Tax season is here. As a result, many companies may be seeking to claim the increased tax credits and deductions available under the Inflation Reduction Act (the “IRA”). As we discussed in previous posts you can read here and here, many of the IRA’s tax credits and deductions for various clean energy projects are available only to taxpayers whose projects complied with nuanced and complex prevailing wage and apprenticeship requirements (the “PWA Requirements”). These requirements must be met before a taxpayer files a return claiming credits and deductions under the IRA.
While the Treasury Department and the IRS have not yet issued a final rule on the PWA requirements, proposed regulations were published on August 30, 2023 to provide preliminary guidance and clarifications on many of the PWA Requirements (the “Proposed Regulations”). Taxpayers are allowed to rely upon the Proposed Regulations for projects that begin construction after January 28, 2023, and prior to the date a final rule is published, provided that taxpayers follow the Proposed Regulations in their entirety and in a consistent manner for projects beginning construction 60 days after August 29, 2023. Accordingly, taxpayers claiming credits and deductions on qualified projects that started on or after January 29, 2023 should ensure compliance with the Proposed Regulations. In this post, we briefly summarize the PWA Requirements under the IRA and key takeaways from the Proposed Regulations regarding compliance with the PWA Requirements.
The IRA’s Prevailing Wage and Apprenticeship Requirements
The IRA itself generally conditions a taxpayer’s receipt of its increased tax credit or deduction amounts on a qualifying project by either: (1) satisfying the PWA Requirements; (2) meeting the so-called One Megawatt Exception; or (3) meeting the so-called Beginning of Construction (“BOC”) Exception.
The PWA Requirements are set forth in 26 U.S.C. § 45(b)(7) and 26 U.S.C. § 45(b)(8), and consist of both “prevailing wage” and “apprenticeship” requirements.
To satisfy the IRA’s prevailing wage requirements, a taxpayer must do two things:
- The taxpayer must ensure that any laborers and mechanics employed by the taxpayer or any contractor or subcontractor are paid at least the applicable “prevailing wage” under the Davis-Bacon Act for both (a) the construction of the qualifying facility and (b) any alteration or repair of the facility for any taxable year within the production tax credit period or during the tax credit recapture period, as applicable, after the facility is originally placed in service.
- The taxpayer must maintain and preserve records that substantiate payment of prevailing wages on the qualifying facility in accordance with the IRA.
The IRA’s apprenticeship requirements have four basic components:
- The Apprentice Participation Requirement. Each taxpayer, contractor, or subcontractor who employs four or more individuals to perform “construction, alteration, or repair work” with respect to the construction of a qualified facility, must employ at least one qualified apprentice in connection with such work. A “qualified apprentice” means an individual participating in a registered apprenticeship program.
- The Apprentice Labor Hours Requirement. A taxpayer seeking tax benefits under the IRA must ensure that a minimum percentage of “the total labor hours of the construction, alteration, or repair work” on the project (including work by a contractor or subcontractor) is performed by qualified apprentices. The applicable percentages are: (a) 10% of total labor hours if construction began before January 1, 2023; (b) 12.5% of total labor hours if construction began between January 1, 2023, and December 31, 2023; and (c) 15% of total labor hours if construction began on or after January 1, 2024.
- The Apprentice Ratio Requirements. When apprentices are required, the taxpayer must ensure that apprentices are employed in accordance with any “apprentice-to-journeyworker ratios” required by the U.S. Department of Labor or applicable State apprenticeship agency. Under federal regulations, for example, registered apprenticeship programs must prescribe the minimum number of journey workers needed to ensure adequate safety and supervision for each apprentice.
- Recordkeeping Requirements. Taxpayers must maintain and preserve records that substantiate compliance with the “Participation,” “Labor Hour,” and “Ratio” requirements.
As noted above, there are two major exemptions from the PWA Requirements. They are commonly referred to as the “One Megawatt Exception” and the “BOC Exception.”
Under the One Megawatt Exception, a “qualified facility,” as defined in 26 U.S.C. § 45(d), with a maximum net output that is less than one megawatt is eligible for increased tax credits under the IRA regardless of whether the taxpayer satisfies the PWA Requirements. For the purposes of this exemption, net output is measured in alternating current.
Under the BOC Exception, a qualified facility may be eligible for increased tax credits without satisfying the PWA Requirements if construction of the facility began prior to January 29, 2023 (i.e., 60 days after the Treasury Department and the IRS published their initial guidance on the PWA Requirements). The IRA itself does not define when construction “begins” for the purposes of the BOC Exception. However, previous guidance from the Treasury Department and the IRS stated that the BOC Exception will treat construction as beginning on the date when the taxpayer either: (a) started physical work of a significant nature or (b) paid or incurred five percent or more of the total cost of the facility. Taxpayers may utilize either method for establishing that a project falls within the BOC Exception. Under both methods, however, the taxpayer must show that they made continuous progress towards completion of a project once construction began. This “continuous progress” requirement can be satisfied by completing construction within safe harbor periods which, after 2020, is generally four calendar years for most on-shore facilities. This previous guidance on these issues is unaffected by the Proposed Regulations.
Key Takeaways from the Proposed Regulations
The Proposed Regulations attempt to clarify the PWA Requirements in several different ways. We outline some of the major clarifications below.
Incorporation of Certain Davis-Bacon Act Standards
In advance of issuing the Proposed Regulations, the Treasury Department and the IRS solicited comments regarding the extent to which the IRA’s PWA Requirements should track regulations issued under the Davis-Bacon Act—a statute which requires the payment of prevailing wages in construction contracts with the federal government and the District of Columbia. Aiming to strike an “appropriate balance,” the Proposed Regulations would incorporate only certain Davis-Bacon Act requirements as relevant to determining compliance with the PWA Requirements. For example:
- The Proposed Regulations adopt or incorporate the Davis-Bacon Act’s definitions of terms such as “laborer”; “mechanic”; “construction, alteration, or repair”; “wages”; and “employed.” The Proposed Regulations consequently clarify that, as with the Davis-Bacon Act, “construction, alteration, or repair” does not include “maintenance,” such as “work that is ordinary and regular in nature that is designed to maintain and preserve existing functionalities of a facility after it is placed in service,” as opposed to “work that improves a facility, adapts it for a different use, or restores functionality as a result of inoperability.”
- The Proposed Regulations clarify the obligation to pay the prevailing wage in “the locality in which [a qualified facility] is located” and in accordance with the wage determination for the “geographic area” where a facility is located by adopting the Davis-Bacon Act’s “site of the work” standard. Consequently, consistent with the Davis-Bacon Act, the “geographic area” or “locality” in which a qualified facility is located includes secondary construction sites where “a significant portion of the facility is constructed, altered, or repaired,” provided that (a) work at the secondary site is for “specific use” at the qualified facility and (b) the second site was either specifically established or exclusively dedicated for a period of time to the work on the qualifying facility.
- The Proposed Regulations adopt recordkeeping requirements similar to those under the Davis-Bacon Act to substantiate compliance with the PWA Requirements. This includes maintaining payroll records with each worker’s and apprentice’s identifying information, facility information, labor classification, rate(s) of pay, fringe benefits, hours worked, and wages paid. It also includes records of requesting and employing apprentices.
On the other hand, the Proposed Regulations elected not to incorporate Davis-Bacon Act standards that the IRS and the Treasury Department considered inconsistent with “sound tax administration.” These include requirements under the Davis-Bacon Act and the Copeland Act for contractors and subcontractors to submit certified payroll reports to federal entities on a weekly basis. Because the PWA Requirements are binding only when a taxpayer submits a tax return claiming increased tax credits or deductions under the IRA, the Proposed Regulations clarify that a taxpayer is not required to establish compliance with the PWA Requirements until a tax return claiming the increased credits or deductions is filed. Records of compliance are to be provided in a manner, and using forms, specified in IRS forms, publications, or other guidance.
Determination of the Prevailing Wage Rate
The Proposed Regulations clarify that the general prevailing wage determination applicable for a qualified project is the wage determination in effect “when the construction of the facility begins.” Unfortunately, it remains unclear whether the “construction” of a facility will be deemed to “begin” on the date of: (a) groundbreaking; (b) surveying; (c) entering into a prime contract; or (d) construction beginning for the purposes the BOC Exception. The Proposed Regulations also clarify that the applicable wage determination generally remains valid for the duration of the project. However, a taxpayer must ensure compliance with a subsequent wage determination when a contract is modified to include additional work that is either not within the scope of the work contemplated in the original contract or to extend the time to complete the project. This includes situations where a taxpayer, contractor, or subcontractor exercises an option to extend the term of a contract. The modification and additional work rule should generally result in new wage determinations when the BOC Exception was satisfied through off-site work or pursuant to a limited scope of initial construction prior to a full notice to proceed (or “FNTP”) .
The Proposed Regulations require taxpayers to submit a request to the Department of Labor for a supplemental wage determination or a prevailing wage rate for an additional labor classification in two circumstances: (1) when no wage determination has been issued for a geographic area or for a particular type of construction and (2) when a labor classification necessary for the construction, alteration, or repair work for the project is not listed in the determination. These requests must be made within 90 days prior to the beginning of the construction, alteration, or repair of the qualified facility. In cases where a taxpayer is unable to determine the need for a supplemental wage determination until after construction has begun, a taxpayer is expected to submit a request as soon as practicable.
Correction and Penalty Provisions for Failure to Satisfy the Prevailing Wage Requirements
The IRA allows taxpayers to “cure” failures to comply with the prevailing wage components of the PWA Requirements by both: (a) paying a “correction” payment to a worker equal to the amount of underpayment plus interest and (b) paying a penalty to the Secretary of the Treasury in the amount of $5,000 for each underpaid worker. The Secretary can increase the penalty to $10,000 per underpaid worker for violations resulting from “intentional disregard.”
The Proposed Regulations make clear that the obligation to make corrections and penalty payments is not binding until a taxpayer files a tax return claiming credits or deductions under the IRA. Therefore, the Proposed Regulations do not require corrective and penalty payments until the time the additional credits or deductions are claimed. While a taxpayer is permitted to make corrective payments in advance of filing a tax return to avoid the accrual of interest associated with any underpayment, the earliest time a taxpayer can make a penalty payment to the Secretary is at the time of filing the tax return. If the IRS makes a final determination that a taxpayer failed to meet the prevailing wage requirements, the taxpayer has 180 days to make the necessary correction and penalty payments. The Proposed Regulations identify a taxpayer’s promptness in paying a penalty and corrective payments as factors that would be considered in the analysis of increased penalties for intentional disregard.
The Proposed Regulations also provide for a waiver of a penalty payment if both: (1) the taxpayer makes a required correction payment by the earlier of: (a) 30 days after the taxpayer discovers the error or (b) the date on which the tax return claiming the increased credit is filed; and (2) either (a) the period of underpayment to a worker did not exceed 10% of the pay periods in the calendar year when the laborer performed work on the project, or (b) the difference between the amount of wages paid and the amount required to be paid is not greater than 2.5% of the amount required to be paid.
Apprenticeship Requirements and the “Good Faith Effort” Exception
The Proposed Regulations provide two important clarifications with respect to the IRA’s apprenticeship requirements.
First, the Proposed Regulations make clear that, except for taxpayers exempt from the PWA Requirements, taxpayers seeking increased tax credits or deductions must comply with the “Participation,” “Labor Hour,” and “Ratio” components of the apprenticeship requirements. To that end, the Proposed Regulations reiterate that the Apprentice Labor Hours Requirement applies to the total labor hours of work performed on the project (including all work by the taxpayer, contractors, and subcontractors). The Proposed Regulations further provide that while the Apprentice Participation Requirement is not a “daily” requirement, the Apprentice Ratio Requirement does apply on a daily basis. In other words, apprentices do not necessarily need to be working every day, but every day of work on a project must comply with any applicable ratio requirement. For any day when the Apprentice Ratio Requirement is not satisfied, the work performed by any apprentice in excess of the applicable ratio must be paid at the prevailing wage rate for that labor classification and the labor hours performed by the apprentice in excess of the ratio would not count towards the Apprentice Labor Hours Requirement.
Second, the IRA attempts to clarify the “good faith effort” exception for compliance with the apprenticeship requirements. Under the IRA, a taxpayer who fails to employ apprentices in accordance with the apprenticeship requirements will nevertheless be deemed to have satisfied this requirement if the taxpayer can show that: (1) they requested qualified apprentices from a registered apprenticeship program, and (2) either (a) the request was denied for reasons other than a refusal to comply with the program’s standards and requirements, or (b) the apprenticeship program failed to respond to their request within five business days after receiving the request. The Proposed Regulations elaborate on these components of the good faith effort exception. Under the Proposed Regulations:
- A taxpayer, contractor, or subcontractor subject to PWA Requirements must make a written request to at least one registered apprenticeship program that could “reasonably be expected to provide apprentices to the location of the facility” in order to qualify for the good faith effort exception. The preamble to the Proposed Regulations clearly states that the good faith effort exception may necessitate a request for apprentices to more than one apprenticeship program, depending on the size of the project, the number of contractors or subcontractors, and the anticipated number of labor hours for which apprentices are needed. Additionally, submitting a request to a program that is outside the relevant geographic area would not be a request to a program that could “reasonably” be expected to provide apprentices.
- If a request for apprentices complying with the specifications in the IRA is “denied” or “not responded to,” the taxpayer will be deemed to have exercised a “good faith effort” sufficient to comply with the IRA. However, this protection exists only for a period of 120 days from the date of the request that was “denied” or “not responded to.” The Proposed Regulations state that a taxpayer will not be deemed to have exercised a “good faith effort” beyond 120 days of a request that was denied or not responded to unless “the taxpayer submits an additional request” for apprentices. Unfortunately, it is not clear whether one additional request is sufficient, or if the good faith effort exception will only apply for one additional 120-day period. The safest course of action is to make continued attempts to obtain apprentices over the life of a project, so that the good faith effort exception would clearly apply for 120 days each time an apprenticeship program denies or fails to respond to a taxpayer’s request for apprentices.
- If a registered apprenticeship program fails to respond within five business days of receiving an IRA-compliance request for apprentices, the Proposed Regulations will consider the request denied. However, a program’s acknowledgment—whether in writing or otherwise—of the receipt of the request is sufficient to qualify as a “response.” Examples in the Proposed Regulation indicate that a response is deemed to be “received” even if the response was routed to a “junk” or “spam” folder in a taxpayer’s, contractor’s, or subcontractor’s email account.
- If an apprenticeship program only denies a portion of a request for apprentices (e.g., it provides some apprentices, but is unable to provide the total amount requested), the good faith effort exception will apply only to the portion of the request that was denied.
Benefits for Using Pre-Hire Project Labor Agreements
To incentivize “stronger labor standards and worker protection,” the Proposed Regulations allow taxpayers who enter into a qualifying pre-hire “project labor agreement” with one or more labor organizations to “cure” an underpayment of prevailing wages without tendering a penalty payment to the Secretary (i.e., by only making a “correction payment”). The penalty associated with a taxpayer’s failure to satisfy the Apprentice Labor Hours Requirement and Apprentice Participation Requirement is also waived when there is a qualifying pre-hire project labor agreement in place.
The Proposed Regulations clarify that these benefits extend only to taxpayers with a “Qualifying Project Labor Agreement.” To constitute a Qualifying Project Labor Agreement, a pre-hire agreement must:
- bind all contractors and subcontractors on the construction project with appropriate specifications in all relevant solicitation provisions and contract documents;
- guarantee against strikes, lockouts and similar job disruptions;
- adopt “effective, prompt, and mutually binding” procedures for resolving any labor disputes that may arise during the term of the project labor agreement;
- contain provisions requiring the payment of prevailing wages;
- contain provisions for referring and using qualified apprentices consistent with the requirements under the IRA and any guidance issued by the Treasury Department and the IRS; and
- be a collective bargaining agreement with one or more labor organizations of which building and construction employees are members.
What’s Next?
The Treasury Department and the IRS have not yet issued a “final” rule adopting the Proposed Regulations or any variation thereof. We will continue to provide updates on the Proposed Regulations, including when they are published as final regulations.
In the meantime, the Treasury Department and the IRS have authorized taxpayers to rely on the Proposed Regulations for claiming IRA credits on construction or installation between January 29, 2023, and the date when any final regulations are published in the Federal Register. Given the IRA’s numerous complexities, taxpayers who seek to claim credits and deductions under the IRA should ensure they have complied with the IRA over the applicable tax year, including the PWA Requirements set forth in the Proposed Regulations. Reliance on the Proposed Regulations prior to the issuance of final regulations is generally conditioned on compliance with the entirety of the Proposed Regulations.
Please reach out to us should you have questions relating to the IRA or the PWA Requirements. Our colleagues in Sheppard Mullin’s Energy, Infrastructure and Project Finance Team can also assist with the navigating the numerous other complexities of the IRA.