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By Geoff Garber
On November 30, the IRS published guidance on the prevailing wage and apprenticeship requirements implemented in the Inflation Reduction Act (IRA). Taxpayers must meet these requirements to qualify for the maximum credit and deduction amounts for a variety of energy efficient tax incentives, including the 179D Energy Efficient Commercial Building Deduction and 45L Energy Efficient Homes Credit. In previous articles, we covered the IRA’s main impacts to 45L and 179D and what the IRS guidance on prevailing wages and apprenticeships might look like. In this article, we will review the recently published IRS guidance and give a deeper dive into the impacts to builders and AEC firms claiming 45L and 179D.
The IRA made several positive changes to 179D for properties placed in service in 2023, such as increasing the max deduction to $5.00 per square foot and allowing tax-exempt entities (not just governments) to allocate the deduction to designers. But Congress giveth, and Congress taketh away. The IRA also created a lower base deduction of $0.50 to $1.00 per square foot (1/5 of the max deduction). To avoid dropping to the lower benefit, taxpayers must meet one of the following criteria:
In other words, taxpayers automatically get the increased deduction if installation of the energy efficient property begins before 60 days has passed since the guidance was published on November 30. According to the Treasury, that date 60 days later is January 30, 2023, even though 60 days after November 30 is January 29. Unless the Treasury corrects this error, installation must begin on or before January 29, 2023 to receive the bonus deduction with PWA requirements.
A qualified facility, property, project, or equipment are referred to as a “facility” in the guidance. A facility generally must meet the PWA requirements to receive the increased credit or deduction amounts if construction (or installation for purposes of § 179D) of the facility begins on or after the date 60 days after the Secretary publishes guidance with respect to the PWA requirements of the Code. The IRS guidance establishes two methods for determining the “beginning of installation”: the Physical Work Test and the Five Percent Safe Harbor. The Physical Work Test establishes that installation begins when physical work of a significant nature begins, provided that the taxpayer maintains a continuous program of construction (Continuity Requirement). The test focuses on the nature of the work performed, not the amount or the costs, and does not include preliminary activities such as planning or design, obtaining permits, conducting surveys, or clearing a site. Both on-site and off-site work (performed either by the taxpayer or by another person under a binding written contract) may be considered for meeting the Physical Work Test. The Continuity Requirement is based on the facts and circumstances but can also be met through a safe harbor where construction is completed under a certain timeframe, the shortest being 4 years. However, it is unclear which of the timeframes would apply to 179D.
How does the Physical Work Test apply to a 179D project? The guidance focuses on facility installation for 179D, and a facility includes a qualified property and project. If installation of a facility includes any construction of the energy efficient building, then running plumbing and electrical to the site or pouring/preparing the foundation could be considered physical work of a significant nature. Alternatively, the test could apply only to installation of the qualified 179D property, such as the interior lighting systems, the HVAC and hot water systems, or the building envelope. The foundation is a part of the building envelope, so beginning installation of the foundation could arguably begin construction on a qualified facility for 179D purposes. The guidance leaves a lot to be desired on what would trigger the Physical Work Test for 179D, but there is room for interpretation.
Under the Five Percent Safe Harbor, installation commences if the taxpayer has 1) paid or incurred within the meaning of IRC Section 461 2) 5% or more of the project’s total costs includable in the depreciable basis of the property, and 3) thereafter makes continuous efforts to complete the facility. Unlike the Physical Work Test above, taxpayers can consider certain preliminary activities includable in the tax basis such as planning, design, and permitting and allocate the costs incurred for purposes of meeting the 5% threshold.
However, multiple questions exist given the focus on installation of the facility. For new construction, does a taxpayer meet the Safe Harbor by establishing 5% of the total costs of the building or just the costs related to installation of the qualified property (HVAC/hot water, lighting, and envelope)? The simplest answer would be to look at the overall cost of the building, but again the guidance is not clear here. The IRS would have been better served to provide separate guidance on 179D given how different it is compared to the other incentives covered under the notice.
Section 5 of the notice opens the door for multiple interpretations with the following:
For purposes of § 179D, the IRS will accept that installation has begun if a taxpayer generally satisfies principles similar to the two tests described in section 2.02 of this notice, above, regarding the beginning of construction under Notice 2013-29 (Physical Work Test and Five Percent Safe Harbor). The relevant facts and circumstances will ultimately be determinative of whether a taxpayer has begun installation.
The “principles similar to” and “relevant facts and circumstances” language leaves significant room for interpretation in line with the options presented above. Given the general nature of the notice applying to multiple incentives, that may be exactly what the IRS intended.
A taxpayer satisfies the prevailing wage rate requirements when:
(1) The taxpayer satisfies the Prevailing Wage Rate Requirements with respect to any laborer or mechanic employed in the construction, alteration, or repair of a facility, property, project, or equipment by the taxpayer or any contractor or subcontractor of the taxpayer; and
(2) The taxpayer maintains and preserves sufficient records, including books of account or records for work performed by contractors or subcontractors of the taxpayer, to establish that such laborers and mechanics were paid wages not less than such prevailing rates, in accordance with the general recordkeeping requirements under § 6001 and § 1.6001-1, et seq.
To meet item 1 above, taxpayers must first look to the GSA’s www.sam.gov website to see if the Department of Labor already issued a prevailing wage determination for the geographic area and type of construction applicable to the facility. Wages are defined under 29 CFR 5.2(p) and also include any bona fide fringe benefits. There is a method to request an unlisted classification on a determination by contacting the Department of Labor, Wage and Hour Division under the procedures described in section 3.02, but the notice seems to suggest that is unlikely and there is probably an existing determination to leverage. Questions regarding the applicability of a wage determination or its listed classifications and wage rates should be directed to the Department of Labor, Wage and Hour Division via email at IRAprevailingwage@dol.gov.
The prevailing wage requirements also state that laborers and mechanics altering or repairing the facility must be paid prevailing rates for up to 10 years after the property was originally placed in service. The guidance is focused on Section 45, which specifically pays out production credits for a period of 10 years after being placed in service. 179D has no such payout structure, so it would seem odd to require a school district or other entity to pay maintenance workers a prevailing rate for 10 years where the entity did not benefit from 179D in the first place. We expect that subsequent guidance will clarify that the 10-year window applies to incentives like Section 45, 48, and 45Q, but likely not 179D (or 45L).
Taxpayers can correct failure to pay prevailing rates through back pay and penalties. The total for the taxpayer is 1) payment to the worker equal to the additional wages they should have been paid plus 6% interest and 2) payment to the Treasury of $5,000 times the number of workers underpaid. If the underpayment is an intentional disregard, then item 1 above is tripled and item 2 goes to $10,000.
The notice singles out 179D stating that “the prevailing wage rate is for installation of energy efficient commercial building property, energy efficient building retrofit property, or property installed pursuant to a qualified retrofit plan…” This indicates that the relevant prevailing wages for 179D are those paid for installation of the HVAC/hot water, interior lighting, and building envelope systems. In some cases, this would simplify the tracking of prevailing wages if those were the only laborers and mechanics required to be paid a prevailing wage, but it could also complicate things when individuals from the same company work on different parts of a building with some making more than others due to prevailing rates based solely on the system they installed.
The first prevailing wage example lays out some of the records that a taxpayer might maintain, including:
General contractors can identify the laborers and mechanics working for them on the project and determine the labor classification and wage rates to meet the requirements. However, general contractors may not have visibility into each subcontractor’s hourly rate and hours worked by labor classification. For lump sum contracts, that information would be akin to the subcontractor “showing their hand” on their job profitability and may not be something they choose to share. Without a contractual requirement to share such details, there may be no way to verify that prevailing wages were paid, relegating the claimant to the reduced deduction.
The architecture and engineering companies are even further removed from the laborers and mechanics. The notice provides zero insight into how A&E firms should “maintain records” that contractors and subcontractors are paying prevailing rates. Do they need to provide a written declaration for the GC and subs to sign and validate that they are paying certain rates? Even then, why would the GC and subs go through the work of validating that for the A&E firm without compensation? The new requirements may lead A&E firms working on tax-exempt projects to seek out contractors who pay their workers prevailing rates and hire subcontractors who do the same. The project estimate will increase due to prevailing rates, so it remains to be seen which tax-exempt owners will be willing to incur the additional costs, or if they decide to select non-prevailing wage contractors leading to the reduced deduction for all designers involved.
A taxpayer satisfies the apprenticeship requirements if:
(1) The taxpayer satisfies the Apprenticeship Labor Hour Requirements, subject to any applicable Apprenticeship Ratio Requirements;
(2) The taxpayer satisfies the Apprenticeship Participation Requirements; and
(3) The taxpayer complies with the general recordkeeping requirements under § 6001 and § 1.6001-1…
The Apprenticeship Labor Hour Requirements focus on the required percentage of apprentice hours compared to total labor hours, which escalates to 15% over time based on when the installation begins:
| Installation Start Date | Required Apprentice Hours |
| Before 1/1/2023 | 10% |
| After 12/31/2022 and before 1/1/2024 | 12.5% |
| After 12/31/2023 | 15% |
Labor hours are the total number of hours performed for construction, alteration, or repair by employees of the taxpayer, including those employed by any contractor and subcontractor. Excluded from this number are hours worked by foremen, superintendents, owners, or persons employed in a bona fide executive, administrative, or professional capacity (“excluded hours”). Taxpayers calculate the percentage as follows:
The Apprenticeship Ratio Requirements focus on any applicable requirements for apprentice-to-journeyworker ratios of the DOL or the applicable State Apprenticeship Agency. This will vary by jurisdiction and require investigation of requirements by state.
The Apprenticeship Participation Requirement states that each taxpayer, contractor, or subcontractor who employs 4 or more individuals to perform construction, alteration, or repair work with respect to the construction of a qualified facility must employ 1 or more qualified apprentices to perform such work. The taxpayer can meet a Good Faith Exception to the apprenticeship requirement if the taxpayer requested qualified apprentices from a registered apprenticeship program and the request was either denied or not responded to in 5 business days. Alternatively, a taxpayer could pay a penalty in the amount of $50 multiplied by the total labor hours for which the Apprenticeship Labor Hour or Ratio Requirements were not satisfied. The penalty goes up to $500 per hour for an intentional disregard. For recordkeeping purposes, the guidance is broad in stating taxpayers must maintain sufficient records to establish the requirements.
Like the prevailing rate requirements, A&E firms will have little to no control over whether the contractors and subcontractors meet the apprenticeship requirements. A&E firms could request contractor apprenticeship information during the bidding process or reach out to the state apprenticeship agencies to inquire about contractors participating in their programs. Contractors and subcontractors may find they have more control over the 179D program given the significant impact their wage rates and deductions have on the 179D claimants.
Like 179D, Congress made sweeping changes to the 45L tax credit starting in 2023, including transitioning to ENERGY STAR as the baseline qualification and increasing the credit to as much as $5,000 for achieving the Zero Energy Ready Home certification. Additionally, the IRA added a wrinkle to the multifamily 45L credit, reducing the base credit to $500 or $1,000 with a bonus credit of $2,500 or $5,000 if the taxpayer ensures the laborers and mechanics constructing the property are paid a prevailing wage. Unlike 179D, there is no apprenticeship requirement for increased 45L credits.
The 179D guidance above on prevailing rates applies equally to multifamily developers claiming 45L credits, except there is no grace period for the increased credit based on the beginning of construction. Units constructed and first sold or leased in 2023 must meet the prevailing wage requirement for the entire project to receive the $2,500 or $5,000 credit in 2023 or else settle for the reduced credit of $500 or $1,000. Units originally constructed and sold or leased prior to 2023 would still be eligible for the $2,000 credit under the prior 45L regime.
In the end, the guidance for prevailing wages and apprenticeships left a lot to be desired without more pointed direction for AEC firms claiming 179D. There will likely be a subsequent notice from the IRS eventually on some of the questions posed above, leaving taxpayers to do their best in the interim.
IRS Circular 230 Disclosure – To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. tax advise contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding tax-related penalties under the Internal Revenue Code, or (ii) promoting, marketing, or recommending to another party any transaction or matter addressed herein.
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