The term “prevailing wage” has long been used in the context of federal agencies that award or fund contracts for the construction or repair of public buildings or public works. The rules were originally proscribed in the Davis-Bacon and Related Acts and Reorganization Plan No. 14 of 1950. They mandate that contractors and subcontractors must pay their laborers and mechanics employed under the contract no less than the locally prevailing wages for corresponding work on similar projects in the area. Prior to the introduction of legislation in 2022, there was no direct interplay between prevailing wages and tax incentives. However, after the introduction of both the CHIPS Act and the Inflation Reduction Act of 2022, certain tax incentives can qualify for significant bonuses if their underlying projects and expenses meet prevailing wage rules. Understanding how these rules affect deductions under §179D, credits under §45L, the myriad of energy incentives introduced in the Inflation Reduction Act, and credits under the CHIPS Act is critical for maximizing your tax savings while staying in compliance with regulatory standards.
Firstly, the interplay between prevailing wage and the accelerated depreciation available under §179D for projects placed in service after 12/31/2022 is significant. Commercial building owners, as well as designers and engineers responsible for the design of energy-efficient commercial buildings owned by governmental entities or non-profits, can capture deductions up to $1.00/square foot if the buildings meet energy efficiency thresholds related to the building’s HVAC, lighting, and/or building envelope systems. However, if prevailing wage and apprenticeship requirements are met, then the building may qualify for a 5x bonus resulting in deductions of up to $5.00/square foot. The same holds true for multi-family homes that qualify for §45L credits, where an Energy Star-compliant home could earn a $500 credit. Still, an Energy Start-compliant home built utilizing prevailing wage labor could be worth a $2,500 credit (and up to $5,000 if it is “Zero-Energy Ready”).
Similarly, many of the credits available under the energy incentives included in the Inflation Reduction Act of 2022 (most notably the §48C Advanced Energy Project Credit and the §48E Investment Tax Credit) contain lucrative bonus provisions for those projects built with prevailing wage labor. Different from credits and deductions earned under §179D and §45L, these credits can be more easily monetized as they can be bought and sold or in some cases, treated as tax payments.
Documentation is critical to both qualifying as well as substantiating any claims made under these programs. The first level of documentation relates to the energy-efficient investments being made and usually lies in plans, mechanical cut sheets, and other byproducts of the design. The second and equally important level of documentation relates to the paying of prevailing wages, which can be cumbersome and will require both planning and effort to complete. The IRS has placed the risk upon taxpayers claiming these credits, and those that make unsupported claims can be subject to a disallowance of the credits as well as hefty penalties. When credits are sold on the open market, the burden is on the purchaser to perform due diligence on the credit makeup, which will inevitably make the better documented and substantiated claims more valuable.
One additional item worth mentioning is that projects that started construction prior to January 23, 2023, are grandfathered in and can receive incentive bonuses without meeting prevailing wage or apprenticeship rules.
In conclusion, understanding prevailing wage rates and how they interplay with tax credits and the documentation necessary is essential for taxpayers either constructing or designing energy-efficient commercial buildings, energy-efficient homes, and other relevant projects under the Inflation Reduction Act and CHIPS Act. As always, consult with a knowledgeable tax professional such as Tri-Merit to ensure that you make the most of your tax planning efforts.