With effective negotiations, preparation, and performance, contractors and subcontractors can ensure they meet owners’ requirements to secure available tax credits for solar energy system construction projects.
How subcontractors can ensure they don’t get burned!
By Michael Metz-Topodas, Saul Ewing LLP
Introduction
Solar energy construction has increased significantly in recent years across the United States, with some forecasters expecting another rise of at least 75% for 2024. This growth in solar projects results in good measure from existing and additional tax credits continued and implemented through the Inflation Reduction Act (IRA). These credits, however, do not apply to any and all solar projects. Instead, the amount of such credits varies according both the materials used and the labor supplied to the project
under a detailed set of regulations. Naturally, developers are turning to knowledgeable and experienced builders to make sure construction meets these regulatory requirements to maximize tax credit eligibility. As a result, such requirements are finding their way into solar energy project contracts and associated subcontracts. For general contractors and subcontractors, alike, they need to review carefully contractual obligations meant to satisfy solar energy project tax credit requirements. Failing to meet these contractual terms could make contractors liable for an owner’s resulting additional tax burden for up to ten years after the project ends.
Available Tax Credits for Solar Energy Construction Projects
Developers and owners having solar energy systems installed can take advantage of one of two tax credits—the investment tax credit (ITC) or the production tax credit (PTC) (and in rare cases both). The ITC reduces federal income tax liability based on the solar energy project’s cost with additional credits for using certain domestic materials. The PTC provides a per-kilowatt hour tax credit for the electricity a completed solar energy project generates during its first ten years of operation. Project owners usually determine the credit that makes the most sense based on the project’s unique circumstances. As credits, they can result in significant reductions in tax liability. These credits, however, apply only to eligible projects—those sited in the United States, using new (or almost new) equipment, and not leased to a tax exempt entity. Because the ITC is based on project cost, it has inherent materials requirements. Both credits have labor requirements related to prevailing wage and apprenticeship participation.
Construction Requirements for Solar Energy Project Tax Credits
The ITC’s credit varies based on eligible project costs, which include solar panels and supporting equipment, energy conversion materials, electrical connection equipment, installation, and certain energy storage equipment. Furthermore, the ITC has a bonus credit for using a certain portion of domestically produced materials, including structural steel. Consequently, project owners want to ensure that as much of the materials and equipment used or installed fall within the scope of those to which these credits apply. Both the ITC and the PTC have project labor requirements. To remain eligible for either credit, all construction, alteration, or repair performed on any solar energy production facility must be paid at the applicable prevailing wage rates in accordance with federal Davis-Bacon Act (DBA) rules for the first five years of such work for the ITC and the first ten years for the PTC. Additionally, at least ten to fifteen percent (depending on the project start date) of all project labor hours must be performed by an apprentice working through an apprenticeship program registered with the federal Department of Labor and meeting all related regulatory requirements. Furthermore, the workforce must maintain the applicable federal or state apprentice to journeyman ratio, and for any construction performed by four or more individuals, the workforce must have at least one apprentice. In short, the IRA conditions the tax credit available for private solar energy system construction on complying with prevailing wage and apprenticeship requirements normally applicable on public work.
Contract Terms Related to Solar Energy Construction Tax Credit Requirements
In planning solar energy construction projects developers and owners factor tax credits in calculating project cost and profitability projections. Consequently, owners need to ensure they obtain all expected tax credits, which in turn means construction must meet all associated requirements. To do so, owners must pass those requirements onto builders through contract terms. But in making tax credit requirements contract obligations, owners shift to contractors the risk of failing to obtain those tax credits. Failing to meet such obligations would constitute a breach of contract for which the general contractor or subcontractor would have liability for the resulting damages, i.e. the owner’s lost tax credits. So, if a contractor fails to meet the prevailing wage or apprenticeship requirements, then it could owe the owner for any additional tax liability it incurs from the lost credits—potentially millions of dollars, depending on the project.1 Faced with such risk, solar energy project contractors need to ensure (1) they can meet contractual obligations related to tax credit requirements and (2) their project performance actually satisfies such requirements.
Contractor and Subcontractor Guidance for Solar Project Contract Negotiation and Performance
In negotiating solar energy project contracts, general contractors and subcontractors alike need to employ multiple strategies in finalizing contract terms, in particular warranties and representations, indemnification, consequential damages, and notice. Typical agreements require a contractor to represent and warrant that it can perform the contract’s obligations, such as procuring all materials, paying prevailing wage, using a registered apprenticeship program, and using the necessary number of apprentices. To avoid a false representation, and thus a breach of the agreement, contractors must obtain and then review all project specifications to make sure they can achieve all necessary procurement. Also they, should check that they have systems in place to ensure they pay proper wages and fringe and that they have a current registration for their apprenticeship program with the Department of Labor. To the extent the contract requires indemnification for lost tax credits, the agreement should specifically list the contractor’s performance requirements for those credits or require the owner to identify them. Further, such indemnification should be conditioned on the owner complying with its obligations for obtaining the credits, such as submitting a proper tax return. Any consequential damages waiver should expressly waive or eliminate any liability for lost tax credits or cap such liability. Finally, if possible, the contractor should seek language requiring the owner to notify the contractor of any performance that does not comply with tax credit requirements within certain time or forever waive any claim for damages from lost credits.
Should negotiations not necessarily protect the contractor from any and all risk associated with solar construction project tax credit obligations, the contractor can safeguard against remaining risk by managing properly how it performs the contract, especially with respect to ordering materials, paying prevailing wage, documenting performance, and communicating with the owner. In ordering materials, contractors should ensure both accurate and complete submittals and materials orders that match quality and quantities in project plans and specifications. For payroll, contractors should determine the proper wage and fringe for all workers as the DBA requires or consider a third party provided or auditor to provide or ensure correct payment. Contractors should also keep regular and accurate procurement and payroll records and, where appropriate, share them with the general contractor or owner to provide notice that the contractor has satisfied project performance requirements for obtaining tax credits.
Conclusion
Given the significant tax savings a solar construction project can have, owners and developers will be seeking to rely on knowledgeable solar contractors. With effective negotiations, preparation, and performance, general contractors and subcontractors can ensure they meet owners’ requirements to secure available tax credits for solar energy system construction projects. Due to the complexity any given solar project entails, following the above guidelines on contract terms requires advice from experienced construction counsel. In this way builders ensure solar projects do not mean they get burned, but rather they shine.
About the Author:
Michael Metz-Topodas is a partner in the Construction Group at Saul Ewing, LLP. His practice includes construction litigation, day-to-day project and claims counseling, contract review, drafting, and negotiation, and OSHA compliance and citation defense. Michael represents general contractors, subcontractors, owners, designers, and suppliers on private, public, and federal projects, including solar energy construction projects. He counsels clients and handles construction disputes involving delay and inefficiency claims, design and construction defects, unforeseen site conditions, project scope disputes, bid protests, and payment claims, including mechanics liens, bond claims, and Miller Act claims. He can be reached at michael.metz-topodas@saul.com.
- For example, a $4 million solar project could be eligible for a $1.2 million credit. ↩︎
