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Reasonableness of Compensation

Frequently Asked Questions

Are there any cost accounting requirements for a DBE certified firm that has been awarded an FTA funded contract? FAR Part 30 exempts small companies from CAS requirements. Because of this, can an S corporation consider the corporation distribution as part of the owner's compensation? If so, can you please direct me to the appropriate document? The owner's/ president /CEO compensation is far below reasonable compensation level.

With one exception, as discussed below, the FAR does not apply to grantee contracts. The FAR applies only to direct contracts of the Federal Government. FAR Part 30 does not apply to grantee contracts. Thus the cost accounting standards do not apply to your contract.

The only FAR requirement applicable to FTA funded grantee third party contracts is FAR Part 31 - "Contract Cost Principles and Procedures." The allow ability of costs on cost-type contracts funded by FTA must be determined in accordance with the cost principles in FAR Part 31. (This requirement comes from 49 CFR Part 18.22.)

Part 31.2 contains the cost principles for commercial contractors. The issue of "reasonableness" of an incurred cost is generally addressed in Part 31.201-3, and the general principle is that the cost "not exceed that which would be incurred by a prudent person in the conduct of a competitive business."

With respect to compensation, Part 31.205-6 (a)6 - "Compensation For Personal Services," states the following:

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

(ii) For these individuals, compensation must-

(B) Be reasonable for the personal services rendered; and
(C) Not to be a distribution of profits (which is not an allowable contract cost).

We cannot answer your question specifically with respect to the allow-ability of "the corporation distribution." As you can see from the cost principles above, owner compensation will not be considered as an allowable cost if it is in fact a distribution of profits. We would recommend that you contact the cognizant government audit agency that will be reviewing your costs and request a review of your specific situation. The best approach would be to structure the compensation in advance in such a way that the auditors will not later disallow the compensation as a distribution of profits based on FAR Part 31.205-6. (Posted: July, 2011)