The Inflation Reduction Act of 2022 fundamentally changed the way most renewable energy tax credits are calculated by obligating companies to meet prevailing wage and apprentice requirements to be entitled to the full tax credit amount.
The mechanics of the prevailing wage requirements allow a multiplier for eligible businesses at five times the base rate for production and investment tax credits for qualifying projects. On Aug. 29, the IRS proposed regulations that provide additional rules to address a number of issues, including easing penalties for developers and investors who fail to meet the labor rules for the clean energy tax credits on their projects.
While seemingly simple to implement, the prevailing wage requirements are more difficult to get certainty on at a practical level.
Penalty and Cure Provisions
To satisfy the prevailing wage requirement, companies must ensure that any laborer, mechanic, contractor, or subcontractor employed in the construction of a qualified facility are paid wages at no less than the prevailing rates as most recently determined by the Department of Labor.
But wage rates aren’t always apparent for each category of laborers and mechanics. For example, the DOL hasn’t yet prescribed categories for workers installing solar panels and wind turbines. As a result, businesses must choose a broad category that may not be appropriate for the particular type of laborer or mechanic. This lack of clarity leaves companies guessing if they’ve complied with the correct prevailing wage rate.
If companies fail to pay a prevailing wage, they can still remain eligible for the increased credit amount by making applicable correction and penalty payments. A correction payment must be made to the laborer or mechanic equal to the difference between the prevailing wage amount required to be paid and the actual amount paid, plus interest at the federal short-term rate increased by 6%.
A penalty penalty also must be made to the Department of the Treasury equal to $5,000 multiplied by the total number of laborers or mechanics who were paid wages below the prevailing wage rate. These amounts are increased for intentional disregard.
The preamble to the proposed regulations clarifies that the obligation to make such payments arises when a business fails to pay prevailing wages but becomes binding only when the increased credit is claimed on a tax return. However, they can make correction payments to laborers and mechanics in advance of filing to minimize the amount of interest due.
There are additional nuanced rules for hiring apprentices and paying penalties for failure to comply with the apprenticeship requirements.
Penalty Waivers
The proposed regulations include a safe harbor for union labor that’s likely to continue to be controversial.
The preamble states that “pre-hire labor agreements may be used to incentivize stronger labor standards and worker protections, which may also help ensure compliance with the prevailing wage requirement. For these reasons, the penalty provisions would also not apply to pre-hire collective bargaining agreements with one or more labor organizations meeting certain requirements when correction payments are made before a return is filed.”
This exception favors labor unions that are active in the energy industry and will likely attract the attention of businesses that are concerned about complying with the prevailing wage requirement but some see this as an unfair advantage.
The proposed regulations also grant the IRS discretion to waive penalties when businesses make correction payments by the earlier of 30 days after becoming aware of the error, or the date on which the tax return claiming the increased credit is filed.
Companies hoping to claim the increased credit amount should remain diligent in monitoring payroll practices for all employees—including engineering, procurement, and construction contractors and subcontractors—to ensure any mistakes are identified and corrected within these deadlines.
Transferability of Tax Credits
In the past, businesses haven’t been able to transfer renewable energy tax credits absent tax equity partnerships or through leasing transactions. The new law now allows those eligible to elect to transfer certain tax credits to unrelated persons for cash.
While a transferee would claim a transferred eligible credit (or portion thereof) on their tax return, the proposed regulations provide that the obligation to make correction and penalty payments would remain with the transferor. This provision generally keeps the transferor liable for correction and penalty payments post-sale but would suggest that, if the penalty and correction payments aren’t made, then the amount of the credit would be reduced to the lower base credit, which would generally be 20% of the full credit.
Businesses entering into tax credit transfer transactions will need to consider protections against this risk through indemnities, tax insurance, and diligence. Careful drafting of the purchase agreement could address or mediate this issue.
Treasury and the IRS have requested comments on the proposed regulations by Oct. 30, ahead of a Nov. 21 public hearing. The comments can include alternate ways that businesses might use project labor agreements to meet the prevailing wage requirement and the transferability of credits.
This article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.
Author Information
Martha “Marty” Pugh is a corporate tax partner in K&L Gates’ power practice group, focusing on renewable energy incentives related to wind, solar, and energy storage projects.
France Beard Johnson is an associate at K&L Gates whose practice focuses on US federal and international tax matters.
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