure occurred.
- The wage failures occurred in not more than 10% of the pay periods for the affected individual or the amount underpaid was less than 5% (double from the proposed regulations) of the total required to be paid.
Labor agreements
There is another exception to the penalty payments for projects done under a “qualifying project labor agreement” if any corrective payments are made to workers before the return is filed. The final regulations slightly expand requirements for an agreement to qualify as a “qualifying project labor agreement.”
Grant Thornton Insight:
Performing a project under a union agreement will not relieve taxpayers from the need to document and monitor compliance with the underlying rules. The requirements of a union agreement may ultimately mirror or exceed the PWA requirements, but for purposes of claiming a credit, the agreement only provides penalty relief, and only if lapses are promptly addressed. Taxpayers will still need to monitor compliance with the underlying PWA rules (and labor contracts) and document that compliance in order to claim the full credits and avoid penalties.
Transferred credits
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 final regulations retain rules providing that the taxpayer that sells and transfers the credit 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 final regulations under Section 6418 generally require the buyer to repay any liability for adjustments to credits upon examination, but these regulations also require the seller to pay the penalty to cure PWA lapses. So sellers are essentially required to pay any penalty necessary to preserve the full credit for the buyer. Deliberate contractual language may be needed to compel the seller to pay for any failures uncovered later. Taxpayers planning to sell credits will also likely need to provide buyers with substantial documentation demonstrating compliance with the underlying rules.
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:
- Certified payroll on DOL Forms WH-347
- 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
- Records of any complaints received
- 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 IRS again declined to require certified payroll forms to be submitted throughout the project before the credit is claimed for a variety of valid reasons, but the rules make clear that taxpayers themselves should be continually collecting certified payrolls and other applicable sufficient records in order to document compliance. The preamble notes that payroll records alone will not be enough. Developing operating processes to periodically monitor and assess status, at least quarterly, will also be crucial to substantiate compliance and mitigate potential penalties. These issues are expected to be heavily audited. Treasury Secretary Janet Yellen has said publicly that the IRS is committed to strong enforcement in this area.
Next steps
The regulations generally apply to facilities, property, projects or equipment for which construction or installation began after June 25, 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 monitor and document their compliance.
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