Federal Acquisition Regulation
Compensation for personal services
FAR 31.205-6
(a) General. Compensation for personal services is allowable subject to the following general criteria and additional requirements contained in other parts of this cost principle: (1) Compensation for personal services must be for work performed by the employee in the current year and must not represent a retroactive adjustment of prior years’ salaries or wages (but see paragraphs (g), (h), (j), (k), (m), and (o) of this subsection). (2) The total compensation for individual employees or job classes of employees must be reasonable for the work performed; however, specific restrictions on individual compensation elements apply when prescribed. (3) The compensation must be based upon and conform to the terms and conditions of the contractor’s established compensation plan or practice followed so consistently as to imply, in effect, an agreement to make the payment. (4) No presumption of allowability will exist where the contractor introduces major revisions of existing compensation plans or new plans and the contractor has not provided the cognizant ACO, either before implementation or within a reasonable period after it, an opportunity to review the allowability of the changes. (5) Costs that are unallowable under other paragraphs of this subpart Contracts with Commercial Organizations (FAR 31.2) are not allowable under this subsection 31.205-6 solely on the basis that they constitute compensation for personal services. (6) (i) Compensation costs for certain individuals give rise to the need for special consideration. Such individuals include: (A) Owners of closely held corporations, members of limited liability companies, partners, sole proprietors, or members of their immediate families; and (B) Persons who are contractually committed to acquire a substantial financial interest in the contractor’s enterprise. (ii) For these individuals, compensation must- (A) Be reasonable for the personal services rendered; and (B) Not be a distribution of profits (which is not an allowable contract cost). (iii) For owners of closely held companies, compensation in excess of the costs that are deductible as compensation under the Internal Revenue Code (26 U.S.C.) and regulations under it is unallowable. (b) Reasonableness- (1) Compensation pursuant to labor-management agreements . If costs of compensation established under "arm’s length" labor-management agreements negotiated under the terms of the Federal Labor Relations Act or similar state statutes are otherwise allowable, the costs are reasonable unless, as applied to work in performing Government contracts, the costs are unwarranted by the character and circumstances of the work or discriminatory against the Government. The application of the provisions of a labor-management agreement designed to apply to a given set of circumstances and conditions of employment (e.g., work involving extremely hazardous activities or work not requiring recurrent use of overtime) is unwarranted when applied to a Government contract involving significantly different circumstances and conditions of employment (e.g., work involving less hazardous activities or work continually requiring use of overtime). It is discriminatory against the Government if it results in employee compensation (in whatever form or name) in excess of that being paid for similar non-Government work under comparable circumstances. (2) Compensation not covered by labor-management agreements . Compensation for each employee or job class of employees must be reasonable for the work performed. Compensation is reasonable if the aggregate of each measurable and allowable element sums to a reasonable total. In determining the reasonableness of total compensation, consider only allowable individual elements of compensation. In addition to the provisions of 31.201-3 , in testing the reasonableness of compensation for particular employees or job classes of employees, consider factors determined to be relevant by the contracting officer. Factors that may be relevant include, but are not limited to, conformity with compensation practices of other firms- (i) Of the same size; (ii) In the same industry; (iii) In the same geographic area; and (iv) Engaged in similar non-Government work under comparable circumstances. (c) [Reserved] (d) Form of payment. (1) Compensation for personal services includes compensation paid or to be paid in the future to employees in the form of- (i) Cash; (ii) Corporate securities, such as stocks, bonds, and other financial instruments (see paragraph (d)(2) of this subsection regarding valuation); or (iii) Other assets, products, or services. (2) When compensation is paid with securities of the contractor or of an affiliate, the following additional restrictions apply: (i) Valuation placed on the securities is the fair market value on the first date the number of shares awarded is known, determined upon the most objective basis available. (ii) Accruals for the cost of securities before issuing the securities to the employees are subject to adjustment according to the possibilities that the employees will not receive the securities and that their interest in the accruals will be forfeited. (e) Income tax differential pay. (1) Differential allowances for additional income taxes resulting from foreign assignments are allowable. (2) Differential allowances for additional income taxes resulting from domestic assignments are unallowable. (However, payments for increased employee income or Federal Insurance Contributions Act taxes incident to allowable reimbursed relocation costs are allowable under 31.205-35 (a)(10).) (f) Bonuses and incentive compensation. (1) Bonuses and incentive compensation are allowable provided the- (i) Awards are paid or accrued under an agreement entered into in good faith between the contractor and the employees before the services are rendered or pursuant to an established plan or policy followed by the contractor so consistently as to imply, in effect, an agreement to make such payment; and (ii) Basis for the award is supported. (2) When the bonus and incentive compensation payments are deferred, the costs are subject to the requirements of paragraphs (f)(1) and (k) of this subsection. (g) Severance pay . (1) Severance pay is a payment in addition to regular salaries and wages by contractors to workers whose employment is being involuntarily terminated. Payments for early retirement incentive plans are covered in paragraph (j)(6) of this subsection. (2) Severance pay is allowable only to the extent that, in each case, it is required by- (i) Law; (ii) Employer-employee agreement; (iii) Established policy that constitutes, in effect, an implied agreement on the contractor’s part; or (iv) Circumstances of the particular employment. (3) Payments made in the event of employment with a replacement contractor where continuity of employment with credit for prior length of service is preserved under substantially equal conditions of employment, or continued employment by the contractor at another facility, subsidiary, affiliate, or parent company of the contractor are not severance pay and are unallowable. (4) Actual normal turnover severance payments shall be allocated to all work performed in the contractor’s plant. However, if the contractor uses the accrual method to account for normal turnover severance payments, that method will be acceptable if the amount of the accrual is- (i) Reasonable in light of payments actually made for normal severances over a representative past period; and (ii) Allocated to all work performed in the contractor’s plant. (5) Abnormal or mass severance pay is of such a conjectural nature that accruals for this purpose are not allowable. However, the Government recognizes its obligation to participate, to the extent of its fair share, in any specific payment. Thus, the Government will consider allowability on a case-by-case basis. (6) Under 10 U.S.C. 3744(a)(13) and 41 U.S.C. 4304(a)(13) , the costs of severance payments to foreign nationals employed under a service contract performed outside the United States are unallowable to the extent that such payments exceed amounts typically paid to employees providing similar services in the same industry in the United States. Further, under 10 U.S.C. 3744(a)(14) and 41 U.S.C. 4304(a)(14) , all such costs of severance payments that are otherwise allowable are unallowable if the termination of employment of the foreign national is the result of the closing of, or the curtailment of activities at, a United States facility in that country at the request of the government of that country; this does not apply if the closing of a facility or curtailment of activities is made pursuant to a status-of-forces or other country-to-country agreement entered into with the government of that country before November 29, 1989. 10 U.S.C. 3744(b) and 41 U.S.C. 4304(b) permit the head of the agency to waive these cost allowability limitations under certain circumstances (see Severance payments to foreign nationals (FAR 37.113) and the solicitation provision at 52.237-8 ). (h) Backpay . Backpay is a retroactive adjustment of prior years’ salaries or wages. Backpay is unallowable except as follows: (1) Payments to employees resulting from underpaid work actually performed are allowable, if required by a negotiated settlement, order, or court decree. (2) Payments to union employees for the difference in their past and current wage rates for working without a contract or labor agreement during labor management negotiation are allowable. (3) Payments to nonunion employees based upon results of union agreement negotiation are allowable only if- (i) A formal agreement or understanding exists between management and the employees concerning these payments; or (ii) An established policy or practice exists and is followed by the contractor so consistently as to imply, in effect, an agreement to make such payments. (i) Compensation based on changes in the prices of corporate securities or corporate security ownership, such as stock options, stock appreciation rights, phantom stock plans, and junior stock conversions. (1) Any compensation which is calculated, or valued, based on changes in the price of corporate securities is unallowable. (2) Any compensation represented by dividend payments or which is calculated based on dividend payments is unallowable. (3) If a contractor pays an employee in lieu of the employee receiving or exercising a right, option, or benefit which would have been unallowable under this paragraph (i), such payments are also unallowable. (j) Pension costs. (1) Pension plans are normally segregated into two types of plans: defined-benefit and defined-contribution pension plans. The contractor shall measure, assign, and allocate the costs of all defined-benefit pension plans and the costs of all defined-contribution pension plans in compliance with 48 CFR9904.412-Cost Accounting Standard for Composition and Measurement of Pension Cost, and 48 CFR9904.413-Adjustment and Allocation of Pension Cost. Pension costs are allowable subject to the referenced standards and the cost limitations and exclusions set forth in paragraph (j)(1)(i) and in paragraphs (j)(2) through (j)(6) of this subsection. (i) Except for nonqualified pension plans using the pay-as-you-go cost method, to be allowable in the current year, the contractor shall fund pension costs by the time set for filing of the Federal income tax return or any extension. Pension costs assigned to the current year, but not funded by the tax return time, are not allowable in any subsequent year. For nonqualified pension plans using the pay-as-you-go method, to be allowable in the current year, the contractor shall allocate pension costs in the cost accounting period that the pension costs are assigned. (ii) Pension payments must be paid pursuant to an agreement entered into in good faith between the contractor and employees before the work or services are performed and to the terms and conditions of the established plan. The cost of changes in pension plans are not allowable if the changes are discriminatory to the Government or are not intended to be applied consistently for all employees under similar circumstances in the future. (iii) Except as provided for early retirement benefits in paragraph (j)(6) of this subsection, one-time-only pension supplements not available to all participants of the basic plan are not allowable as pension costs, unless the supplemental benefits represent a separate pension plan and the benefits are payable for life at the option of the employee. (iv) Increases in payments to previously retired plan participants covering cost-of-living adjustments are allowable if paid in accordance with a policy or practice consistently followed. (2) Defined-benefit pension plans . The cost limitations and exclusions pertaining to defined-benefit plans are as follows: (i) (A) Except for nonqualified pension plans, pension costs (see 48 CFR9904.412-40(a)(1)) assigned to the current accounting period, but not funded during it, are not allowable in subsequent years (except that a payment made to a fund by the time set for filing the Federal income tax return or any extension thereof is considered to have been made during such taxable year). However, any portion of pension cost computed for a cost accounting period, that exceeds the amount required to be funded pursuant to a waiver granted under the provisions of the Employee Retirement Income Security Act of1974 (ERISA), will be allowable in those future accounting periods in which the funding of such excess amounts occurs (see 48 CFR9904.412-50(c)(5)). (B) For nonqualified pension plans, except those using the pay-as-you-go cost method, allowable costs are limited to the amount allocable in accordance with 48 CFR9904.412-50(d)(2). (C) For nonqualified pension plans using the pay-as-you-go cost method, allowable costs are limited to the amounts allocable in accordance with 48 CFR9904.412-50(d)(3). (ii) Any amount funded in excess of the pension cost assigned to a cost accounting period is not allowable in that period and shall be accounted for as set forth at 48 CFR9904.412-50(a)(4). The excess amount is allowable in the future period to which it is assigned, to the extent it is not otherwise unallowable. (iii) Increased pension costs are unallowable if the increase is caused by a delay in funding beyond 30 days after each quarter of the year to which they are assignable. If a composite rate is used for allocating pension costs between the segments of a company and if, because of differences in the timing of the funding by the segments, an inequity exists, allowable pension costs for each segment will be limited to that particular segment’s calculation of pension costs as provided for in 48 CFR9904.413-50(c). The contractor shall make determinations of unallowable costs in accordance with the actuarial method used in calculating pension costs. (iv) The contracting officer will consider the allowability of the cost of indemnifying the Pension Benefit Guaranty Corporation (PBGC) under ERISA Section 4062 or 4064 arising from terminating an employee deferred compensation plan on a case-by-case basis, provided that if insurance was required by the PBGC under ERISA Section 4023, it was so obtained and the indemnification payment is not recoverable under the insurance. Consideration under the foregoing circumstances will be primarily for the purpose of appraising the extent to which the indemnification payment is allocable to Government work. If a beneficial or other equitable relationship exists, the Government will participate, despite the requirements of 31.205-19 (c)(3) and (d)(3), in the indemnification payment to the extent of its fair share. (v) Increased pension costs resulting from the withdrawal of assets from a pension fund and transfer to another employee benefit plan fund, or transfer of assets to another account within the same fund, are unal
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