Introduction
For government contractors, managing executive compensation and employee benefits is a complex balancing act. When navigating the strict cost accounting standards and the Federal Acquisition Regulation (FAR), understanding how to structure long-term incentives is critical. A deferred compensation agreement is a strategic arrangement where a portion of an employee's compensation is set aside to be paid out at a future date. For contractors, these agreements are not just human resources tools; they are significant financial instruments that impact your allowable costs and audit readiness.
Definition
A deferred compensation agreement is a formal contract between an employer and an employee to postpone the receipt of earned income until a future period, typically upon retirement, termination, or the achievement of specific performance milestones. In the context of government contracting, these agreements are governed primarily by FAR 31.205-6(k), which dictates the allowability of these costs.
Under federal regulations, deferred compensation is generally considered an allowable cost only if it is measured, assigned, and allocated in accordance with the Cost Accounting Standards (CAS) or, where CAS is not applicable, Generally Accepted Accounting Principles (GAAP). The key challenge for contractors is ensuring that the liability is properly accrued and that the timing of the payment aligns with federal reimbursement requirements.
Examples
- Supplemental Executive Retirement Plans (SERPs): A contractor may offer a key executive a promise to pay a specific sum annually after they reach age 65. If the contractor seeks to recover these costs through government contracts, they must ensure the plan is funded and accounted for according to the specific criteria in FAR 31.205-6.
- Performance-Based Stock Units (PSUs): An agreement where an employee earns stock units based on multi-year contract performance, with the actual payout occurring three years after the grant date. This constitutes a deferred compensation arrangement that must be tracked for cost allowability.
- Bonus Deferral Programs: A program allowing senior management to defer a portion of their annual incentive pay into a future year to manage tax liabilities and retention, which must be carefully documented to avoid "unreasonable compensation" findings during a DCAA audit.
Frequently Asked Questions
Are deferred compensation costs always allowable on government contracts?
No. Costs are only allowable if they are reasonable, allocable, and comply with FAR 31.205-6(k). If the agreement is not funded or if the compensation levels exceed what is considered reasonable for the industry, the government may disallow the costs.
How does the DCAA view deferred compensation during an audit?
The Defense Contract Audit Agency (DCAA) scrutinizes these agreements to ensure that the contractor is not "front-loading" costs or improperly shifting liabilities between accounting periods. Contractors using SamSearch to monitor compliance trends often find that clear, contemporaneous documentation of the agreement's purpose and valuation is the best defense during an audit.
Does a deferred compensation agreement require specific accounting treatment?
Yes. If you are subject to CAS, you must follow CAS 415 (Accounting for the Cost of Deferred Compensation). This standard requires that the cost be assigned to the period in which the employee performs the services that entitle them to the compensation.
Conclusion
Navigating deferred compensation agreements requires a deep understanding of both tax law and federal procurement regulations. By ensuring that your agreements are structured to meet FAR and CAS requirements, you protect your firm from cost disallowances and audit findings. For contractors looking to stay ahead of regulatory changes, utilizing tools like SamSearch can provide the intelligence needed to maintain a compliant and competitive compensation strategy.
