Compensation Caps - 2014 - 2022

Yesterday, we published the recently announced contractor compensation cap for calendar year 2022. Here is a listing of the caps since the cost principles were amended to apply to all employees on contracts awarded after June 24, 2014. 

Prior to that date, compensation caps applied variously to 'top five employees in management positions', and 'all employees', depending on the year and whether the contract was awarded by DoD/NASA or a civilian agency. Also, compensation caps back then were much higher, peaking at $1.1 million in 2014. If you still have contracts awarded prior to June 24, 2014, you should become very familiar with FAR 31.205-6(p).

 

Contractor Compensation Cap for 2022

The Office of Federal Procurement Policy (OFPP) recently published the contractor compensation cap amount for 2022. The cap, for costs incurred between January 1 and December 31, 2022 is $589,000 and applies to all employees on contracts awarded after June 24, 2014.

As a reminder, 'compensation' in this context includes wages, salary, bonuses, deferred compensation, and employer contributions to defined contribution pension plans (see FAR 31.205-6(p)(1)(i)).

Compensation Caps - Update

Section 702 of the Bipartisan budget Act of 2013 (BBA) established a cap of $487,000 per year on the amount the Federal Government will reimburse contractors employee compensation on contracts with defense and civilian agencies. By law, this amount must be adjusted annually to reflect the change in the Employment Cost Index for all workers, as calculated by the Department of Labor, Bureau of Labor Statistics (BLS). This cap applies to all contracts awarded after June 24, 2014.

The cap has been adjusted each year since it was instituted. For costs incurred in 2018, the cap now sits at $525,000. See the table below for adjusted cap amounts for all years.

Note, these compensation caps limits the reimbursement of compensation costs for all contractor employees on all contracts awarded by all executive agencies of the Government after June 24, 2014. For caps on executive compensation on contracts awarded prior to that date, see Allowable Compensation Costs.

One final note, these caps do not limit what contractors can pay to their employees. It only limits was contractors can request reimbursement from the Government.

Contractors Cannot Anticipatorily Adjust Statutory Compensation Caps

Section 702 of the Bipartisan Budget Act (BBA) of 2013 significantly reduced the cap on compensation charged to Government contracts. The old statutory formula applicable to contracts awarded prior to June 24, 2014 now sits at $1,144,888. The new cap applicable to contracts awarded after that date is $487,000 and applies to all contractor employees on contracts awarded by all executive agencies.

The BBA also required that the compensation cap be adjusted annually to reflect the change in the Employment Cost Index for all workers, as calculated by the Bureau of Labor Statistics. That has not been done - yet.

The BBA also required the Office of Management and Budget to figure out whether any alternative benchmarks and industry standards for compensation would provide a more appropriate measure of allowable compensation. The OMB solicited feedback on alternative measures and after reviewing the feedback, decided not to recommend any changes to the BBA process.

In the meantime, the $487,000 cap still applies though by this time, it should have been adjusted a couple of times. We don't know why the holdup. But we do know that contractors should not be escalating the $487,000 benchmark on their own - even though the employment cost index has increased by two plus percentage points per year. The way that the cap works is that increases must first be published in the Federal Register before the Government is obligated to pay the higher amounts. As of today, there have been no Federal Register publishing of revised caps. Under the old methodology for example, the ceiling applicable to compensation costs incurred after January 1, 2014 was not established (i.e. posted in the Federal Register) until more than two years later, March 15, 2016.

Contractors that are most likely to feel the pinch are those trying to price out fixed priced contracts. The Government is not going to allow anything higher than the $487,000. Contractors operating under cost reimbursable contracts will also need to price out their labor under the current cap but should get some relief if the ceiling is adjusted before they submit their annual incurred cost submissions.

Update on the 2014 Compensation Cap Law

Section 702 of the Bipartisan budget Act of 2013 (BBA) established a cap of $487,000 per year on the amount the Federal Government will reimburse contractors employee compensation on contracts with defense and civilian agencies. By law, this amount must be adjusted annually to reflect the change in the Employment Cost Index for all workers, as calculated by the Department of Labor, Bureau of Labor Statistics (BLS). This cap applies to all contracts awarded after June 24, 2014 but so far, OMB (Office of Management and Budget) has not increased the cap so contractors should be proposing and seeking reimbursement for no more than the current $487,000 cap. Perhaps the change in the Employment Cost Index has not been sufficient to move the cap.

Section 702 of the BBA also required OMB and DoD to report to Congress on alternative benchmarks and industry standards to the benchmarks established by the BBA. OMB and DoD performed a study and solicited industry comments on several alternatives including:

• creation of multiple caps
• use of "say-on-pay" principle (i.e. compensation voted on by stockholders)
• use of alternative inflators to adjust the cap, and
• creation of an alternative definition of compensation to address the scope of the cap.

Ultimately, OMB and DoD concluded that none of the four alternatives would be more effective than the benchmark established by Section 702 which, they believed, was a substantial improvement over the statutory formula it replaced.

Finally, Section 702 allows agency heads to establish one or more narrowly targeted exceptions for scientists, engineers, or other specialists upon a determination that such exceptions are needed to ensure that the executive agency has continued access to needed skills and capabilities. It also requires OMB to report annually on use of the exception authority, including the total number of contractor employees, the taxpayer-funded compensation amounts, and the duties and services performed.

For fiscal years 2014 and 2015, OMB reported that no exceptions were granted. Information for fiscal year 2016 is not yet available. No company has been brave enough to request an exemption yet.

It appears that the $487,000 cap, adjusted for changes in the Employment Cost Index, will be the benchmark for the foreseeable future.

Final Rule on Compensation Limits on Post- June 2014 Contracts

In our last two postings, we discussed last Friday's regulation dump where the FAR regulators presented us with a fiscal year-end gift. On Friday we discussed the prohibition against awarding contracts to companies with delinquent taxes or felony convictions. Yesterday we discussed the prohibition against retaliating against employees who share their compensation informtaion with one another. Today we take up the new regulation on contractor employee compensation caps.

The new rule follows an interim rule from June 2014 that implements a provision in the Bipartisan Budget Act of 2013 that significantly reduces employees compensation that contractors and subcontractors can claim on Government contracts. Compensation is capped on contracts awarded after June 24, 2014 to $487 thousand. Under the previous method for computing compensation caps, the maximum would have been (and still is for contracts awarded prior to that date) $1,144,888 for 2014 and lower amounts for earlier years. To view compensation caps by year under the old methodology, click here.

The final rule doesn't make any substantial changes to the interim rule. It adds the following table to help sort out which compensation caps apply to which agencies and which category of employees.

The new rules provide an exception to the limitations. An agency head may establish one or more narrowly targeted exceptions for scientists, engineers, or other specialists upon a determination that such exceptions are needed to ensure that the executive agency has continued access to needed skills and capabilities. Those determinations must take into account the amount of taxpayer funded compensation to be received by each employee and the duties and services performed by each employee. We are not aware of any requests for exemptions however that is not to say that there may have been some. It seems to us the an Agency head would be reluctant to approve such requests without compelling evidence that it was necessary to attract and retain qualified employees. After all, $487 thousand is still pretty high compensation for scientists and engineers.

Will the use of Blended Labor Rates Create a CAS Noncompliance?

We spent a few postings last month discussing DoD's "blended rate" approach to implementing the lowered compensation cap that affects contracts awarded on or after June 24, 2014. There are different methodologies to calculating blended rates depending upon whether the rates are for forward pricing purposes or incurred cost purposes. Incurred cost blending is rather straight forward because all of the factors needed to blend two compensation caps are known. Forward pricing is not so straight forward as it requires an estimate of work to be performed in future periods. You can learn more about these blending methodologies by reading our previous coverage in Part 1, Part 2, Part 3, and Part 4.

A question was posted on DoD's official Q&A website concerning contractors who wished to implement the new $487,000 cap for forward pricing purposes in lieu of using the blended method but wished to use the blended method for incurred cost purposes. The question concerned whether such a practice would constitute a noncompliance with CAS (Cost Accounting Standard) 401, Consistency in Estimating, Accumulating and Reporting Costs.

We understand why a contractor might want to implement such a practice - its simpler and avoids Government auditors and contracting officers from tearing into and second-guessing assumptions as to how much work in future years will be on pre-June 24, 2014 contracts and post-June 24, 2014 contracts. Keep in mind however that the approach will most likely have a negative impact as fixed price contracts will be understated, cost-type contracts will have a lower fixed fee, and resulting overruns will be unfunded. Given these downsides, it might still be in a contractor's best interest to forego the forward pricing aspects of blended rates.

According to DoD, the use of a blended rate versus implementing the new cap from the outset is not a CAS 401 noncompliance because any inconsistency does not involve a cost accounting practice as defined by the CAS Board. According to CAS, a cost accounting practice is any disclosed or established accounting method or technique which is used for allocation of costs to cost objectives, assignment of cost to cost accounting periods, or measurement of cost. Either the blended rate approach or the specified amount approach is none of these three. It is not a method or technique used for allocation of costs to cost objectives, not a method or technique used for assignment of cost to cost accounting periods, and not a method or technique used for measurement of cost.

Keep in mind that the use of the blended rate methodology requires an advance agreement and potential inconsistencies such as the one described above will be sorted out during the advance agreement process.One thing it is not however, is a CAS 401 noncompliance.

Using Blended Labor Rates to Implement New Compensation Caps - Part 4

Before we conclude this series on blending labor rates, here's a link to most of the published guidance on the matter. It includes the initial authorization from the Undersecretary of Defense for Acquisition, Technology, and Logistics dated October 24, 2014, the DCMA (Defense Contract Management Agency implementing guidance on the use of blended rates dated January 29, 2016 (this is the guidance we've been discussing in this series) and DCAA's (Defense Contract Audit Agency) own implementing guidance on blended compensation caps dated February 19, 2016. The latter simply authorizes auditors to support DCMA's efforts in negotiating advance agreements with contractors.

The decision to implement blended labor rates is solely that of the contractor. Contractors are not compelled by law or regulation to go forward with such a plan. The Government has offered up the blending option as a means of facilitating implementation of the significantly lowered compensation caps applicable to contracts awarded after June 24, 2014. Once a contractor chooses to use a blended compensation cap methodology however, the contracting officer must execute an advance agreement (FAR 31.109). The advance agreement is only the beginning of contractor responsibilities. The advance agreement will set forth the agreed to process and frequency for providing auditable data necessary to support the calculation and application of the blended compensation cap for forward pricing, interim billing, and final rates, as well as the expiration date for the ending of the blended compensation cap estimating method. Some contractors might find the requirements onerous.

The use of blended compensation caps can continue as long as contractors are incurring costs on pre-June 24, 2014 contracts. In extreme cases, this could be a decade. However, each year, the number of pre-June 24, 2014 contracts will diminish and eventually, so small that it makes continued operations under advance agreements not cost-effective. Advance agreements are written in such a way as to allow either party to exit whenever they want. Item 12 of the advance agreement template provided as part of the aforementioned DCMA guidance reads: "The parties retain the right to unilaterally and immediately cancel this agreement upon written notification to the other party. However, it is understood that each party will give the other party at least 30 calendar days' written notice, unless urgent and compelling reasons exist, prior to cancelling the agreement."

As we stated in the introduction to this series, the blended compensation cap methodology is not for everyone. For contractors having no employees that exceed the new compensation cap, there is clearly no applicability. Contractors that can implement the old and new caps within their existing system without significantly re-engineering their ERP systems should probably do so. This may not be too difficult if the highly paid employees (e.g. scientists and engineers) charge direct. Contractors where the impact is minimal may decide that the additional work required to develop, maintain, and support blended rates is not worth the added cost.

Using Blended Labor Rates to Implement New Compensation Caps - Part 3

We began this series on DoD's initiative to allow contractors to blend labor rates in order to facilitate the implementation of the new limitation on compensation by discussing the impetus behind the program (see Part 1)Yesterday, we demonstrated how the blending would be calculated for incurred cost (see Part 2). Today we tackle the slightly more difficult task of blending rates for forward pricing proposals.

At first blush, one would think that there would be no reason to blend labor rates for forward pricing purposes. After all, if the contract is going to be awarded after June 24, 2014 it must comply with the new compensation cap. The complication arises when factoring in modifications and change orders for contracts awarded prior to June 24, 2014. Those contracts and modifications thereto are still subject to the old compensation caps.

The greatest challenge in this exercise is to estimate the value of pricing for new solicitations and for modifications to existing contracts. This is not an easy task and will require the exercise of judgment. How easy is it to estimate the value of contracts it will be awarded during the year? To some extent, its always a guess. How can one estimate the value of modifications to existing contracts that will be awarded during the year? Often times contractors have no idea that the Government is contemplating contract modifications.

Once those two baselines are established, the mathematics to blending rates are the same as for incurred costs.

Like the blended rate calculations for incurred costs, the blended rate examples from DCMA rely on total contract costs. But as we warned yesterday, total contract costs might not be a good basis for blending rates. Contractors need to be aware of their indirect rate allocation methodologies to ensure that the blending method achieves an equitable result.

Tomorrow we will conclude this series by highlighting other aspects of the newly issued DCMA guidance on blending labor rates.

Using Blended Labor Rates to Implement New Compensation Caps - Part 2

The Department of Defense has formally authorized contractors to used blended labor rates to implement the new compensation cap applicable to contracts awarded after June 24, 2014. If you missed Part 1 of this series, click here. Briefly, the Bipartisan Budget Act of 2013 established a new compensation ceiling applicable to all employees (not just the top level management) of $487 thousand. The challenge for contractors and the Government is to find a method to implement that new compensation ceiling in fiscal years where there are contracts with different ceiling amounts.

The Government would love to have contractors implement the new compensation cap on all contracts regardless of when they were awarded. This makes is easy for everyone. However, for many contractors, this would create a significant adverse impact on the bottom line. There is an option for contractor to develop discrete rates for contracts under each of the caps. For example, two G&A rates; one for pre-June 24, 2014 contract and the other for post-June 24, 2014 contracts. While this may be feasible for some contractors, it is probably very difficult to implement in most of today's accounting software or ERP systems.

The calculation of blended rates are going to be different for incurred costs and for forward pricing purposes. The incurred cost calculation is the easiest to calculate so we'll start there. There are three steps to calculating a blended rate.

1. Identify the total costs incurred for contracts awarded before and after June 24, 2014 and calculate percentages to the total
2. Identify the compensation cap applicable to both groups
3. Multiply the percentages from Step 1 by the respective compensation caps and add the results.

For example, if in 2014 a contractor incurred cost under pre-June 24, 2015 contracts of $700,000 and incurred cost under contracts that were awarded after that date, the blended rate computation would look like this:

This method prescribed by DCMA (Defense Contract Management Agency) could result in some inequities so contractors need to be cognizant of their indirect rate structure. For example, if a contractor were on a value-added G&A allocation base and all of the the post-June 24, 2014 costs were subcontract costs, the above calculation would not result in an equitable blended rate because no labor costs would be charged to post-June 24, 2014 costs and the labor charged to pre-June 24, 2014 costs would be "watered-down" by costs charged to post-June 24, 2014 contracts.

Tomorrow we will look at blended rate calculations for forward pricing purposes.

Using Blended Labor Rates to Implement New Compensation Caps - Part 1

This is a follow-up to our posting of March 18, 2015, Subject: Compensation Caps Cross the $1 Million Threshold. In that posting, we promised to discuss DCMA's (Defense Contract Management Agency) newly released guidance on blending labor rates. We did not get around to doing so as soon as we had hoped. Other news seemed more urgent. Today we rectify that situation.

The Bipartisan Budget Act of 2013 implemented a compensation limitation of $487 thousand applied to all contractor employees contracts awarded after June 24, 2014. As a result, contractors may be subject to multiple compensation limits each year beginning in 2014 until such time as all contracts issued prior to June 24, 2014 have been completed.

This "blending" concept only applies to contractors paying employees in excess of $487 thousand per year. If you are not one of those contractors, you can move on. Keep in mind however, that these are only compensation caps. These are not "reasonableness" determinations. You will still need to establish reasonableness of compensation amounts. For example, $487 thousand is most likely not going to be reasonable for a entry-level engineer.

One note of caution. This policy allowing blended labor rates applies to DoD contracts only. It is not binding on other Governmental agencies. However, we suspect that other agencies will be quite willing to accept DoD's methodologies.

Back in October 2014, the Director of Defense Pricing authorized the use of blended labor rates to help contractors avoid undue complexity and related cost to implement multiple labor rates in the same accounting period. Last January, DCMA issued guidance for implementing the blended rate approach.

DCMA's basis policy reads as follows:

The cap amount for each year should be calculated as a weighted average by blending the separate cap amounts based on the contract actions entered into before June 24, 2014 and on or after June 24, 2014. The relative percentage that the new cap contributes to the blended rates will increase over time as the business mix shifts from modifications to older contracts to new contracts. DCMA's method does not require the contractor to develop multiple sets of rates and relies on the contractor's existing cost accounting practices and processes to apply the cap to all contracts subject to FAR 31.205-6(p). Contractors will be required to demonstrate the accuracy of their calculations based on their accounting records and to provide objective, auditable support for the basis selected for forward pricing rates, interim billing rates, and final incurred cost rates. The information used to calculate the blending should be consistent in quantum and detail with the information used to calculate the proposed rate.

Next week, we will provide an example of how the blending might be calculated.

Compensation Caps Cross the $1 Million Threshold

The Office of Management and Budget (OMB) announced the compensation caps for certain executives and contractor employees for fiscal years 2013 and 2014. These caps apply to both defense and civilian agencies for their respective applicable periods for contracts awarded before June 24, 2014.

These benchmarks are:

     2013:  $ 980,796
     2014:  $ 1,144,888

Contractors that submitted incurred cost proposals for 2013 and 2014 with compensation capped at the 2012 amount of $952,308 may need to revise their submissions if the new caps result in a material difference in amounts charged to Government cost-reimbursable contracts.

These benchmark amounts apply to contracts awarded prior to June 24, 2014 and limit the reimbursement or allowability of compensation under Federal Government contracts at FAR 31.205-6(p). For covered contracts awarded after June 24, 2014, a new cap applies pursuant to the Bipartisan Budget Act of 2013. That cap is currently set at $487,000  but will be adjusted annually based on the change in the Employment Cost Index for all workers, as calculated by the Bureau of Labor Statistics.

Since enactment of the statutory formula in 1998, the "old" cap has increased by more than 300 percent and Congress became duly alarmed not only by the amount  but by the adverse perception of the public finding out that contractors were paying out huge salaries at taxpayer expense. A number of proposals were proffered as part of the fiscal year 2012 and 2013 National Defense Authorization Acts, some as low as $200 thousand. The final compromise at $487 thousand came about as part of the Bipartisan Budget Act of 2013.

Each of these statutory formula cap amounts limits reimbursement of compensation at the beginning of the contractor fiscal year that begins January 1st for the respect year (or pro-rated over that portion of the contractor fiscal year that includes January 1st for the respective years). So, for example, the statutory formula cap for fiscal year 2013 is applicable to compensation costs incurred on contracts during the period January 1, 2013 through December 31, 2013.

The 2014 compensation cap of $1.1 million applies to years after 2014 as well, until OMB revises it.

Contractors, of course, can compensate employees at any level they deem appropriate. These caps only limit the amount the Government will pay.

Next week, we will look at DCMA (Defense Contract Management Agency) guidance on blending the old and new compensation caps.

Allowable Compensation Costs

Here's a quick primer on applying the compensation caps found in FAR 31.205-6(p).

For contracts awarded after June 24, 2014, the cap is straight-forward. Compensation for all employees is limited to $487,000 annually. This ceiling on compensation comes from the Bipartisan Budget Act (BBA) of 2013 and has been incorporated into FAR 31.205-6(p)(3) as an interim rule. This compensation level is subject to annual adjustment based on the Employment Cost index for all workers. For the latest cap amounts, refer to OMB's Contractor Employee Compensation Cap per BBA webpage. We call this the "new cap". So far, the new cap has not increased from its initial setting at $487,000. The BBA and the corresponding regulations allows agency chiefs to create narrowly-targeted exemptions for scientists, engineers and other specialists where the cap might not be high enough to acquire needed skills. Note, these are specialty skills and it is unlikely that the Government would entertain waiver requests for company executives.

For contracts awarded prior to June 24, 2014, application of the compensation cap becomes more complicated. The statutory cap itself is found in OMB's Contractor Compensation Cap per Statutory Formula webpage. We call this one the "old cap". In 2004, the cap was $432,851 and it increased steadily (and rapidly) to $952,308 in 2012. The application of the cap is where things get tricky.

If you hold a DoD, Coast Guard, or NASA contract awarded after December 31, 2011 and before June 24, 2014, the cap applies to all employees.

If you hold a DoD, Coast Guard, or NASA contract awarded after January 1, 1998, the cap applies to senior executives.

If you hold a contract awarded by an executive agency other than DoD, Coast Guard, or NASA between January 1, 1998 and June 24, 2014, the cap applies to senior executives only.

To further complicate matters, the definition of "senior executive" changes. Prior to January 2, 1999, senior executive meant the CEO and the four most highly compensated employees in management position. After January 1, 1999, the definition changed to mean the five most highly compensated employees in management positions at each home office and each segment of the contractor.

The compensation amounts listed under the old cap ends with calendar year 2012 and the new cap begins on June 24, 2014. This raises the question of what cap applies to costs incurred in 2013 and in 2014 prior to June 24, 2014. It is DoD's position that the 2012 cap of $952,308 applies to costs incurred in all subsequent years (e.g. 2013, 2014, 2015, etc) for contracts awarded prior to June 24, 2014.

Using Blended Rates to Implement Multiple Compensation Caps

Last December, the President signed into law the Bipartisan Budget Act (BBA). Among its provisions is a $487 thousand limitation on compensation for all employees on all Government contracts awarded after June 24, 2014 (click here for more details). Compensation, in this case, includes basic salary/wages, bonuses/incentive compensation, deferred compensation, and employer contributions to ESOPs and defined benefit pension plans This is different than the FAR definition of "compensation" (click here for more details).

This new limitation is causing implementation issues. Any contract awarded prior to June 24, 2014 is subject to the significantly higher compensation limit provision found in FAR 31.205-6(p) For calendar year 2012, that cap is $952 thousand. The 2013 rate has not yet been published. Only contracts awarded after that date, are subject to the lower compensation cap. This means that for a time, contractors will be working on contracts subject to differing compensation ceilings.

DoD has recognized this implementation issue and has authorized the use of blended rates during this transition period. In a October 24, 2014 letter, the DoD wrote,

Many contractors will have contracts subject to both the current and earlier compensation limit provisions in (FAR), causing the potential for undue complexity and related costs to implement multiple rates to accommodate these revisions. After careful review and consideration of the law and regulations, contractors' use of a "blended rate" approach is deemed as a practical and cost efficient solution to implement these requirements.

The letter goes on to provide guidance on how to calculate a blended rate:

Blended rates will be calculated by each individual contractor as a weighted average composite cap amount specific to their contract volume prior to June 24, 2014, and on or after June 24, 2014.

...for the purpose of establishing final overhead rates, contractors will calculate blended rates reflecting actual proportion of contract costs for the current year for contracts prior to and after June 24, 2014. The contractors' final overhead submission for the completed fiscal year must include auditable substantiation of the calculation of the actual blended rates. An audit will ensure that only the total allowable compensation is billed to the Government for the fiscal year based on the different authorized caps. The objective is to simplify compliance while continuing to protect the interests of the Government. 

Contractors who chose to use blended rates, will need to execute advance agreements with their contracting officers. The advance agreement will outline the agreed-to-process, auditable data submission and expiration for the application of the blended rate. DCMA (Defense Contract Management Agency) will be issuing implementation guidance at some unspecified date. 

Contractors who are impacted by the lower compensation cap in 2014 should be thinking about how to develop blended rates now and begin to engage their contracting officers. Don't wait for DCMA guidance because that might not happen quickly. Get outside help, if necessary.

This new policy is from DoD and applies only to DoD contracts. We have not yet heard how other Agencies will implement the $487 thousand annual compensation cost limit. However, contractors could certainly make a good case for applying the DoD methodology to non-DoD contracts.

OMB and DoD Looking for Alternative Sources for Benchmarking Compensation

The Office of Federal Procurement Policy (OFPP) and the Department of Defense issued a "Notice of Request For Public Comment" yesterday, seeking public input into the development of a report to Congress on alternative measures of determining allowable compensation costs.

As we reported on these pages, the President, last December, signed into law the Bipartisan Budget Act of 2013 which capped compensation for all Government contractor employees at $487 thousand per year and became effective for contracts entered into after June 24, 2014. By law, this cap must be adjusted annually for inflation, based on the change in the Employment Cost Index for all workers (as published by the Bureau of Labor Statistics).

A separate provision of that legislation (Section 702(e)) directed that OMB and DoD report to Congress on alternative benchmarks and industry standards for compensation, including whether any such benchmarks or allowable compensation.

The $487 thousand cap was purely a subjective figure. Congress and the Executive Branch were proposing varying amounts based on the President's salary, the Vice President's salary and other arbitrary amounts. The old benchmark, which had grown to $950 thousand per year was based on the median (59th percentile) amount of compensation accrued over a recent 12-month period for the top five highest paid employees in management positions at each home office and each segment of publicly traded U.S. companies with annual sales over $50 million.

Evidently, neither the OMB nor DoD came up with any good alternative benchmarks to present to Congress because they are now asking the public for ideas. Specifically, OMB and DoD are seeking public input on alternative benchmarks that would provide a more appropriate measure of allowable compensation including appropriate inflators (i.e., alternatives in lieu of the Employment Cost Index for all workers. Any public input should be accompanied by explanations as to why such might be more suitable than the benchmark and inflators set forth in statute.

The new compensation cap is going to hit a lot of contractors, some pretty hard. Perhaps there will be some relief as a result of this request for public comment.

It should be noted that the $487 thousand figure is an absolute cap on compensation. It does not mean however that contractors can pay any employee up to that amount and call it reasonable. The reasonableness criteria in the FAR cost principle for compensation still applies.

Comments will be accepted until October 16th, 2014.

Lowered Compensation Cap - What's Included in Amount?

Last week we discussed the new compensation cap ($487 thousand) that goes into effect this month (for contracts awarded after June 24th) and the need for contractors to reflect the lowered cap in their proposals and in the forward pricing rates. If contractors don't, the Government will. You can read that posting here.

"Compensation", in the context of the new statute, is defined in the law and is different than what one might conclude if referring to FAR Part 31.205-6, Employee Compensation. But that's not the case. "Compensation" subject to the compensation cap includes the following:

1. Basic salary/wages
2. Bonuses/Incentive compensation (to the extent it is otherwise allowable)
3. Deferred compensation
4. Employer contributions to Employee Stock Ownership Plans (ESOPs)
5. Employer contributions to defined contribution pension plans

Notable exclusions from this listing include medical insurance, unemployment benefits, post-retirement benefits other than pensions, contributions to qualified pension plans, company furnished automobiles, and severance pay.

This new compensation cap applies to all Government contracts, not just DoD contracts. Each Agency however, is implementing it differently. DoD, for example will relay on DCMA and DCAA to ensure compliance. DOE (Energy) on the other hand, since it has a lot of M&O contracts (Management and Operating) and already has procedures in place to approve compensation levels, will require its contractors to submit information by January 15th of each year in order for the contracting officer to make a determination. We haven't surveyed all of the Agencies but contractors could expect to hear from their contracting officers regarding implementation.

We stated this in a previous post but it bears repeating. The Government is not responsible for ensuring that contractors' cost or pricing data is current, complete, and accurate. That is contractor responsibility. Failing to adjust proposals and indirect rates for the new, lowered compensation cap could leave contractors open to TINA (Truth-in-Negotiations Act) violations.

Contractors Need to Reflect the New Compensation Caps in Forward Pricing

Last December 26th, the President signed into law the Bipartisan Budget Act (BBA). Among its provisions is a $487 thousand limitation on compensation for all employees on all Government contracts awarded after June 24, 2014. Now, some of you might be confused. We sure were. On the same date, the President signed the 2014 NDAA (National Defense Authorization Act) which capped compensation at $625 thousand. So what gives?

Well, the President first signed the 2014 NDAA and then the BBA which means that the BBA limitation takes precedence. So there you have it. Compensation is capped at $487 thousand, which will undoubtedly impact a lot of Government contractors. Incidentally, contractors can still pay whatever they want, they just cannot claim anything in excess of $487 on Government contracts.

Like previous incarnations of the compensation cap, the BBA provides for higher caps in limited situations:

The head of an executive agency may establish one or more narrowly targeted exceptions for scientists, engineers, or other specialists upon a determination that such exceptions are needed to ensure that the executive agency has continued access to needed skills and capabilities.

Additionally, the law provides for an annual escalation based on the Employment Cost Index for "all workers as calculated by the Bureau of Labor Statistics."

DCAA (Defense Contract Audit Agency) and DCMA (Defense Contract Management Agency) are already on record advising their auditors and cost/pricing analysts to ensure that contractors are adhering to the reduced caps in their proposals for contracts to be awarded after June 24th and in forward pricing indirect rate proposals. Contractors who don't impact their proposals for the lowered cap are in danger of submitting defective pricing.

The FAR (Federal Acquisition Regulations) Councils have not issued final rules but they are working to implement this statutory change. According to DoD however, the absence of a final rule does not let contractors off the hook as the basis for the limit is statutory, not regulatory.

Executive Compensation - December Update

Last month, we discussed the various executive compensation caps that exist within the President's budget and the Senate and House versions of the 2014 NDAA. You can read about it here.

The latest news on this subject has the House and Senate Armed Services Committee reaching an agreement on the cap. This agreement sets the cap at $625 thousand and provides for adjustments based on the BLS's (Bureau of Labor Statistics) Employment Cost Index. That index is currently hovering around the two percent level.

The House Armed Services Committee introduced the agreement with these words. The "flawed formula" being discussed is the one that has executive compensation set at $950 thousand for 2012.

Executive Compensation Reform: The NDAA recognizes the White House’s formula for calculating allowable private sector compensation on DOD contracts has become dysfunctional and does little to protect the taxpayer or provide transparency in government contracting. The NDAA rationalizes the cap to $625,000 and does away with the flawed formula. The NDAA allows for the cap to be adjusted based on the Employment Cost Index, which is commonly known and publicly available index computed by the Bureau of Labor Statistics. The NDAA rejected calls by some to cap individual industry compensation at the President or Vice President’s salary level, as such a standard represents an arbitrary comparison between compensation and salary and will only serve to drive critical talent from the nation’s defense industrial base.

The specific wording appearing in the Bill, amending Section 2324(e)(1) of title 10, United States Code, states that the following costs are unallowable:

Costs of compensation of any contractor employee for a fiscal year, regardless of the contract funding source, to the extent that such compensation exceeds $625,000 adjusted annually for the U.S. Bureau of Labor Statistics Employment Cost Index for total compensation for private industry workers, by occupational and industry group not seasonally adjusted, except that the Secretary of Defense may establish exceptions for positions in the science, technology, engineering, mathematics, medical, and cybersecurity fields and other fields requiring unique areas of expertise upon a determination that such exceptions are needed to ensure that the (Government) has continued access to needed skills and capabilities.’’.

The House passed this version of the 2014 NDAA (National Defense Authorization Act) but the Bill has not passed in the Senate yet, where, some 507 amendments have been offered. Reports we've read however, state that the Senate is rushing to pass it before the end of the year.

"Compensation" in the House Passed 2014 Defense Authorization Act

The House passed the 2014 National Defense Authorization Act earlier this month. Now its on to the Senate for consideration. This is a good time to take a look at what they've done with employee compensation recoverable by contractors under Government contracts.

First, it should be noted that the new coverage applies to all contractors, not just Defense contractors. Right now, there are different limits set on Defense, NASA, and Coast Guard contracts than for civilian agency contractors. That's confusing because contractors, with both Defense and non-Defense contracts must account for those difference when estimating and billing.

Secondly, there is a new definition for "senior executive". Currently it includes the five most highly compensated employees within each contractor component (e.g. division, subsidiary). Under the House version, it will apply to the five most highly compensated employees contractor-wide. Those five individuals will continue to be subject to the compensation cap methodologies that have been in place for some time. For fiscal year 2011, that cap is $763 thousand. The cap for 2012 has not yet been announced but is expected to top $900 thousand.

New to the compensation discussion is a cap on all contractor employees (except for the top five executives). The House NDAA would cap compensation for everybody at the $763 level and adjust that cap each year based on the U.S. Bureau of Labor Statistics Employment Cost Index for total compensation for private industry workers. The DoD or executive agency would be able to establish exceptions to those caps for positions in the science, technology, engineering, mathematics, medical and manufacturing fields upon a determination that such exceptions are needed to ensure that they have continued access to needed skills and capabilities.

The effective date for this proposed legislation would be 180 days after enactment. It seems to us that this provision, if enacted, is unlikely to impact a significant number of contractors. There doesn't seem to be that many contract employees whose compensation comes anywhere near that limit.

Commonsense Contractor Compensation Act of 2013

Its about time for our periodic update on contractor compensation. Our last update was on June 7 where the 2014 NDAA (National Defense Authorization Act) had come out of committee with a formula that would freeze the current cap except for a cost of living adjustment.We don't know whether that proposal will get too far, probably not.

There's a new bill that was simultaneously introduced in the Senate (S. 1192) and the House of Representatives (HR 2444) on June 19, 2013 that, if enacted, will cap everybody's salaries at the level of the Vice President's (currently $230,700). The purpose of the Act is " to implement common sense controls on taxpayer-funded salaries of government contractors by limiting reimbursement for excessive compensation.". The bill, which would apply to both Defense and civilian contracts reads:

Costs of compensation of contractor and subcontractor employees for a fiscal year, regardless of the contract funding source, to the extent that such compensation exceeds the rate payable for the Vice President under section 104 of title 3, United States Code, except that the head of an executive agency may establish one or more narrowly targeted exceptions for scientists, engineers, or other specialists upon a determination that such exceptions are needed to ensure that the executive agency has continued access to needed skills and capabilities.’

The bill also includes a reporting requirement for those "narrowly targeted" exceptions to the compensation caps. Within 90 days after the end of the fiscal year, agencies must report to Congress;

• the total number of contractor employees, by executive agency, in the narrowly targeted exception positions described under subsection (a) during the preceding fiscal year;
• the taxpayer-funded compensation amounts received by each contractor employee in a narrowly targeted exception position during such fiscal year; and
• the duties and services performed by contractor employees in the narrowly targeted exception positions during such fiscal year.

Seems like there might be some privacy issues in such reports. In any event, this seems to be another Congressional posturing event as GovTrack.us give the bill a 7 percent chance of getting out of the Senate Homeland Security and Governmental Affairs Committee and a 2 percent chance of ever getting out of House Armed Services Committee. 

By the way, the President's budget sets the cap at $400 thousand.