SBIR Compliance FAQ Part 1 - Salaries, Indirect Rates, and Accounting

We get a lot of great questions from small business owners every week, and some of the most common surround issues that come up during an SBIR Phase I, and especially as a contractor or grantee transitions from a Phase I to a Phase II. Topics can range from appropriate compensation levels, to when to get a compliant system, how to calculate indirect rates, and even the tax implications as the business grows. Starting with this first installment, ReliAscent® will begin posting an ongoing blog series featuring some of these important questions, and the answers and advice from our experts, so all contractors and grantees can benefit from these discussions.

Today, ReliAscent® Account Executive, Dave Donley, and Marketing & Sales Director, Tyler Link, answer five SBIR questions regarding compensation, when to get a compliant system, and calculating indirect billing rates for the Phase II proposal.

SBIR Award Employee and Owner Salary/Compensation Questions

Question: I plan on NOT taking a salary during the Phase I so that I can simply use that extra money for more research or to further build up the company. Is that a problem with the Government and DCAA?

Answer:  This is a VERY common question we hear from contractors nearly every week. Here is the problem with this approach: if you show a salary for labor in the budget, then do not take a salary—and that budget and application is approved for award—you could potentially be accused of fraud by the Government. It is FAR better to pay yourself as proposed, and then loan money back to the company or retain as "equity."

By not paying yourself, you are putting yourself at risk, to be sure. Another part of that problem is how does the awarding agency know what you worked on, or even if you did the work? A simple timekeeping system or system of notes would help prove the work effort was accomplished—but not having any salary taken will raise doubts in the Government’s mind that any work was actually performed.

Question: I am a CEO of a small business with a Ph I SBIR. Our CPA setup my salary at $60,000/year for tax savings purposes. Meaning I take a $60,000 salary and then supplement that salary with Owner Draws which are not subject to FICA. This has worked out so far, since my contracts to date have been firm fixed price (FFP). However, if I take a $60,000 salary, my loaded labor rate on the SBIR Ph II Cost Reimbursable contract would only be around $50/hr.

Prior to starting my company, I was an executive, and my salary was well over $200,000 per year. Now, I would like to increase my salary from $60,000 to $200,000 during the proposal process, so my time is sufficiently reimbursed when invoicing and so I don’t leave money on the table. Do you foresee any issues with such a substantial bump in salary prior to pursuing a Phase II award? If I increase my salary now, would that potentially lower the risk of someone from the Government throwing a flag?

Answer: That might be a red flag, for sure, but I think you have a valid explanation. It sounds like you’re either a S-corp or an LLC taking on W2 wages as well as distributions. You could continue doing that, as long as your distributions are considered “guaranteed payments.” This is because the Federal Acquisition Regulations (FAR) rules for compensation says, “distribution of profits are unallowable.” But if you document that you get the same amount of pay each month, no matter the source, you should be OK. Also, since your “employer paid payroll taxes” are an allowable fringe expense the gov’t pays for, why not just go exclusively W2?

Can I continue to justify her salary if she’s only charging a few hours per week? Is there anything I should be concerned about with respect to a DCAA audit? She does not have to work full time as long as she fills out a timesheet.

Answer: Depending on your pay cycle (semi-monthly or bi-weekly) divide $30,000 by 24 or 26, respectively. This yields her “salary per period” as either $1,250 or $1,153. If paid monthly, it would be $2,500. If all she does is G&A, then just book those amounts to G&A labor.

Regarding how you classify it, I don’t think “on-call” or idle time works unless it’s for contracted services vs indirect. So, it is probably best to book the idle time as unallowable.

When to Setup a DCAA Compliant Accounting System for Phase II

Question: I was recently told by a consultant that I must have a DCAA compliant accounting system setup and in operation by the time I am selected for a Ph II award. Is that true, and should I be paying for any templates or other DCAA compliance-related services during my Phase I?

Answer: This is incorrect.  And not only is it wrong, but not knowing the truth can cost you dearly  (especially if a consultant or accounting firm is trying to sell you unnecessary templates or services for thousands—or tens of thousands—of dollars).

• First: to clarify, you do NOT need to have a DCAA compliant accounting system while working on your Ph I, nor while waiting on the Ph II to be awarded, nor at the time of award.  Now there’s nothing wrong with having one ahead of time, but it is not required (and it will be costly—and most small businesses/start-ups are trying to stretch every dollar).

As long as you track ALL of your direct costs (we always recommend hiring a local bookkeeper or accountant to handle your accounting during Ph I), and you track your time spent on the award (we always recommend a DCAA compliant timekeeping system and tracking all hours—not just direct work), then you are going to be just fine for Ph I, and any competent Government Contract Accounting Firm should be able to set you up with a compliant system for Ph II (though it’s their expertise, structure, additional consulting services, and customer service that can vary greatly in our industry).

• Second: assuming the Ph II award will be a Cost Type contract (and not Firm Fixed Price), then yes, you will need to have a DCAA compliant accounting system. But only once you have been selected for the award. Once you are selected for the Cost Type Ph II award, you are going to have several weeks to submit your SF1408 preaward audit survey. The SF1408 survey is the document that lists the various requirements of a DCAA compliant system, and is how you notify the government that you do or do not have a compliant system, or when one will be setup (see the last question on the SF1408). To better understand the questions on the survey, you can download a copy of our popular white paper: “A Quick Guide to the DCAA Compliant Accounting System – Understanding the SF1408.”

It is important to be honest on the survey, as the preaward audit will be coming soon, and it is perfectly normal to not yet have a system up and running at this time. But, you will need to be sure you have begun doing your research ahead of time, and have an idea of your path forward to ensure you will have a compliant system up and running by the time of the audit.

After you submit the SF1408, you then have several days or weeks until the DCAA actually comes to do the preaward audit and review your system.

As most Government Contract Accounting Firms should be able to setup new clients on a compliant platform in a matter of 1-3 weeks (barring any substantial issues with your books), you will be perfectly fine to wait until you are SURE you have been selected for a Ph II award, BEFORE you begin spending thousands of dollars on your accounting system.

While most non-DoD grantees will not face this level of scrutiny prior to a Phase II award (the notable exception being NSF), a job-cost accounting system meeting SF1408 requirements is crucial for quarterly and annual financial reports and potential audit requirements of their Ph II grants.

Developing SBIR Phase II Indirect Rates

Question: It’s likely to be the case that the wrap rates that I use during the Phase II proposal differ significantly from the wrap rates you will calculate once you establish my cost accounting system, post-Phase II award. How do you recommend I bid proposal costs in advance of having actual ICE rates? And if those rates differ significantly, am I at risk during a DCAA audit? Does ReliAscent® help me calculate rates for the Phase II proposal?

Answer: You would want to do your best to forecast your revenue, project costs, and indirect expenses for the immediate year of the proposal in order to establish indirect rates for the proposal. If you’re anticipating a cost reimbursement contract, rates calculated in this manner will be the basis for establishing a “contract cost ceiling” and a fixed fee. Once negotiated and awarded, you’ll be asked by DCAA to submit a “Provisional Billing Rate” proposal. This establishes a consistent indirect billing rate for each annual period of the contract. You have the ability to request new billing rates at any time you think current billing rate are too high (overbilling costs) or too low (underbilling costs). As you accrue actual costs and actual rates throughout the Phase II contract, you’ll be required to submit what’s called an ICP – Incurred Cost Proposal. This is an annual look back at your actual indirect rates. This ICP may or may not be audited by the DCAA, but changing rates is not a factor – it’s the total ADV-“auditable dollar value” that’s in the proposal. This would be the value of all costs that year that are the result of cost-plus type contracts. If that figure is under $1M, you are considered low risk and you will likely not be audited. As you get closer to the end of the contract, you’ll need to be mindful of not having costs exceed the contract cost ceiling since you won’t be compensated for that.

ReliAscent® does help small businesses calculate their indirect rates for a Ph II proposal (this is a very common request, as most startups have a difficult time calculating rates with so little data or experience).  This service is provided to our monthly accounting clients, as well as on an as-needed basis to all small business government contractors and grantees (in which case, a small, one-time retainer is paid which we bill against, and any remaining funds can be used towards other consulting services or the accounting system setup once the Ph II is awarded).

We hope you found today's post informative, and keep an eye out for our next installment coming in March. If you have specific questions about SBIR, FAR, or DCAA compliance, or our accounting and consulting services, please feel free to contact us at any time. We are always happy to help.