Complex Wage Rules Make Energy Tax Credits Ripe for IRS Audits

Meeting and documenting the prevailing wage and apprenticeship requirements of the Inflation Reduction Act is a crucial tax exercise, especially for large-scale projects where much of the available credit amount hinges on compliance.

As the IRS refines its audit strategies, taxpayers and their advisers must focus on accurate labor classifications, comprehensive wage calculations, and robust documentation practices.

Reviewing wage compliance may appear straightforward because the rules are grounded in the Department of Labor’s classifications and wage rates. But the IRS’s lack of extensive experience in this domain may complicate matters.

The IRS still hasn’t finalized its audit approach or its audit technique guide. The current expectation is that the process will begin with compliance assurance process taxpayers. This structured approach likely will serve as a pilot program to refine auditing strategies, similar to how the IRS traditionally has approached novel issues.

The practical application and verification of prevailing wage compliance rules can be fraught with challenges. Taxpayers and the IRS may disagree on labor class designations and applicable wage rates. IRS auditors must understand the classifications and how they apply to the myriad roles and responsibilities on a given project. And each project will have unique facts and circumstances, requiring a nuanced understanding of labor roles.

To navigate the complexities, the IRS should collaborate with the DOL proactively. Such cooperation could involve training and assistance to bridge the IRS’s experience gap. The DOL has managed application of prevailing wages in other contexts, such as the Davis Bacon and Related Acts, and will have firsthand experience on best practices for reviewing and auditing.

Taxpayers unfamiliar with the nuances of prevailing wage documentation may find unexpected challenges. The responsibility falls squarely on the taxpayer claiming the credit to maintain necessary records. This might catch some taxpayers off-guard if they haven’t obtained the appropriate documentation from their developers and contractors. Taxpayers should consider these tasks early in a project’s lifecycle and at the outset of dealmaking.

To mitigate risks and ensure compliance, taxpayers must substantiate their laborer classification choices with robust documentation. They should establish clear communication with their contractors and subcontractors to secure the proper documentation well in advance of any potential IRS audits.

Documentation also plays a pivotal role in substantiating claims for tax credits under the 2022 tax and climate law. Taxpayers must maintain comprehensive records that detail the classification of each laborer, the wage rates applied, and the hours worked. This documentation should be organized and accessible, ready to present during an audit.

Establishing a streamlined communication process with contractors and subcontractors can help obtain necessary, accurate documentation. Open lines of communication can prevent potential misunderstandings or discrepancies in documentation that could lead to compliance issues.

The tax community may have several other questions about guidance and rulings for what the IRS deems acceptable documentation. These include:

• How will taxpayers substantiate their conclusions regarding laborer classification choices?
• What complexities will arise in calculating the inclusive wage rate for laborers?
• How will taxpayers document compliance with cure provisions and efforts to seek apprentices?
• What constitutes acceptable documentation from contractors and subcontractors?

Misclassification can lead to serious compliance issues, affecting the overall credit amount claimed. Taxpayers must learn the nuances of each classification and ensure that their documentation accurately reflects the work performed by each laborer. For example, nuanced classifications between types of electricians can affect the appropriate wage rate to use.

Though the DOL provides detailed classifications for laborers, the nature of certain projects can blur these lines. Taxpayers must regularly review these classifications as projects progress—this can help accommodate any shifts in project scope or labor roles that might require reclassification.

The DOL uses classifications as nuanced as classifying insulation workers who work on mechanical aspects of the project differently than insulation workers who work on walls and ceilings. Each classification can have a wage rate difference of as much as 50%. In such situations, the IRS may disagree with which sub-category was chosen, but taxpayers also may make technical errors that will affect the correct wages paid.

Taxpayers should consider offering regular training sessions for their project managers and human resources personnel, so everyone involved in the hiring and documentation process is well-versed in prevailing wage requirements. Periodic audits of internal documentation practices can help identify and rectify any discrepancies before they become larger issues during an IRS audit.

The IRS may challenge which labor and laborers are subject to the rules. Many large developments involve assets and property development that aren’t part of the facility or assets which generate the credit.

Navigating when and to which labor hours the wage requirements apply is an additional documentary exercise. This is true across applicable technologies and can be a unique challenge for taxpayers who have been allocated a Section 48C credit as well.

As the IRS continues to develop its audit approach, taxpayers should engage with professional associations or legal advisers specializing in tax law. They should participate in industry forums or workshops focused on prevailing wage compliance, where they can share best practices and learn from the experiences of others who have navigated similar compliance landscapes.

By fostering a collaborative environment with contractors and using available resources for training and compliance, taxpayers can position themselves to meet prevailing wage requirements effectively. Staying informed and prepared is the key to navigating potential audit challenges.

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

Martin Karamon is a partner with and leader of the tax credits and incentives advisory group at Cherry Bekaert.

David Mohimani is a senior manager with the energy tax credits and incentives advisory group at Cherry Bekaert.

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