Bonus and Incentive Compensation

Allowable or Unallowable: Allowable

Source: Federal Acquisition Regulation (FAR)

Bonuses and Incentive Compensation - FAR 31.205-6

Bonuses and incentive compensation are generally allowable, subject to notable items below.

Conditions and Descriptions Determining Allowability;

Awards must meet the following criteria under 31.205-6 (f);

(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 additional requirements, under section (k) of this subsection of FAR, which states;

(k) Deferred compensation other than pensions. The costs of deferred compensation awards are allowable subject to the following limitations:

(1) The costs shall be measured, assigned, and allocated in accordance with 48 CFR 9904.415, Accounting for the Cost of Deferred Compensation.

(2) The costs of deferred compensation awards are unallowable if the awards are made in periods subsequent to the period when the work being remunerated was performed.

Notable Unallowable elements of Bonus Plans

1.Deferred compensation award subsequent to the period when the work being remunerated was performed, as shown above.

Elements described under (i) of the Subsection

(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.

Additional Note for Closely Held Corporations

Under FAR 31.206 (a)(6)(i) (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.

Retention Bonuses

A contractor may pay a retention incentive to a current employee if the contractor determines that the unusually high or unique qualifications of the employee or a special need for the contractor for the employee's service makes it essential to retain the employee that the employee would likely leave the contractor in the absence of a retention incentive. (copied right out of OPM's site, replacing agency with contractor, https://www.opm.gov/policy-data-oversight/pay-leave/recruitment-relocation-retention-incentives/fact-sheets/retention-incentives-likely-to-leave-the-federal-service/#:~:text=An%20agency%20may%20pay%20a%20retention%20incentive%20of%20up%20to,of%20the%20agency%20for%20the)

While FAR 31.205-6 does not address retention bonuses specifically, it does state requirements for an incentive plan, which retention plans fall within. Therefore retention plans are not expressly unallowable. Guidelines and requirements within FAR 31.205-6 still need to be followed.

In support of those retention costs, 31.201-3 should be followed, which states,

(a) A cost is reasonable if, in its nature and amount, it does not exceed that which would be incurred by a prudent person in the conduct of competitive business. Reasonableness of specific costs must be examined with particular care in connection with firms or their separate divisions that may not be subject to effective competitive restraints. No presumption of reasonableness shall be attached to the incurrence of costs by a contractor. If an initial review of the facts results in a challenge of a specific cost by the contracting officer or the contracting officer’s representative, the burden of proof shall be upon the contractor to establish that such cost is reasonable.

(b) What is reasonable depends upon a variety of considerations and circumstances, including-

(1) Whether it is the type of cost generally recognized as ordinary and necessary for the conduct of the contractor’s business or the contract performance;

(2) Generally accepted sound business practices, arm’s-length bargaining, and Federal and State laws and regulations;

(3) The contractor’s responsibilities to the Government, other customers, the owners of the business, employees, and the public at large; and

(4) Any significant deviations from the contractor’s established practices.

Additional References

DCAM 5-800 - Compensation System Reviews (CSR) and Audit of Internal Control
DCAM 6-413 - Reasonableness of Compensation Costs
DCAM 6-414 - Reasonableness of Compensation Costs of Owners, Executives, and Other Employees Having a Higher Risk of Unreasonable Compensation