Compensation - Part 6 - Bonuses and Incentive Compensation

Imagine a situation where, toward the end of the year, the boss crunches some numbers and finds that the company enjoyed a record profit year. He is ecstatic and announces that every employee is going to get a $1,000 Christmas bonus. Would this bonus be an allowable cost under a Government contract? Not likely. It would not meet the allowability criteria for bonuses and the Government would probably view the action as a distribution of profits.

That does not mean that all bonuses and incentive compensation costs are unallowable. Such costs  are allowable under specific circumstances. First. the awards must be paid (or accrued) under an agreement entered into in good faith between the contractor and the employees before the services were 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. Secondly, the basis for the award must be supported.

There are many ways to construct a bonus or incentive compensation plan that complies with these requirements. However, contractors must ensure that they are developed ahead of time, before the services are rendered. Increased production over a baseline amount or increased sales over prior years are a couple of "compliant" methods that come to mind.

The provision that bonuses paid pursuant to an established plan or policy followed by the contractor so consistently as to imply, in effect, an agreement to make such payments is often difficult for contractors to support. Unless a contractor is absolutely consistent in granting such awards (e.g. $1,000 every Christmas come rain or shine, good years and bad years), the Government is not going to accept it as an allowable compensation cost element.

Next: Section (g): Severance Pay