What Is the Cost of Individual Coverage When Compared With Administrative Cost?

When Compared With The Administrative Cost Found In Individual Coverage, understanding the nuances of compensation for personal services is crucial for businesses and contractors alike. At COMPARE.EDU.VN, we provide in-depth analyses to help you navigate these complexities. By examining various forms of compensation, including salaries, bonuses, and fringe benefits, and postretirement benefits other than pensions (PRB), we offer insights into what constitutes reasonable and allowable costs.

This comprehensive guide delves into the intricacies of compensation, covering everything from general criteria to specific limitations. We aim to clarify the often-confusing landscape of employee remuneration, ensuring that you’re well-equipped to make informed decisions. Explore related topics such as employee benefits, payroll management, and compliance strategies to ensure your compensation practices are both fair and financially sound.

1. What General Criteria Govern Allowable Compensation for Personal Services?

Allowable compensation for personal services must adhere to several general criteria, including being for work performed in the current year, reasonable for the work performed, and based on the contractor’s established compensation plan. These criteria ensure fairness and prevent retroactive adjustments.

To elaborate, the compensation must:

Relate to Current Year’s Work: The compensation should be for work performed by the employee in the current year and not be a retroactive adjustment of prior years’ salaries or wages.
Be Reasonable: The total compensation for individual employees or job classes of employees must be reasonable for the work performed. This reasonableness is assessed by considering the aggregate of each measurable and allowable element.
Conform to Established Plans: The compensation must be based upon and conform to the terms and conditions of the contractor’s established compensation plan or practice.
Adhere to Review Processes: Major revisions of existing compensation plans or new plans require review by the cognizant Administrative Contracting Officer (ACO) to ensure allowability.
Comply with Cost Regulations: Costs that are unallowable under other regulations cannot be made allowable solely because they are considered compensation for personal services.

2. How is Compensation Determined for Owners and Individuals with Substantial Financial Interests?

For owners of closely held corporations, members of limited liability companies, partners, sole proprietors, or members of their immediate families, compensation must be reasonable for the personal services rendered and not be a distribution of profits. Additionally, compensation for owners of closely held companies should not exceed the costs deductible as compensation under the Internal Revenue Code.

Specific considerations include:

Reasonableness for Services: The compensation must be reasonable for the personal services rendered by these individuals.
Non-Distribution of Profits: The compensation must not be a distribution of profits, as profit distributions are not allowable contract costs.
Compliance with Tax Code: For owners of closely held companies, compensation should not exceed the costs that are deductible as compensation under the Internal Revenue Code.

3. What Factors Determine the Reasonableness of Compensation?

The reasonableness of compensation is determined by evaluating whether the aggregate of each measurable and allowable element sums to a reasonable total. Factors considered include conformity with compensation practices of other firms of similar size, industry, geographic area, and those engaged in similar non-Government work under comparable circumstances.

Here’s a more detailed look:

Labor-Management Agreements: If costs of compensation are established under “arm’s length” labor-management agreements negotiated under the terms of the Federal Labor Relations Act or similar state statutes, the costs are reasonable unless they are unwarranted by the character and circumstances of the work or discriminatory against the Government.
Comparable Compensation: Compensation for each employee or job class of employees must be reasonable for the work performed.
Relevant Factors: Factors that may be relevant include, but are not limited to, conformity with compensation practices of other firms—
- Of the same size;
- In the same industry;
- In the same geographic area; and
- Engaged in similar non-Government work under comparable circumstances.

4. What Forms Can Compensation for Personal Services Take?

Compensation for personal services can take various forms, including cash, corporate securities (stocks, bonds, and other financial instruments), or other assets, products, or services. When compensation is paid with securities, the valuation must be based on fair market value determined on the first date the number of shares awarded is known.

Cash Payments: Direct monetary payments to employees.
Corporate Securities: Stocks, bonds, and other financial instruments. The valuation is based on the fair market value on the first date the number of shares awarded is known.
Other Assets: Includes products or services provided as compensation.

When securities are used, additional restrictions apply:

Fair Market Valuation: The 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.
Accrual Adjustments: 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.

5. Are Income Tax Differential Payments Allowable?

Differential allowances for additional income taxes resulting from foreign assignments are allowable, while those resulting from domestic assignments are generally unallowable. However, payments for increased employee income or Federal Insurance Contributions Act taxes incident to allowable reimbursed relocation costs are allowable.

Foreign Assignments: Differential allowances for additional income taxes resulting from foreign assignments are allowable.
Domestic Assignments: Differential allowances for additional income taxes resulting from domestic assignments are unallowable, except for payments related to reimbursed relocation costs.

6. Under What Conditions Are Bonuses and Incentive Compensation Allowable?

Bonuses and incentive compensation are allowable if the 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 consistently. The basis for the award must also be supported.

Good Faith Agreement: Awards must be paid or accrued under an agreement entered into in good faith between the contractor and the employees before the services are rendered.
Established Plan or Policy: Payments must be made pursuant to an established plan or policy followed consistently by the contractor.
Supported Basis: The basis for the award must be supported with documentation.

When the bonus and incentive compensation payments are deferred, the costs are subject to the requirements mentioned above and the regulations related to deferred compensation.

7. What Regulations Govern Severance Pay Allowability?

Severance pay, which is a payment in addition to regular salaries and wages, is allowable only to the extent that it is required by law, employer-employee agreement, established policy, or circumstances of the particular employment. Payments made in the event of employment with a replacement contractor or continued employment by the contractor at another facility are not considered severance pay and are unallowable.

Required by Law: Severance pay is allowable to the extent required by law.
Employer-Employee Agreement: If severance pay is part of an employer-employee agreement, it is allowable.
Established Policy: If the contractor has an established policy that constitutes an implied agreement, severance pay is allowable.
Circumstances of Employment: Allowability depends on the specific circumstances of the employment termination.

Normal turnover severance payments should be allocated to all work performed in the contractor’s plant. Accruals for abnormal or mass severance pay are generally unallowable, but the Government will consider allowability on a case-by-case basis.

8. How Is Backpay Treated in Terms of Allowable Compensation?

Backpay, which is a retroactive adjustment of prior years’ salaries or wages, is generally unallowable, except for payments resulting from underpaid work, payments to union employees for working without a contract, and payments to nonunion employees based upon results of union agreement negotiation under specific conditions.

The allowable exceptions are:

Underpaid Work: Payments to employees resulting from underpaid work actually performed are allowable, if required by a negotiated settlement, order, or court decree.
Union Employees: 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.
Nonunion Employees: Payments to nonunion employees based upon results of union agreement negotiation are allowable only if a formal agreement or understanding exists between management and the employees, or an established policy or practice exists.

9. Are Compensation Costs Based on Changes in Corporate Securities Allowable?

Any compensation calculated or valued based on changes in the price of corporate securities, such as stock options, stock appreciation rights, phantom stock plans, and junior stock conversions, is unallowable. Additionally, any compensation represented by dividend payments or calculated based on dividend payments is unallowable.

Securities-Based Compensation: Any compensation which is calculated, or valued, based on changes in the price of corporate securities is unallowable.
Dividend-Based Compensation: Any compensation represented by dividend payments or which is calculated based on dividend payments is unallowable.

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 regulation, such payments are also unallowable.

10. What Are the Requirements for Allowable Pension Costs?

Pension costs are allowable subject to specific standards, cost limitations, and exclusions. These costs must be funded by the time set for filing the Federal income tax return or any extension. 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.

Key aspects include:

Compliance with Standards: The contractor must measure, assign, and allocate the costs of all defined-benefit pension plans and the costs of all defined-contribution pension plans in compliance with Cost Accounting Standards (CAS).
Funding Requirements: To be allowable in the current year, the contractor must fund pension costs by the time set for filing of the Federal income tax return or any extension.
Agreement Terms: 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.
Consistency: 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.

10.1. How Are Defined-Benefit Pension Plans Treated?

For defined-benefit pension plans, costs assigned to the current accounting period but not funded during it are not allowable in subsequent years, with certain exceptions related to waivers under the Employee Retirement Income Security Act of 1974 (ERISA). Any amount funded in excess of the pension cost assigned to a cost accounting period is not allowable in that period and is accounted for in future periods.

Funding: Pension costs assigned to the current accounting period, but not funded during it, are not allowable in subsequent years, except under specific waiver conditions.
Excess Funding: Any amount funded in excess of the pension cost assigned to a cost accounting period is not allowable in that period and is accounted for in future periods.
Funding Delays: 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.

10.2. How Are Pension Adjustments and Asset Reversions Handled?

For segment closings, pension plan terminations, or curtailment of benefits, the amount of the adjustment is determined based on whether the contracts and subcontracts are subject to full coverage under the Cost Accounting Standards (CAS) Board rules and regulations. In situations where assets revert to the contractor, the contractor must refund or credit the Government for its equitable share of the gross amount withdrawn.

Segment Closings: The amount of the adjustment is measured, assigned, and allocated in accordance with CAS rules.
Asset Reversions: The contractor must refund or credit the Government for its equitable share of the gross amount withdrawn. Excise taxes on pension plan asset reversions or withdrawals are unallowable.

10.3. What Are the Rules for Defined-Contribution Pension Plans?

For defined-contribution pension plans, allowable pension cost is limited to the net contribution required to be made for a cost accounting period after taking into account dividends and other credits. The provisions regarding funding and indemnification of the Pension Benefit Guaranty Corporation (PBGC) also apply to defined-contribution plans.

Net Contribution Limit: Allowable pension cost is limited to the net contribution required to be made for a cost accounting period after taking into account dividends and other credits.
ERISA Waivers: 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 ERISA will be allowable in those future accounting periods in which the funding of such excess amounts occurs.

10.4. How Are Early Retirement Incentives Treated?

Early retirement incentives are allowable subject to the pension cost criteria and provided that the contractor measures, assigns, and allocates the costs in accordance with their accounting practices for pension costs. The incentives must be in accordance with the terms and conditions of an early retirement incentive plan, applied only to active employees, and the present value of the total incentives must not significantly exceed the employee’s annual salary.

Accounting Practices: The contractor must measure, assign, and allocate the costs in accordance with their accounting practices for pension costs.
Plan Terms: The incentives must be in accordance with the terms and conditions of an early retirement incentive plan.
Active Employees: The contractor applies the plan only to active employees.
Salary Limit: The present value of the total incentives given to any employee in excess of the amount of the employee’s annual salary for the previous fiscal year before the employee’s retirement is unallowable.

11. What Limitations Apply to Deferred Compensation Other Than Pensions?

The costs of deferred compensation awards are allowable if they are measured, assigned, and allocated in accordance with specific accounting standards and if the awards are made in the period when the work being remunerated was performed. 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.

Accounting Standards: The costs must be measured, assigned, and allocated in accordance with accounting standards.
Timing of Awards: The awards must be made in the period when the work being remunerated was performed.

12. Are There Restrictions on Compensation Incidental to Business Acquisitions?

Payments to employees under agreements in which they receive special compensation, in excess of the contractor’s normal severance pay practice, if their employment terminates following a change in the management control over, or ownership of, the contractor, are unallowable. Also unallowable are payments to employees under plans introduced in connection with a change in management control or ownership, where employees receive special compensation contingent upon remaining with the contractor for a specified period.

Termination Payments: Payments to employees that exceed normal severance practices following a change in management control are unallowable.
Retention Payments: Payments contingent upon the employee remaining with the contractor for a specified period are also unallowable.

13. How Are Fringe Benefits Treated in Terms of Allowability?

Fringe benefits, including the cost of vacations, sick leave, holidays, military leave, employee insurance, and supplemental unemployment benefit plans, are allowable to the extent that they are reasonable and required by law, employer-employee agreement, or an established policy of the contractor. The portion of company-furnished automobiles that relates to personal use by employees is unallowable.

Reasonableness: Fringe benefits must be reasonable in cost.
Legal or Contractual Requirement: They must be required by law, employer-employee agreement, or an established policy of the contractor.
Personal Use: The portion of company-furnished automobiles that relates to personal use by employees is unallowable, regardless of whether the cost is reported as taxable income to the employees.

14. Are Employee Rebate and Purchase Discount Plans Allowable?

Rebates and purchase discounts, in whatever form, granted to employees on products or services produced by the contractor or affiliates are unallowable.

15. What Are the Regulations for Postretirement Benefits Other Than Pensions (PRB)?

PRB covers all benefits, other than cash benefits and life insurance benefits paid by pension plans, provided to employees during retirement. To be allowable, PRB costs must be incurred pursuant to law, employer-employee agreement, or an established policy of the contractor and comply with specific criteria.

Legal or Contractual Requirement: PRB costs must be incurred pursuant to law, employer-employee agreement, or an established policy of the contractor.
Methods of Accounting: Costs can be accounted for using pay-as-you-go, terminal funding, or accrual basis.

15.1. What Is the Pay-As-You-Go Method for PRB?

Under the pay-as-you-go method, PRB costs are assigned to the period in which benefits are actually provided or the costs are paid to an insurer, provider, or other recipient for current year benefits or premiums.

15.2. What Is Terminal Funding for PRB?

Terminal funding occurs when the entire PRB liability is paid in a lump sum upon the termination of employees to an insurer or trustee to establish and maintain a fund for providing PRB to retirees. Terminal funded costs must be amortized over a period of 15 years.

15.3. How Does the Accrual Basis Work for PRB?

Under the accrual basis, PRB costs are accrued during the working lives of employees. These costs must be measured and assigned in accordance with generally accepted accounting principles or contributions to a welfare benefit fund determined in accordance with applicable Internal Revenue Code.

Measurement and Assignment: Accrued PRB costs must be measured and assigned in accordance with generally accepted accounting principles or contributions to a welfare benefit fund.
Funding: Costs must be paid to an insurer or trustee to establish and maintain a fund or reserve for providing PRB to retirees.
Actuarial Principles: Costs must be calculated in accordance with generally accepted actuarial principles and practices.
Unfunded Actuarial Liability: The unfunded actuarial liability (unfunded accumulated postretirement benefit obligation) is calculated using the market (fair) value of assets that have been accumulated by funding costs assigned to prior periods.

15.4. Funding and Liquidation Requirements for PRB Costs

To be allowable, PRB costs must be funded by the time set for filing the Federal income tax return or any extension thereof, or paid to an insurer, provider, or other recipient by the same deadline. Increased PRB costs caused by delay in funding beyond 30 days after each quarter of the year to which they are assignable are unallowable.

Funding Deadline: PRB costs must be funded by the time set for filing the Federal income tax return or any extension thereof.
Funding Delays: Increased PRB costs caused by delay in funding beyond 30 days after each quarter of the year to which they are assignable are unallowable.

16. What Are the Limitations on the Allowability of Compensation?

The allowability of compensation is subject to specific limitations, including benchmark compensation amounts determined by the Administrator, Office of Federal Procurement Policy (OFPP). These limits vary depending on the contract award date and the agency involved.

16.1. Compensation Limits for Contracts Awarded Before June 24, 2014

For executive agencies other than DoD, NASA, and the Coast Guard, for contracts awarded before June 24, 2014, costs incurred for the compensation of a senior executive in excess of the benchmark compensation amount are unallowable. For DoD, NASA, and the Coast Guard, this limit applies to contracts awarded before December 31, 2011.

16.2. Compensation Limits for Contracts Awarded On or After December 31, 2011, and Before June 24, 2014

For DoD, NASA, and the Coast Guard, for contracts awarded on or after December 31, 2011, and before June 24, 2014, costs incurred for the compensation of any contractor employee in excess of the benchmark compensation amount are unallowable.

16.3. Compensation Limits for Contracts Awarded On or After June 24, 2014

For all executive agency contracts awarded on or after June 24, 2014, costs incurred for the compensation of all employees in excess of the benchmark compensation amount are unallowable.

16.4. Exceptions to Compensation Limits

An agency head may establish exceptions for scientists, engineers, or other specialists if needed to ensure continued access to needed skills and capabilities, considering the amount of taxpayer-funded compensation and the duties performed by each employee.

17. What Are the Rules for Employee Stock Ownership Plans (ESOP)?

ESOPs are stock bonus plans designed to invest primarily in the stock of the employer corporation. The contractor’s contributions to an Employee Stock Ownership Trust (ESOT) may be in the form of cash, stock, or property.

Accounting Standards: The contractor must measure, assign, and allocate costs in accordance with accounting standards.
Deductibility Limits: Contributions by the contractor in any one year that exceed the deductibility limits of the Internal Revenue Code for that year are unallowable.
Stock Valuation: When the contribution is in the form of stock, the value of the stock contribution is limited to the fair market value of the stock on the date that title is effectively transferred to the trust.

17.1. Cash Contributions to ESOPs

When the contribution is in the form of cash, stock purchases by the ESOT in excess of fair market value are unallowable. Any excess price over fair market value must be credited to the same indirect cost pools that were charged for the ESOP contributions.

17.2. Valuation of Unissued Stock or Stock of Closely Held Corporations

When the fair market value of unissued stock or stock of a closely held corporation is not readily determinable, the valuation will be made on a case-by-case basis, taking into consideration the guidelines for valuation used by the IRS.

FAQ: Understanding Compensation for Personal Services

1. What is considered reasonable compensation for personal services?

Reasonable compensation is the aggregate of each measurable and allowable element that sums to a reasonable total. Factors considered include conformity with compensation practices of other firms of similar size, industry, geographic area, and those engaged in similar non-Government work.

2. Are bonuses and incentive compensation always allowable?

No, bonuses and incentive compensation are allowable only if the 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 consistently. The basis for the award must also be supported.

3. What types of payments are considered unallowable compensation?

Unallowable compensation includes payments based on changes in the price of corporate securities, compensation represented by dividend payments, and certain payments incidental to business acquisitions or changes in management control.

4. How are pension costs treated in terms of allowability?

5. What are the limitations on the allowability of compensation?

The allowability of compensation is subject to benchmark compensation amounts determined by the Administrator, Office of Federal Procurement Policy (OFPP). These limits vary depending on the contract award date and the agency involved.

6. Can compensation include forms other than cash?

Yes, compensation for personal services can take various forms, including cash, corporate securities (stocks, bonds, and other financial instruments), or other assets, products, or services.

7. Are employee rebate and purchase discount plans allowable?

No, rebates and purchase discounts, in whatever form, granted to employees on products or services produced by the contractor or affiliates are unallowable.

8. How are postretirement benefits other than pensions (PRB) regulated?

9. What is the pay-as-you-go method for PRB?

10. Are there exceptions to the compensation limits for certain employees?

Yes, an agency head may establish exceptions for scientists, engineers, or other specialists if needed to ensure continued access to needed skills and capabilities, considering the amount of taxpayer-funded compensation and the duties performed by each employee.

Navigating the complexities of compensation for personal services requires a thorough understanding of the regulations and standards involved. Whether you’re dealing with salaries, bonuses, pensions, or postretirement benefits, it’s crucial to ensure compliance and reasonableness in all compensation practices.

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By leveraging the resources at COMPARE.EDU.VN, you can confidently navigate the complexities of compensation for personal services and ensure that your practices are both fair and financially sound. Explore related topics such as payroll management, employee benefits, and compliance strategies to create a comprehensive and effective compensation plan.

This article provides a detailed exploration of compensation for personal services, offering a comprehensive understanding of the regulations, standards, and best practices involved. By following the guidance provided and utilizing the resources at compare.edu.vn, businesses and contractors can ensure compliance and create effective compensation strategies that benefit both employers and employees.