Monthly Tax Roundup (Volume 3, Issue 7)
Tax Alert
Introduction
The summer commenced with a cornucopia of decisions by the Supreme Court with relevance for taxpayers. In this month's newsletter, we review the long-awaited decision in Moore, the high-profile challenge to the constitutionality of the section 965 transition tax, along with a decision in Connelly, involving a novel issue under the estate tax. As expected, the most significant decisions for taxpayers involved challenges to regulations wholly unrelated to tax: fishery management in Loper Bright and debit card "interchange fees" in Corner Post. This month's roundup explains how Loper Bright will curtail judicial deference to certain Treasury regulations and Corner Post will reduce the risk that facial challenges to Treasury regulations are time-barred. Beyond the Supreme Court, we summarize significant guidance on partnership "basis-shifting" transactions, explain the prevailing wage and apprenticeship requirements for clean energy tax incentives, review the latest judicial decision invalidating a "listed transaction" notice, and highlight recent procedural changes to refund claims for research credits.
See you in September! After an August recess, the Monthly Tax Roundup will return to your inboxes after Labor Day.
Tax Fact: The Congressional Budget Office (CBO) projects that corporate income taxes will total $525 billion (1.8 percent of GDP) this year and decline to 1.2 percent of GDP by 2034.
"As the rules are currently written, one constant remains: There will always be an appetite to compete, whether inside the tax code or in the form of direct state subsidies." –Rep. Kevin Hern (R-OK) on the Organisation for Economic Cooperation and Development's (OECD) global tax negotiations.
IRS Releases Guidance Package on Partnership "Basis-Shifting" Transactions
Jim Gadwood, Robert Kovacev, and Candice James
On June 17, 2024, the U.S. Department of the Treasury (Treasury) and the Internal Revenue Service (IRS) announced that they had issued a guidance package aimed at "basis shifting" transactions that occur with respect to partnerships that have related partners. At the same time, the IRS also announced that the existing IRS Office of Associate Chief Counsel (Passthroughs & Special Industries) will split in two, with one Associate Office focusing exclusively on passthrough entities and the other Associate Office focusing on energy, credits and incentives, and excise taxes. These are the latest in a series of Treasury and IRS actions and initiatives targeting partnerships for increased scrutiny. See here and here for prior coverage.
The guidance package focuses on certain partnership transactions that the IRS believes generate inappropriate tax benefits. These transactions generally take one of two forms. In the first form, a partnership distributes partnership property to a partner who is related to one or more other partners, and the distribution results in a person related to the distributee partner, the distributee partner, or both, receiving all or a share of a basis increase in the distributed property or remaining partnership property under section 732 or section 734(b). In the second form, a partnership interest is transferred between related persons or to a transferee partner who is related to an existing partner in the partnership, and the transfer results in an increase to the inside basis in partnership property with respect to the transferee partner under section 743(b). The basis increase in these transactions generally is allocated to property that is eligible for cost recovery allowances (or eligible for a shorter cost recovery period) or that the partnership or the distributee partner disposes of in a taxable sale or exchange. According to Treasury and the IRS, this basis shifting in the related-party context is contrary to congressional intent in enacting subchapter K of the Internal Revenue Code.
The guidance package consists of the following:
- Notice 2024-54 announces that Treasury and the IRS intend to issue two sets of proposed regulations that would address certain basis-shifting transactions involving partnerships and related partners. One set would be issued under various sections of subchapter K of the Internal Revenue Code and would apply to taxable years ending on or after June 17, 2024. The other set would be issued under section 1502, relate to consolidated groups whose members own interests in a partnership, and have a yet-to-be-proposed effective date.
- Proposed regulations would identify certain partnership related-party basis adjustment transactions and substantially similar transactions as "transactions of interest," which would trigger disclosure requirements for certain participants engaged in such transactions and their material advisors. Comments on the proposed regulations are due by August 19, 2024.
- Revenue Ruling 2024-14 presents the IRS's position that certain basis-shifting transactions between related parties lack economic substance under section 7701(o) and are subject to economic substance penalties under section 6662.
Treasury and IRS guidance that eliminates the tax benefits from basis adjustments in the context of certain transactions involving related partners would likely face validity challenges from taxpayers. Because the governing statutory provisions in the Internal Revenue Code do not discriminate between transactions involving related and unrelated partners, taxpayers may argue that Treasury and the IRS are attempting to circumvent the statutory text and act beyond the scope of their authority. This may lead to an early test of the new standard for deference to agency regulations set forth in the Supreme Court's recent decision in Loper Bright Enterprises v. Raimondo (No. 22-451) and Relentless, Inc. v. Department of Commerce (No. 22-1219). There the Court overruled the Chevron deference standard that has long applied to courts adjudicating challenges to agency rulemaking and held that courts must exercise independent judgment in deciding whether an agency has acted within its statutory authority and may not defer to an agency's interpretation of law when the statute is ambiguous. See below for our discussion of this decision. This newly established precedent may very well embolden taxpayers to challenge the recent guidance package from Treasury and the IRS.
Supreme Court Overturns Chevron Doctrine in Loper Bright and Relentless
Kevin Kenworthy, Robert Kovacev, Lisandra Ortiz, Sam Lapin, and Omar Hussein
On June 28, 2024, the Supreme Court issued its much-awaited opinion in Loper Bright and Relentless, overturning Chevron U.S.A. Inc. v. Natural Resources Defense Council, Inc., 467 U.S. 837 (1984), which has been a fundamental pillar of administrative law for the last 40 years. The Chevron doctrine set forth a two-step framework for reviewing agency actions. In Step One, the court determined whether the statute clearly and unambiguously addressed the precise question at issue. If the statute was unambiguous, the court applied the plain text of the statute. If the statute was silent or ambiguous, then under Chevron Step Two, the court deferred to the agency's interpretation so long as it was a permissible interpretation of the statute. In Loper Bright, the Court abandoned the Chevron doctrine, which it found irreconcilable with the Administrative Procedure Act (APA) and in conflict with longstanding judicial precedent.
The Court's majority held that the Chevron doctrine must be overturned because it is inconsistent with the APA's mandate that courts "shall decide all relevant questions of law" that arise when reviewing agency action. 5 U.S.C. § 706. The Court noted that unlike for agency factfinding (which the APA subjects to a deferential standard of review), the APA does not prescribe any deferential standard of review for legal questions. By requiring deference to agency interpretations of ambiguous statutes, Chevron defied the APA, essentially requiring courts to abdicate their duty to employ their independent judgment "to say what the law is." The Court acknowledged that under longstanding caselaw and consistent with the APA, courts accord due "respect" to agency interpretations of the statutes under their purview. As the Court explained in Skidmore v. Swift & Co., 323 U.S. 134, 140 (1944), courts may consider an agency's statutory interpretation and accord it due weight depending "upon the thoroughness evident in its consideration, the validity of its reasoning, its consistency with earlier and later pronouncements, and all those factors which give it power to persuade, if lacking power to control."
The Court held that stare decisis did not require continued adherence to Chevron. In addition to concluding that Chevron's reasoning was flawed, the Court explained that the Chevron doctrine cannot be maintained because it is too subjective and susceptible to inconsistent application such that it had become unworkable. Further, the Court explained that the Chevron doctrine undermined reliance interests in the underlying statutes because regulated parties were exposed to the changing policy preferences and interpretations of successive administrations. The Court noted, however, that prior cases decided based on the Chevron two-step framework remain good law, notwithstanding the doctrine's demise. That said, the underlying regulation in those cases would be subject to review under the Court's new framework in any future challenge.
There were two concurring opinions and one dissent. Justices Thomas and Gorsuch each wrote a concurring opinion to raise constitutional issues with the Chevron doctrine and to discuss the application of stare decisis principles in greater detail, respectively. Justice Kagan wrote a dissenting opinion, which was joined by Justices Jackson and Sotomayor. In her dissent, Justice Kagan argues that the Chevron doctrine is not in conflict with the APA and that Congress had ample opportunity to address any supposed inconsistency during the 40 years in which the doctrine applied. Further, the dissent argues that Congress can safely be presumed to have delegated to agencies the authority to interpret the statutes they administer, a premise that the majority soundly rejected. Lastly, the dissent argues that Chevron should be retained based on stare decisis because Congress crafted and enacted laws in reliance on courts' continued application of the doctrine and because overturning the doctrine would cause a jolt to the legal system.
Loper Bright represents a fundamental shift in how courts approach their review of agency action, including Treasury regulations. Significant questions follow from Loper Bright, including how lower courts will review agency rulemaking under pre-Chevron jurisprudence like Skidmore, whether and to what extent agencies such as Treasury and the IRS might take a different approach to rulemaking in light of the reversal of the Chevron doctrine, and whether Congress will more clearly and specifically delegate rulemaking authority in light of Loper Bright. It is clear, however, that courts have greater freedom now to determine the best reading of a silent or ambiguous provision of the Internal Revenue Code, notwithstanding the existence of an applicable Treasury regulation. Taxpayers should review their tax positions to determine whether any applicable Treasury regulation is now vulnerable to a challenge in light of Chevron's demise, starting, in particular, with regulations that survived prior validity challenges under the Chevron framework.
Supreme Court Upholds Constitutionality of Section 965 Transition Tax
In the year that elapsed after the Supreme Court agreed to review the constitutionality of the section 965 transition tax in Moore v. United States, the case attracted 44 amicus curiae briefs, spawned dozens of scholarly articles, generated feature stories in national newspapers, and triggered protective claims for refund by major multinational enterprises. Notwithstanding the immense anticipation, the denouement of the Moore case proved uneventful. On June 20, 2024, the Supreme Court upheld the constitutionality of the transition tax on a robust 7-2 basis, with a majority opinion which expressly cautioned that its decision is "narrow."
Although the taxpayers described the "question presented" as whether the Sixteenth Amendment authorizes Congress "to tax unrealized sums without apportionment among the states," the majority opinion, authored by Justice Kavanaugh (joined by Chief Justice Roberts and Justices Kagan, Sotomayor, and Jackson) swiftly dispatched the claim that the Court needed to answer whether "realization is required for an income tax." The transition tax applies to domestic shareholders of foreign corporations that realized income, and therefore "the precise and narrow question" for the Court was instead "whether Congress may attribute an entity's realized and undistributed income to the entity's shareholders or partners, and then tax the shareholders or partners on their portions of that income."
The majority opinion methodically reviews the Court's precedents from the early twentieth century, which "established a clear rule" that "Congress can attribute the undistributed income of an entity to the entity's shareholders or partners, and tax the shareholders or partners on their pro rata share of the entity's undistributed income." The opinion observes that "longstanding congressional practice reflects and reinforces" that precedent. Finally, the opinion rejects the "array of ad hoc distinctions" the petitioners offered to explain how the transition tax might exceed the authority of Congress under the Sixteenth Amendment, while comparable fixtures of the Internal Revenue Code (including partnership taxation, S corporation taxation, and subpart F inclusions) remained constitutionally valid.
The framing of the majority opinion is a remarkable illustration of judicial restraint, with the Court expressly limiting its decision to "when Congress treats [an] entity as a pass-through." Nevertheless, in carefully crafted dicta, the majority opinion ventures into territory beyond section 965. In particular, the Court cautions that a future wealth tax "might be considered a tax on property, not income" and that a potential tax on appreciation would force the Court to resolve whether realization "is a constitutional requirement for an income tax." Based on the concurrence authored by Justice Barrett (joined by Justice Alito) and the dissent penned by Justice Thomas (joined by Justice Gorsuch), the current Court contains at least four justices that would conclude that realization is required. Although the majority opinion cabins the immediate holding to the "precise and narrow" question of attribution, there is no doubt that taxpayers, practitioners, and Congress will intensely study the tea leaves left behind in Moore for years to come.
Supreme Court Expands Opportunities to Challenge Agency Regulations in Corner Post
Robert Kovacev and Jaclyn Roeing
On July 1, 2024, the Supreme Court issued its opinion in Corner Post, Inc. v. Board of Governors of the Federal Reserve System, No. 22-1008. In a 6-3 opinion, the majority held that the statute of limitations under 28 U.S.C. § 2401(a) for a facial challenge to final agency action under the APA does not accrue until the plaintiff is injured. The majority thus rejected the government's argument that section 2401(a)'s six-year period of limitations ran from the date of final agency action, which would have severely limited the time frame in which such challenges could be brought. Corner Post arose outside of the tax world but applies to all facial challenges brought under the APA. A facial challenge is one that argues the agency action is on its face invalid (versus an as-applied challenge that looks at how the agency action impacts a specific litigant) and may include arguments that the agency failed to follow the necessary rulemaking procedures or that the action exceeds the agency's statutory authority or is otherwise contrary to law. Corner Post greatly expands the ability of taxpayers to bring such challenges against longstanding regulations and other guidance issued by Treasury and the IRS.
Corner Post involved a challenge by a convenience store, Corner Post, Inc., to regulations issued by the Federal Reserve regarding the "interchange fees" (e.g., transaction fees) that banks impose on credit card transactions. Those regulations were finalized and published in the Federal Register in 2011, so under the government's interpretation of section 2401(a), the deadline to bring a facial APA challenge would have been six years later in 2017. Corner Post was not incorporated until 2017 and did not open for business until 2018. When Corner Post brought a facial challenge under the APA to the regulation in 2021 – 10 years after final publication – the government successfully moved to dismiss the case on the grounds that the six-year statute of limitations had expired. Corner Post appealed to the Court of Appeals for the Eighth Circuit, which affirmed the dismissal in 2022, and then to the Supreme Court.
The majority opinion was written by Justice Barrett and joined by Chief Justice Roberts and Justices Thomas, Alito, Gorsuch, and Kavanaugh. The majority held that the plain language of section 2401(a) could only have one meaning for all causes of action that were governed by the statute: a cause of action accrues "when the plaintiff has a 'complete and present cause of action'—i.e., when she has the right to 'file suit and obtain relief.'" Majority slip op at 6. This "traditional," plaintiff-centric rule of accrual was grounded in the statutory text and the history of section 2401(a). Court precedent also created a "strong background presumption" that the traditional rule should be followed unless Congress specifically legislated otherwise. Id. at 8. Congress did not do so here. Thus, the majority held that the six-year statute of limitations for facial APA challenges runs from the date of injury to the plaintiff.
Corner Post is welcome news for taxpayers considering a challenge to Treasury and IRS regulations and sub-regulatory guidance that has legislative effect (for simplicity, hereinafter called "tax regulations"). Generally, taxpayers can only bring APA challenges in a judicial forum after exhausting some amount of administrative process with the IRS (the Anti-Injunction Act and Declaratory Judgment Act preclude the vast majority of pre enforcement challenges that taxpayers might bring). For many taxpayers – especially large corporate taxpayers and multinationals or those with complex issues – the administrative process can take many years and could easily exceed the six-year period following final publication of a tax regulation. Corner Post affirms that such taxpayers will not lose their opportunity to bring a facial APA challenge. Furthermore, taxpayers may now challenge older tax regulations that otherwise would have been considered settled as well as more recent regulatory packages that were approaching the six-year cut off, such as tax regulations issued as a result of the 2017 Tax Cuts and Jobs Act (TCJA).
Furthermore, Corner Post suggests a framework for addressing an open question on the statute of limitations that should apply to refund suits. Congress provided a specific statute – Internal Revenue Code section 6532 – that, in relevant part, allows a taxpayer to file a refund suit in federal court after it has filed an administrative claim for refund and the IRS has not acted on that administrative claim in six months. In recent years, a handful of courts have held that section 6532(a), which provides no deadline for when a refund suit must be filed, should be capped by the six-year statute of limitations in section 2401(a), e.g., Govig & Associates Inc. v. United States, 2023 WL 2614910 (D. Ariz. Mar. 23, 2023). In Corner Post, however, all nine justices agreed that section 2401(a) does not apply if "the timing provision of a more specific statute displaces it." Majority slip op. at 5; see also dissent slip op. at 6-7. Section 6532 arguably provides such a more specific statute that should take precedence over section 2401(a). This outcome would be consistent with the long-standing IRS position that section 2401(a) does not apply to refund suits. See Rev. Rul. 56-381, 1956-2 C.B. 953; IRS Office of Chief Counsel Notice CC-2012-012 (June 1, 2012); IRS IRM 34.5.2.2 (Dec. 21, 2012). This line of reasoning would suggest there is no effective statute of limitation on refund suits when the IRS does not act on a duly filed administrative claim.
Another framework for taxpayers and courts to consider was provided by Justice Kavanaugh's concurring opinion on vacatur. He argued that 5 U.S.C. § 706, which allows courts to "set aside agency action," is best understood as allowing courts to vacate agency regulations. This interpretation is consistent with the historical understanding of the term "set aside" as well as the traditional power of the judiciary to vacate lower court decisions and agency adjudications. Vacatur is also essential to ensure that unregulated parties, like Corner Post, can obtain meaningful relief under the APA. This concurrence is not precedential and the majority expressly declined to address vacatur. Majority slip op. at 6 n.2. Moving forward, however, courts may be emboldened to embrace vacatur if they determine that tax regulations are facially invalid under the APA.
Supreme Court Holds in Connelly That Fair Market Value Redemption Obligations Are Not Offsetting Liabilities in Closely Held Corporations
Kevin Kenworthy and Omar Hussein
On June 6, 2024, the Supreme Court unanimously held in Connelly v. U.S., 602 U.S. ___ that a closely held corporation's redemption obligation, funded through life insurance, is not an offsetting liability that offset the value of the life insurance policy for purposes of estate tax. In Connelly, two brothers owned a closely held corporation valued at $3.86 million, with one owning 77.18 percent, and the other 22.82 percent. To ensure that the company remained in the family, the company obtained $3.5 million life insurance policies on each brother. If the surviving brother declined to purchase the other's shares, the company was contractually obligated to repurchase the deceased brother's shares at fair market value. The taxpayer (estate) argued that this contractual obligation was a liability that offset the life insurance asset, resulting in a net zero effect to the value of the redeemed corporate shares. Ultimately, the majority shareholder died and the living brother opted not to repurchase the deceased brother's shares, obligating the company to repurchase his shares. The company used $3 million of the life insurance proceeds to repurchase the stock, and determined that the value of the shares was also $3 million ($3.86 million x .7718). The estate's federal tax return reflected a $3 million valuation of the redeemed shares and the IRS audited the return.
The IRS rejected the taxpayer's position and asserted that the proceeds from the life insurance policy were not offset by the obligation to redeem the stock. As such, the IRS determined that the total value of the corporation was instead $6.86 million ($3.86 million + $3 million in life insurance proceeds) and the value of the redeemed shares was $5.3 million ($6.86 million x .7718). The IRS then assessed a deficiency based on the redetermined value of the redeemed shares. The taxpayer paid the deficiency and filed for a refund. The Supreme Court agreed with the IRS, holding that "a fair-market-value redemption has no effect on any shareholder's economic interest," and "no willing buyer purchasing [the shares] would have treated [the company's] obligation to redeem [the shares] at fair market value as a factor that reduced the value of those shares." The court based this conclusion on the principle that, for purposes of estate tax, the company is valued at the time the decedent died, i.e., the value of the shares, in addition to the life insurance proceeds. As such, an arm's-length buyer that sought to purchase the deceased brother's shares would have paid $5.3 million, rather than $3 million.
Notably, the Supreme Court included in a footnote that a redemption obligation can, in certain circumstances, decrease a corporation's value – for example, if the liquidation of operating assets is required to cover the redemption, the loss of asset value would in turn reduce the corporation's total value. In addition, the court explained that the brothers could have arranged their affairs in a manner that avoided this outcome by establishing a cross-purchase agreement and obtaining life insurance policies on one another. The Connelly decision serves as a reminder of the importance of proper planning in both closely held corporations and estates.
Eleventh Circuit Voids IRS Notice on Reportable Transactions for Failing to Comply with the APA
The IRS suffered another defeat in June in its war against conservation easements. In Green Rock LLC v. IRS, et al., the Eleventh Circuit held that the IRS violated the APA in issuing Notice 2017-10 without following the procedures for notice and comment. Notice 2017-10 designated certain syndicated conservation easements as "listed transactions," which are a sub-category of "reportable transactions" under Treas. Reg. § 1.6011-4. Listed transactions are those that the IRS has "determined to be a tax avoidance transaction and identified by notice, regulation or other form of publish guidance as a listed transaction." Taxpayers that participate in a listed transaction must report their participation on their tax return and separately to the IRS Office of Tax Shelter Analysis or face penalties. "Material advisors" that provide tax advice with respect to such transactions also have reporting and list maintenance requirements, which are enforceable with civil penalties.
Green Rock LLC (Green Rock), an Alabama-based company that facilitates conservation easement transactions, served as a material advisor to transactions described in Notice 2017-10. Green Rock filed the required reports, but then filed suit under the APA, arguing that Notice 2017-10 was a legislative rule that was improperly issued without the required notice-and-comment procedures, and that it was arbitrary, capricious, and otherwise contrary to law.
The Eleventh Circuit upheld the district court's determination that the Notice was void because the IRS did not follow the notice-and-comment requirements of the APA. In reaching this conclusion, the court followed the recent trend of courts that have considered APA challenges to listing notices. See e.g., Mann Construction Inc., v. United States, 27 F.4th 1138 (6th Cir. 2022) (holding that IRS Notice 2007-83, which designated certain cash value life insurance transactions as listed transactions, violated the APA because it was issued without notice and comment); CIC Servs., LLC v. I.R.S., 592 F. Supp. 3d 677 (E.D. Tenn. 2022) (on remand from Supreme Court, striking down Notice 2016-66 regarding the designation of micro-captive insurance arrangements as transactions of interest); Green Valley Invs., LLC v Comm'r, 159 T.C. 80 (2022) (holding Notice 2017-10 unlawful due to lack of notice and comment).
A federal agency such as the IRS generally must follow the APA's notice-and-comment requirements in the enactment of legislative rules with the force of law unless a clear exception applies. Under the notice-and-comment procedures, the public has an opportunity to voice comments about proposed rules and the IRS must consider those comments before finalizing the rules. The Eleventh Circuit found that section 6707A, which Congress enacted in 2004 and which establishes penalties on taxpayers for failing to properly report listed transactions, did not expressly override the notice-and-comment requirements of the APA.
Section 6707A defines a "reportable transaction" as "any transaction with respect to which information is required to be included with a return or statement because, as determined under regulations prescribed under section 6011, such transaction is of a type which the Secretary determines as having a potential for tax avoidance or evasion." The referenced regulation, Treas. Reg. § 1.6011-4, which was in effect before the enactment of section 6707A, allowed the IRS to designate reportable transactions "by notice." But the Eleventh Circuit concluded that the statutory language of section 6707A that referenced the regulation did not exempt the IRS from notice-and-comment requirements. Rather, that language simply referred to the authority of the IRS to "define the substance for a reportable transaction through regulations issued under the Service's section 6011 authority."
In reaching its decision, the court was quick to note that its holding was limited to Notice 2017-10 and that it did not intend to rule on the validity of any other listed transactions. The court also left open the possibility that listed transactions that were designated by notice (and without notice and comment) prior to the 2004 enactment of section 6707A might be deemed to have been ratified by Congress's enactment of that section, "without exempting the Service from prospective notice-and-comment procedures [after 2004]." Thus, in the Eleventh Circuit, Green Rock supports a finding that any IRS designation of reportable transactions by notice after 2004 is likely to be void. Consistent with this holding, it is unsurprising that the IRS has been moving to identify reportable transactions (including some that were previously identified with notices) through proposed regulations that will need to meet the APA's notice-and-comment requirements before being finalized. Two recent examples include proposed regulations released on June 18, 2024, to identify certain partnership related-party basis adjustment transactions as reportable transactions and on March 25, 2024, identifying certain charitable remainder annuity trust (CRAT) transactions as listed transactions.
For reportable transactions designated by IRS notice, we expect to continue to see APA challenges similar to Green Rock's. As noted, there have already been similar successful challenges in the Sixth Circuit and the Tax Court (see our previous coverage here). Of course, this does not mean that the underlying transactions at issue will be upheld on their merits, but it could save taxpayers and their advisors some headaches on reporting, and for those that were not properly reported in the past, perhaps some money on civil penalties.
Treasury and the IRS Consider Taxpayer Comments in the Finalization of the Prevailing Wage and Apprenticeship Regulations for Clean Energy Tax Incentives
Andy Howlett and Candice James
On June 17, 2024, Treasury and the IRS published final regulations addressing the requirements for taxpayers to obtain increased credit and deduction amounts under the prevailing wage and apprenticeship (PWA) requirements under the Inflation Reduction Act (IRA) (the Regulations).
The PWA requirements, if met, provide for an increased credit amount under sections 30C (alternative fuel vehicle refueling property credit), 45 (renewable electricity production credit), 45L (new energy efficient home credit), 45Q (carbon oxide sequestration credit), 45U (zero-emission nuclear power production credit), 45V (clean hydrogen production credit), 45Y (clean electricity production credit for facilities placed in service in 2025 or later), 45Z (clean fuel production credit for facilities placed in service in 2025 or later), 48 (energy credit), and 48C (qualifying advanced energy project credit), and an increased deduction under section 179D (energy efficient commercial buildings deduction). The Regulations do not include final regulations under section 48E (clean electricity investment credit for facilities placed in service after December 31, 2024), which also provides an enhanced credit if the PWA requirements are met. Treasury and the IRS announced that they intend to issue final regulations with respect to the PWA requirements in proposed regulations §§ 1.48-13 and 1.48E-3.
The Regulations serve as the culmination of a large portion of proposed regulations that were published in the Federal Register on August 30, 2023 (Proposed Regulations) (see our prior coverage discussing the key provisions of the Proposed Regulations), and demonstrate a concerted effort by Treasury and the IRS to reflect key taxpayer comments on the effectiveness and administrability of the PWA requirements.
Background
There are two aspects to the PWA requirements: prevailing wage requirements and apprenticeship requirements. To meet the prevailing wage requirements as outlined in section 45(b)(7), taxpayers must ensure that laborers and mechanics employed by the taxpayer (or its contractor or subcontractors) in the construction, alteration, or repair of a facility are paid wages at or above the prevailing wage rates as determined by the Department of Labor (DOL) under the Davis-Bacon Act (DBA).
To meet the apprenticeship requirements in section 45(b)(8) taxpayers must satisfy three separate sub-tests. The first test is the Labor Hours Requirement, which requires that qualified apprentices perform 12.5 percent of the total labor hours relating to the "construction, alteration, or repair work" for facilities beginning construction in 2023 and 15 percent for facilities beginning construction in 2024 or after. The second test is the Ratio Requirement, which requires that construction, alteration, or repair work meets the applicable apprentice-to-journey worker ratio established by the DOL or the applicable state apprenticeship agency. The third test is the Participation Requirement, which requires that any taxpayer that is employing four or more individuals to perform construction, alteration, or repair work on the facility employ at least one qualified apprentice.
Prevailing Wages – Regulations Outline Key Contrasts to the DBA
Treasury and the IRS emphasize that the Regulations are intended to be interpreted "in accordance with" the prevailing wage rate requirements of the DBA so long as it is relevant for the purposes of sound tax administration. Nevertheless, the Regulations do not alter the general approach taken in the Proposed Regulations of adopting the DBA primarily for the purposes of ascertaining the PWA requirements under section 45(b)(7)(A). Therefore, the Regulations adopt much of the the methodology and guidance within the Proposed Regulations of establishing wage rates, wage determinations, and the meaning of defined terms such as "laborer," "mechanic," "wages," and "employed." Outside of this scope, Treasury and the IRS's reliance on the DBA in the Regulations is otherwise limited and does not apply DBA provisions regarding contracts and enforcement processes. The Regulations also retain the approach in the Proposed Regulations of requiring that taxpayers be solely responsible for PWA requirements, including ensuring that the relevant laborers and mechanics are paid wages at the prevailing wage rates.
The Regulations provide some additional guidance on the distinction between "alteration and repair" (for which the PWA requirements must be satisfied) and maintenance (for which they do not). Accordingly, the Regulations more closely align with the definitions in 29 C.F.R 5.2 and DOL sub-regulatory guidance, defining maintenance work as work that is routinely scheduled and continuous and recurring. The Regulations further clarify that maintenance work normally includes an activity that:
- Improves the facility, either by fixing something that is not functioning properly or by improving upon the facility's existing condition;
- Involves the correction of individual problems or defects as separate and segregable incidents and is not continuous or recurring; or
- Improves the facility's structural strength, stability, safety, capacity, efficiency, or usefulness
Maintenance work that occurs before the facility is placed in service will generally be treated as construction work.
Timing of Prevailing Wage Determination
The Regulations also clarify that the applicable prevailing wage ought to be determined at the time a contract for the construction, alteration, or repair of the facility is executed by the taxpayer (or the taxpayer's designee, assignee, contractor, or agent). In the absence of such a contract, taxpayers may utilize the applicable wage determinations that are in effect at the time construction starts. Taxpayers who enter into contracts for alteration or repair work that are not tied to the completion of any specific work over an indefinite period of time are required to update applicable wage rates on an annual basis. In the event that taxpayers receive supplemental wage determinations, such determinations are required to be incorporated in construction contracts within 180 days of issuance.
Apprenticeship Requirement Clarifications
The Regulations have largely adopted the Apprenticeship Requirements that Treasury and the IRS set forth in Prop. Treas. Reg. § 1.45-8 and clarify that, with respect to the Ratio Requirement, multiple apprentice-to-journey worker ratios could apply to a taxpayer if construction work occurs in a geographic area where the apprenticeship program is not registered. In such a case, the taxpayer must comply with the apprentice-to-journey worker ratio set for the geographic area where the construction occurs.
Recordkeeping and Reporting Requirements
Regarding recordkeeping and reporting requirements under section 45(b)(12) and Prop. Treas. Reg. § 1.45-12(a), the Regulations largely conform to the Proposed Regulations. Increased credit amounts must be claimed in accordance with the manner prescribed in IRS forms, instructions, publications, or guidance as published in the Internal Revenue Bulletin. The Regulations clarify that an accurately completed DOL Form WH-347 may serve as a sufficient record for the purpose of reflecting prevailing wage payments to individuals under Treas. Reg. § 1.45-12. The Regulations also adopt rules that are designed to help preserve personally identifiable information of workers with respect to meeting the record keeping requirements.
IRS Retreats (Partially) on its Position on a Valid Claim for Refund for R&E Credit
Robert Kovacev, George Hani, and Sam Lapin
On June 18, 2024, the IRS announced that it is waiving two items that it previously required for a valid research and experimentation (R&E) credit refund claim. In 2021, the IRS announced its position that a valid R&E credit refund claim must include several items of information supporting a taxpayer's qualified research expenses (QREs). In particular, the IRS has maintained that a taxpayer must include information on all business components, research activities and the employees that performed them, and the information that each individual sought to discover. In the June 18 update to its FAQs, the IRS waived the requirement that a valid refund claim must include the names of employees that performed each research activity and the information that each such employee sought to discover. The IRS explained that it decided to waive those items "after significant experience with the Research Credit refund claims process." However, it reserved the right to request that information if a taxpayer's claim is selected for audit.
On June 21, 2024, the IRS also released a revised draft Form 6765, Credit for Increasing Research Activities, in response to "helpful comments from various external stakeholders." The revised draft form reduces the information it requires from taxpayers regarding business components. Rather than report all business components, taxpayers must report only its business components to which the largest amount of QREs are attributable, provided that the business components it reports account for 80 percent of total QREs. In addition, the revised draft form requires less detail regarding each business component. Finally, the revised draft form provides transition relief from reporting requirements with respect to business components for certain small business and taxpayers reporting small R&E credits for the tax year.
See our previous coverage of claims for R&E credit and R&E credit refunds here and here.
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