With all the news lately concerning excessive executive bonuses, it is advisable for contractors to take a look at their compensation practices with respect to bonuses. Bonuses and incentive compensation fall under the Compensation cost principle, FAR 31.205-6. Compensation in general, must be reasonable. This cost principle carries an unusual warning that there is no presumption of allowability where a contractor introduces major revisions of existing compensation plans and has not afforded the contracting officer an opportunity to review beforehand for allowability of changes. There is also a total compensation cap that applies to the five most highly compensationed employees in management positions at each home office and segment. Compensation, in this context means the total amount of wages, salary, bonuses, deferred compensation, and employer contributions to defined contribution pension plans, whether paid, earned, or otherwise accruing, as recorded in the contractor’s cost accounting records for the fiscal year.
Within these parameters, bonuses and incentive compensation are allowable provided
- 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
- Basis for the award is supported.
It is important to understand these conditions. The government considers this a high risk area and will challenge bonuses that do not meet these criteria. Many contractors have been tripped up in this area because they did not have an agreement in place prior to services being rendered.
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