FAR 16.601—Time-and-materials contracts.
Plain-English Summary
FAR 16.601 explains when and how the Government may use time-and-materials (T&M) contracts and labor-hour contracts, and it sets the core rules that make these contract types work. This section covers the definitions of direct materials, hourly rate, and materials; the basic structure of a T&M contract; when T&M is appropriate; the need for Government surveillance; how fixed hourly rates must be structured; special rules for interorganizational transfers and commercial services; treatment of material handling costs; the limitations on use, including the required determination and findings (D&F) and ceiling price; post-award requirements before increasing the ceiling price; and the solicitation provision for noncommercial acquisitions without adequate price competition. In practice, this section matters because T&M contracts shift significant cost risk to the Government unless tightly controlled, so the FAR requires careful justification, pricing structure, surveillance, and file documentation. It is especially important when the scope or duration of work cannot be estimated with confidence, but it also warns contracting officers to use other contract types whenever possible. Contractors should understand that labor is paid at fixed hourly rates while materials are reimbursed at actual cost, subject to the FAR’s cost principles and any contract-specific limits. Contracting officers must ensure the contract includes the right clauses, the right rate structure, a ceiling price, and the required approvals before award or ceiling increases.
Key Rules
Key definitions control pricing
The section defines direct materials, hourly rate, and materials for T&M purposes. These definitions determine what can be billed as labor, what must be billed as materials, and what costs are included or excluded from the hourly rate.
T&M pays labor and materials differently
A T&M contract pays direct labor hours at specified fixed hourly rates and reimburses materials at actual cost, except as otherwise allowed by the cost principles. The hourly rate must already include wages, overhead, general and administrative expenses, and profit.
Use only when estimates are not reliable
A T&M contract may be used only when the Government cannot accurately estimate the extent or duration of the work or anticipate costs with reasonable confidence. The FAR treats this as a fallback contract type, not a default choice.
Government surveillance is required
Because T&M provides no positive profit incentive for cost control or labor efficiency, the Government must actively monitor performance. Surveillance is needed to gain reasonable assurance that the contractor is using efficient methods and effective cost controls.
Fixed hourly rates must be specified
The contract must state separate fixed hourly rates for each labor category. For certain noncommercial acquisitions without adequate price competition, separate rates are also required for labor performed by the contractor, each subcontractor, and each division, subsidiary, or affiliate under common control.
Interorganizational transfers have special rules
For noncompetitive contract actions, transferred labor between related entities generally may not include profit for the transferring organization, though the prime contractor may include profit. For commercial services transferred within a controlled organization, established catalog or market rates may be used if the organization customarily prices interorganizational transfers above cost and the contracting officer finds the price reasonable.
Material handling costs are limited
When material handling costs are included in material costs, they may include only costs clearly excluded from the labor-hour rate. They must be allocated to direct materials using the contractor’s usual accounting procedures consistent with FAR part 31.
A D&F and ceiling price are mandatory
A T&M or labor-hour contract or order may be used only if the contracting officer prepares a D&F stating that no other contract type is suitable. The contract or order must also include a ceiling price, and the contractor bears the risk of exceeding it.
Higher-level approval may be required
The D&F must be signed before execution of the base period or any option periods, and if the base period plus options exceeds three years, the head of the contracting activity must approve the D&F before execution of the base period.
Ceiling increases require analysis and documentation
Before increasing the ceiling price, the contracting officer must analyze pricing and other relevant factors, document the decision in the file, and follow the proper procedures if the change affects the contract’s general scope or the scope of an order under FSS or multiple-award task order contracts.
Special solicitation provision applies
For noncommercial acquisitions without adequate price competition, the contracting officer must insert the required solicitation provision addressing T&M/labor-hour proposal requirements. This ensures offerors submit the information needed to evaluate labor categories, rates, and related pricing.
Responsibilities
Contracting Officer
Determine whether a T&M or labor-hour contract is appropriate only when costs or duration cannot be estimated with reasonable confidence; prepare and sign the required D&F; obtain HCA approval when the base period plus options exceeds three years; ensure the contract includes a ceiling price; establish and document fixed hourly rates and material pricing rules; conduct surveillance-related oversight; analyze and document any ceiling-price increase; and follow the correct procedures for scope changes and order modifications.
Contractor
Perform labor only within the labor categories and qualifications stated in the contract; bill labor at the fixed hourly rates and materials at actual cost as allowed; maintain accounting and pricing practices consistent with the contract and FAR part 31; ensure material handling costs are properly segregated and allocated; and accept the risk of costs above the ceiling price.
Subcontractors
Provide labor, supplies, or incidental services only as priced and authorized under the contract structure; comply with the labor category and rate requirements applicable to their work; and support the prime contractor’s billing and cost documentation as needed.
Head of the Contracting Activity
Approve the D&F before execution of the base period when the base period plus any option periods exceeds three years.
Government Program/Technical Oversight Personnel
Support the contracting officer by monitoring contractor performance, labor usage, and cost control to provide reasonable assurance that the contractor is using efficient methods and effective cost controls.
Agency/Acquisition Team
Use T&M only when justified, ensure the solicitation includes the correct provision, and structure the acquisition so that labor categories, rates, materials treatment, and ceiling-price controls are clear and enforceable.
Practical Implications
T&M contracts are useful when the work is uncertain, but they are risky for the Government because they reimburse labor by the hour and materials at cost, so poor oversight can quickly drive up total price.
A common mistake is using T&M as a convenience when a fixed-price or other contract type would be more appropriate; the FAR requires a real justification that no other type is suitable.
Another frequent pitfall is failing to define labor categories and fixed hourly rates clearly enough, which can lead to billing disputes, unallowable charges, or labor misclassification.
Contracting officers must be careful before increasing the ceiling price: the FAR requires analysis, file documentation, and possibly formal scope-change procedures, not just a simple modification.
Contractors should track labor hours, material costs, and indirect allocations carefully, because anything above the ceiling price is at their own risk and improper cost treatment can create audit and payment issues.
Official Regulatory Text
(a) Definitions for the purposes of Time-and-Materials Contracts. Direct materials means those materials that enter directly into the end product, or that are used or consumed directly in connection with the furnishing of the end product or service. Hourly rate means the rate(s) prescribed in the contract for payment for labor that meets the labor category qualifications of a labor category specified in the contract that are- (1) Performed by the contractor; (2) Performed by the subcontractors; or (3) Transferred between divisions, subsidiaries, or affiliates of the contractor under a common control. Materials means- (1) Direct materials, including supplies transferred between divisions, subsidiaries, or affiliates of the contractor under a common control; (2) Subcontracts for supplies and incidental services for which there is not a labor category specified in the contract; (3) Other direct costs ( e.g. , incidental services for which there is not a labor category specified in the contract, travel, computer usage charges, etc.); and (4) Applicable indirect costs. (b) Description . A time-and-materials contract provides for acquiring supplies or services on the basis of- (1) Direct labor hours at specified fixed hourly rates that include wages, overhead, general and administrative expenses, and profit; and (2) Actual cost for materials (except as provided for in 31.205-26 (e) and (f)). (c) Application . A time-and-materials contract may be used only when it is not possible at the time of placing the contract to estimate accurately the extent or duration of the work or to anticipate costs with any reasonable degree of confidence. See 12.207 (b) for the use of time-and-material contracts for certain commercial services. (1) Government surveillance . A time-and-materials contract provides no positive profit incentive to the contractor for cost control or labor efficiency. Therefore, appropriate Government surveillance of contractor performance is required to give reasonable assurance that efficient methods and effective cost controls are being used. (2) Fixed hourly rates . (i) The contract shall specify separate fixed hourly rates that include wages, overhead, general and administrative expenses, and profit for each category of labor (see 16.601 (f)(1)). (ii) For acquisitions of other than commercial products or commercial services awarded without adequate price competition (see 15.403-1 (c)(1)), the contract shall specify separate fixed hourly rates that include wages, overhead, general and administrative expenses, and profit for each category of labor to be performed by- (A) The contractor; (B) Each subcontractor; and (C) Each division, subsidiary, or affiliate of the contractor under a common control. (iii) For contract actions that are not awarded using competitive procedures, unless exempt under paragraph (c)(2)(iv) of this section, the fixed hourly rates for services transferred between divisions, subsidiaries, or affiliates of the contractor under a common control- (A) Shall not include profit for the transferring organization; but (B) May include profit for the prime contractor. (iv) For contract actions that are not awarded using competitive procedures, the fixed hourly rates for services that meet the definition of “commercial service” that are transferred between divisions, subsidiaries, or affiliates of the contractor under a common control may be the established catalog or market rate when- (A) It is the established practice of the transferring organization to price interorganizational transfers at other than cost for commercial work of the contractor or any division, subsidiary or affiliate of the contractor under a common control; and (B) The contracting officer has not determined the price to be unreasonable. (3) Material handling costs . When included as part of material costs, material handling costs shall include only costs clearly excluded from the labor-hour rate. Material handling costs may include all appropriate indirect costs allocated to direct materials in accordance with the contractor's usual accounting procedures consistent with part 31 . (d) Limitations . A time-and-materials contract or order may be used only if- (1) The contracting officer prepares a determination and findings that no other contract type is suitable. The determination and finding shall be- (i) Signed by the contracting officer prior to the execution of the base period or any option periods of the contracts; and (ii) Approved by the head of the contracting activity prior to the execution of the base period when the base period plus any option periods exceeds three years; and (2) The contract or order includes a ceiling price that the contractor exceeds at its own risk. Also see 12.207 (b) for further limitations on use of time-and-materials or labor-hour contracts for acquisition of commercial products and commercial services. (e) Post award requirements. Prior to an increase in the ceiling price of a time-and-materials or labor-hour contract or order, the contracting officer shall- (1) Conduct an analysis of pricing and other relevant factors to determine if the action is in the best interest of the Government; (2) Document the decision in the contract or order file; and (3) When making a change that modifies the general scope of- (i) A contract, follow the procedures at 6.303 ; (ii) An order issued under the Federal Supply Schedules, follow the procedures at 8.405-6 ; or (iii) An order issued under multiple award task and delivery order contracts, follow the procedures at 16.505 (b)(2). (f) Solicitation provisions . (1) The contracting officer shall insert the provision at 52.216-29 , Time-and-Materials/Labor-Hour Proposal Requirements—Other Than Commercial Acquisition With Adequate Price Competition, in solicitations contemplating use of a time-and-materials or labor-hour type of contract for the acquisition of other than commercial products or commercial services, if the price is expected to be based on adequate price competition. If authorized by agency procedures, the contracting officer may amend the provision to make mandatory one of the three approaches in paragraph (c) of the provision, and/or to require the identification of all subcontractors, divisions, subsidiaries, or affiliates included in a blended labor rate. (2) The contracting officer shall insert the provision at 52.216-30 , Time-and-Materials/Labor-Hour Proposal Requirements—Other Than Commercial Acquisition Without Adequate Price Competition, in solicitations for the acquisition of other than commercial products or commercial services contemplating use of a time-and-materials or labor-hour type of contract if the price is not expected to be based on adequate price competition. (3) The contracting officer shall insert the provision at 52.216-31 , Time-and-Materials/Labor-Hour Proposal Requirements—Commercial Acquisition, in solicitations contemplating use of a commercial time-and-materials or labor-hour contract.