Wage and Apprentice Requirements
The Internal Revenue Service filled in many missing details this week in new wage and apprentice requirements with which developers must comply to claim tax credits at the full rates in the Inflation Reduction Act.
Some of the details may require revisiting existing construction and operations and maintenance contracts.
Proposed regulations the agency released on Tuesday can be found here.
The Inflation Reduction Act restored tax credits to the full rates for projects that use renewable energy to generate electricity, increased tax credits for carbon capture and authorized new tax credits for such things as standalone storage and clean hydrogen, plus authorized bonus credits for projects in "energy communities" or that use domestic content.
The changes came with fine print.
Mechanics and laborers employed directly by the developer or by construction contractors or subcontractors to work on a project must be paid the same "prevailing wages" that are paid on federal construction jobs not only during construction, but also for work on any "alteration" or "repair" for the next five to 12 years after the project is in service. These wages must be paid for five years after the in-service date on projects on which investment tax credits are claimed and for the period that production or carbon capture tax credits are claimed on other projects.
"Qualified apprentices" must also be used for 12.5% or 15% of total labor hours. The percentage is 12.5% for projects on which construction starts in 2023 and 15% for projects on which constructions starts in 2024 or later.
These requirements grew out of a promise by President Biden during the last campaign that green jobs would be well-paying jobs and that the government would help workers who want to learn new trades tied to the green economy.
Projects on which construction started by January 28, 2023 and small facilities with nameplate capacities under 1 MWac are exempted from the wage and apprentice requirements.
Failure to comply means a project cannot qualify for tax credits at the full rates. The owner would be left with tax credits at only a fifth of the full rate: for example, a 6% rather than 30% investment tax credit.
Developers are expected to make cure payments in the event the IRS finds gaps in compliance to preserve the full tax credits. Workers who were underpaid would have to be paid the shortfall plus interest at the federal short-term rate plus 6%, and the project owner would have to pay $5,000 per affected worker per year to the Treasury as a penalty. The cure for missed apprentice hours is $50 an hour.
Construction and O&M contracts for projects that were not under construction for tax purposes by January 28, 2023 now come with standard clauses requiring contractors to comply with the wage and apprentice requirements.
Early versions of these clauses, especially around the time the Inflation Reduction Act passed, required contractors to comply with whatever the IRS requires and allowed change orders, usually up to a cap, to cover the additional cost. Contractors have been pushing back since then on having to interpret what the tax law requires. They prefer specific instructions from the developer.
Most contracts require the contractor to reimburse the owner for any cure payments it must make to preserve the full tax credits. Contractors want a cap on their exposure. Caps in construction contracts are a percentage of the contract price and in O&M contracts are usually expressed as a percentage or a multiple of the annual O&M fee. For other insights into current contract negotiations, see "Wage and Apprentice Negotiations."
The wage and apprentice requirements do not apply to work that an equipment manufacturer does at a factory.
They apply to work by mechanics and laborers, meaning people whose work is physical or manual in nature, at the project site and secondary construction and support sites. Transportation between a secondary construction or support site and the project site is also subject to the requirements.
The phrase secondary construction and support sites is a little broader than the concept—nearby laydown yards—that the IRS used in guidance in November. For the earlier guidance, see "IRS Issues Wages and Apprentice Requirements."
A "secondary" construction site is a construction site dedicated for a period of time to making a significant portion of a single project as opposed to a factory that makes products for sale to a wider market. Examples of "support" sites are office trailers, tool yards, batch plants and borrow pits that are adjacent or virtually adjacent to the project site or a secondary construction site.
Foremen who devote more than 20% of their time during a workweek to manual or physical labor must be paid at least the prevailing wage rate for the physical work.
The wage and apprentice requirements apply not only to private-sector projects claiming tax credits, but also to projects owned by tax-exempt and state or local government entities, rural electric cooperatives, Alaska native claims corporations, the Tennessee Valley Authority and Indian tribes that plan to apply for direct cash payments from the IRS in lieu of tax credits.
However, the Treasury is considering whether to exempt the Tennessee Valley Authority and Indian tribes.
The IRS settled a debate among the tax bar about whether the apprentice requirements apply to O&M contracts. The answer is yes. The regulations make clear that apprentices must be used not only during construction, but also for alterations and repairs.
It also added more detail to what is considered an "alteration" or "repair." Making an improvement whose cost is capitalized or fixing a piece of malfunctioning equipment is a repair that requires compliance with the wage and apprentice requirements. An example is replacing broken parts in an inverter to "restore functionality as a result of inoperability."
However, workers do not have to be paid prevailing wages for doing basic maintenance, such as regular cleaning, replacing materials such as filters and light bulbs and recalibrating equipment.
The required wages vary by job type and location. They are published on the US Department of Labor website here. However, there are no postings for some job types and locations.
The IRS said that developers in such situations should send emails requesting wage determinations to IRAprevailingwage@dol.gov with a prescribed list of information.
Requests for wage determinations should be sent within 90 days before construction or work on alterations and repairs starts or promptly after work starts if the need for a wage determination was not apparent earlier.
Any wage determination relates back to the start of work. The contractor has 30 days after the wage determination to catch up any workers who were underpaid. The back wages in such cases do not have to be paid with interest.
The required wages include fringe benefits. Higher cash wages can be paid in lieu of fringe benefits. Wage determinations usually include an additional hourly rate for such benefits, but contributions for some benefits may be expressed as a formula.
Apprentices can be paid less. Their wage rates are set by the apprentice program and are a percentage of an experienced construction worker's wage, depending on the progress level of the apprentice. However, the apprentice must be paid the full wage for any work that falls outside the labor classification for which he or she was sent to the job site and for any work performed outside the required apprentice ratios. Apprentices must be paid the fringe benefits specified by the apprentice program. If there is none, then the apprentice must be paid full fringe benefits.
Offshore wind projects should use the prevailing wages for the closest location on shore.
The wage rates that must be paid are locked in when construction starts and then again when work starts on each series of alterations and repairs. However, they must be reset to current wage rates if the contract is later amended to add to the scope of work or extend the contract period.
If the work on a project straddles two locations with different wage rates, then the contractor should pay the higher of the two rates.
The IRS views the obligation to use apprentices as having three elements: hours, ratio and participation.
First, qualified apprentices must work 12.5% or 15% of total labor hours, depending on the year construction started on the project. "Qualified apprentices" are workers registered in programs usually run by unions to train workers in construction trades. There were 27,000 registered apprentice programs in 2022. The US Department of Labor website shows at least 607,509 registrants in such programs currently, counting apprentices only in states that report data to the federal government.
Second, apprentice programs have journeyworker-to-apprentice ratios that are like limits on class size to ensure that students get enough attention from teachers. The US Department of Labor or delegated state apprenticeship agencies also have them. Work done by extra apprentices will not count toward the labor hour requirement, and extra apprentices must be paid the full prevailing wages rather than the reduced wages that normally apply to apprentices. Whether apprentices are extra is determined on a daily basis.
Third, each contractor or subcontractor with at least four mechanics and laborers working on a project during construction or on later alterations and repairs must have at least one apprentice.
Developers will have to work harder to find apprentices than suggested by the Inflation Reduction Act. The statute said that a project will be excused from use of apprentices if a good-faith effort is made to find apprentices, but the apprentice program does not answer within five business days or the request is denied.
The IRS said a project will be excused only for 120 days at a time and must make another attempt by the end of each such period. It added more detail to what it considers a good-faith effort. The requests must be made to apprentice programs that serve the area where the project is located or can reasonably be expected to provide the types of trainees needed. The IRS said it expects projects will have to submit requests to multiple apprentice programs to find the range of workers needed. For instance, a contractor cannot request welder apprentices from an apprentice program for electricians and treat the denial of the request as excusing the need to employ welder apprentices. Requests to apprentice programs must be sent electronically or by registered mail. There are detailed instructions for what such requests must say.
Whether 12.5% or 15% of total labor hours were worked by apprentices is tested by combining total hours across all the contractors. Thus, for example, if two contractors fell short and one had more apprentice hours than needed, as long as the one with extra hours did not violate the journeyworker-to-apprentice ratio so that the extra apprentice hours count, the project can still pass the hours test.
Developers should do at least a quarterly review of wages paid by their contractors and subcontractors to ensure compliance.
This is helpful to being able to show that a developer did not intentionally disregard the requirements if violations are later uncovered by the IRS. The cure payments are higher if there was intentional disregard: workers who are underpaid must be paid three times the shortfalls and the penalty to the Treasury increases to $10,000 per affected worker per year for wage violations and to $500 per missed apprentice hour.
Wage rates should also be posted in a prominent place on the job site. The developer should ensure workers have a way to report suspected failures to pay the proper wages or comply with the apprentice requirements.
A developer who spots problems before the IRS finds them will not be held in intentional disregard if cure payments are made before the IRS sends a notice that it is looking into the "increased credit" claimed on a project.
Project owners must keep records to prove compliance. The records must include at a minimum payroll records for each mechanic, laborer and qualified apprentice working on the project during construction or on alterations and repairs after. The IRS said the records "may include" nine other items related to wages and five other items related to apprentices. It would be a good idea to have all 14 if possible. The lists can be found at 26 CFR § 1.45-12(b) and (c).
Violations of the wage and apprentice requirements are not expected to lead to loss of tax credits in practice as project owners are expected to make cure payments and require contractors to reimburse them.
Cure payments must be made within 180 days after the IRS identifies a failure.
The penalty of $5,000 per affected worker per year can be avoided in two situations.
It can be avoided by paying the wage shortfalls to affected workers with interest promptly after the project owner becomes aware of the missed wages or, if earlier, when it files its annual return for the tax credit year, but only if one of two other things is true. Either the worker cannot have been underpaid in more than 10% of all pay periods during the year that he or she was employed on the project or the shortfall was not more than 2.5% of what he or she should have been paid during the year.
The penalty is waived where the worker was working under a pre-hire collective bargaining agreement with one or more labor unions for a specific project and the wage shortfall is paid to the worker before the project owner files its annual return for the tax credit year.
Project owners are able under section 6418 of the US tax code to sell many Inflation Reduction Act tax credits to other companies for cash. In cases where the tax credit on a project is sold, the obligation to make cure payments remains with the project owner. If it fails to make such payments, then it will be treated as having sold tax credits at only a fifth of the full rate.