The Inflation Reduction Act's Labor Rules for Energy Tax Credits and Carbon Capture
What Companies Need to Know
- The Inflation Reduction Act (IRA) significantly changes the tax code to incent companies to invest in energy security, reduce carbon emissions, and increase energy innovation.
- To maximize the value of the tax credits contained in the IRA, companies must follow labor rules that include paying specific workers a "prevailing wage" and employing a certain number of registered apprentices.
- A transition period offers companies some breathing room on the labor rules until the government issues implementation guidance.
President Joe Biden signed the Inflation Reduction Act (IRA) into law on Aug. 16, 2022. The massive legislative package revises policy on taxes, healthcare, agriculture and energy. In particular, the IRA modifies and expands existing credits and creates new tax credits for a variety of renewable energy and carbon capture industries and projects (a full description of these tax credits can be found in a previous Holland & Knight alert, "The Inflation Reduction Act: Summary of the Budget Reconciliation Act," Aug. 8, 2022).
This Holland & Knight alert focuses on the new labor rules that must be followed to take advantage of the higher credit values included in the IRA.
IRA Tax Credits for Energy Generation and Construction
The importance of the tax incentives contained in the IRA for energy and carbon capture are difficult to overstate. These credits represent a major investment in renewable energy generation, including through hydrogen and nuclear power, clean fuels and vehicles, and carbon sequestration.
Many (but not all) of these provisions provide a "bonus credit" if their prevailing-wage and apprenticeship rules are met. For example, under the Production Tax Credit found at Section 45 of the Internal Revenue Code (I.R.C.), as amended by the IRA, a 0.3 cents per kWh credit is available, but if the company meets the prevailing-wage and apprenticeship rules, that credit amount is increased to 1.5 cents per kWh. As with the other credits to which these "bonus" rules apply, the credit is generally increased in value fivefold. The rules apply to the construction of facilities and, in certain instances, the repair and alteration of a facility.
The Labor Rules
Under the IRA, in order to maximize the credit amount, companies will need to pay certain workers a "prevailing wage" and employ a certain number of registered apprentices.
The Prevailing Wage: The IRA's prevailing-wage rules may be unfamiliar to some companies working on the cutting edge of renewable energy and decarbonization technology. But the prevailing-wage concept is actually very old. Starting with the Davis–Bacon Act of 1931, the federal government has required contractors and subcontractors on federally funded projects to pay laborers and mechanics a minimum "prevailing wage" — essentially, at least the average wage for such workers in the area or, if more than half,1 such workers are paid the same wage, that wage instead (essentially, then, the union pay scale if a majority of such workers are unionized). Over time, Congress has extended the prevailing-wage requirement to dozens of other laws, collectively called Davis-Bacon Related Acts. These programs are administered and enforced by the U.S. Department of Labor.
The IRA is a twist on the usual formula, however, by tying the prevailing-wage requirement not to a federal funding opportunity, but to a tax benefit.
Apprenticeship: The IRA also includes a novel provision tying its tax benefits to a requirement to employ apprentices. The IRA requires that a certain percentage of labor hours in the projects go to apprentices, ranging from 10 percent before 2023 to 15 percent thereafter. And not just any apprentices will do. They must be "qualified apprentices," meaning apprentices participating in the U.S. Department of Labor's Registered Apprenticeship program or a state equivalent.
During a transition period, Congress gave companies some breathing room on these labor rules – that is, the IRA deems a company to have met the labor rules in certain instances. For example, under the Production Tax Credit found at I.R.C. Section 45, as amended by the IRA, a facility is deemed to meet the labor rules (and thus eligible for the bonus credit) if construction of the facility began prior to the date that is 60 days after the U.S. Department of Treasury and Internal Revenue Service (IRS) issue guidance with respect to labor rules. There is also an exception to these labor rules for smaller projects, e.g., those with maximum output of less than 1 megawatt.
Corrections and Penalties
In addition to the flexibility during the transition period, Congress anticipated that companies may have some difficulty in meeting the labor rules. The prevailing-wage rules contemplate a correction procedure for unintentional violations under which a company is still eligible for the bonus credit if it makes the underpaid covered employee (i.e., the laborer or mechanic) whole based on what it should have paid under the prevailing wage (plus interest) and pays a penalty to the IRS of $5,000 per covered employee to which the failure relates. However, such correction procedures are available only for a limited amount of time. The apprenticeship rules similarly contain cure provisions.
The IRA offers tremendous opportunities for companies in the form of tax incentives aimed at renewable energy, lowering greenhouse emissions and carbon sequestration. We anxiously await guidance from the U.S. Department of the Treasury and IRS further fleshing out the statute. Taxpayers wanting to maximize the benefits of these credits should be cautious to ensure, however, that they are ready to meet the IRA's unique labor rules.
1 A proposed rule recently issued by the Department of Labor would lower this threshold from 50 percent to 30 percent. See "Updating the Davis-Bacon and Related Acts Regulations," 87 Fed. Reg. 15698 (Mar. 18, 2022).
Information contained in this alert is for the general education and knowledge of our readers. It is not designed to be, and should not be used as, the sole source of information when analyzing and resolving a legal problem, and it should not be substituted for legal advice, which relies on a specific factual analysis. Moreover, the laws of each jurisdiction are different and are constantly changing. This information is not intended to create, and receipt of it does not constitute, an attorney-client relationship. If you have specific questions regarding a particular fact situation, we urge you to consult the authors of this publication, your Holland & Knight representative or other competent legal counsel.