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ohnoudidnt14

Limitations on Subcontracting considering owners direct effort

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As a (small) business owner, qualifying under several socio-economic programs, performing on a Federal construction contract, I am exempt from reporting requirements in accordance with Davis-Bacon. That is, whereas I have to report employees time/pay in accordance with Davis-Bacon, I am exempt from reporting wages (if any) paid to myself.

How would the contracting officer (or SBA if subject to a later audit) allocate my compensation when it comes to calculating the labor portion as it relates to any applicable limitations on subcontracting? I often go without pay, if I chose to do so, for the betterment of the business. In some cases, I am the only employee performing on some small contracts. If it truly is calculated on “actual pay”, then I may not satisfy the goals even though I (owner and qualifier of the small business) may have performed a majority of the hours. More commonly, I have one or two employees performing along with me, but may not meet the 25% goal (or 15% or 50% depending on the contract/applicable FAR clause) if my own time is assumed to be worth NOTHING whether I actually paid “nothing” or not. Also, technically, as a single-owner subchapter S corporation my real “salary” is not figured until my personal and corporate taxes are filed the following year.

I’ve reviewed all of the methods of calculations posted in the forums here and elsewhere, but haven’t seen how this might be addressed. Can anyone give me any insight into how the SBA (or any other auditing agency) would figure this (including any references)?

Thank you in advance for your time and consideration and thank you Bob for allowing me to post this.

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Hi ohnoyoudidnt14,

I have worked with several small businesses in similar situations. You're problem stems from a lack of "accrual" accounting. You're stuck on cash basis, which is fine for taxes but not so fine for government contracting. You need to figure out a salary and pay it to yourself, allocating that salary between direct labor (projects/contracts) and indirect labor (running the business). Your K-1 is not a substitute for a salary; it's simply the profit (or loss) from the business after expenses (including your salary) have been calculated.

Go find yourself a good accountant who understands cost accounting rules for government contracts. It will be an investmest for which you'll thank yourself.

Hope this helps.

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Discuss with your SBA rep and Contracting Officer first, but I think you should follow the new Limitations on Subcontracting requirement found in Section 46 of the Small Business Act. See this article for discussion:

http://smallgovcon.com/statutes-and-regulations/limitations-on-subcontracting-congress-enacts-major-changes/#more-1954

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FederalContractor,

As I interpret the original post, the interlocutor is not looking to subcontract, but instead how to comply with the D-B payroll reporting requirements, where the owner not only runs the business as a whole but also performs direct contract work. If I've misinterpreted, I'm sure "ohnoyoudidnt14" will correct me.

H2H

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Ohno’s initial post is a little confusing and discusses a confusing issue so let me try this as a quick way to try and respond admitting that it can get much more complicated.

The CO should allocate your time based on your original bid/proposal or in other words “cost” for performing the work. In other words in your costing did you show you, as owner, as a cost point either separately or inclusive of other labor on the contract? If so that is what counts, if you did not then you get Zero credit towards your subcontracting limitation. I would add that your “every reference” comment supports this view as at least one authoritative reference – SBA’s regulations 13 CFR 125.6, speaks to “cost” as defined as “(1) Cost of the contract. All allowable direct and indirect costs allocable to the contract, excluding profit or fees. (2) Cost of contract performance incurred for personnel. Direct labor costs and any overhead which has only direct labor as its base, plus the concern’s General and Administrative rate multiplied by the labor cost.”

If you are not charging anything then there is no cost. You might want to think so because you are out there working but…so sorry no credit for your efforts.

From my view showing yourself as cost on projects would work within your current “cash” accounting system where as you have stated sometimes you get paid and sometimes you don’t so what is the conclusion? Every time you prepare a bib/proposal, where the subcontracting limitation applies, you should be paying yourself and showing the costs in the bid/proposal. Why? Because even though you are using it as a way to refine your bid/proposal you are selling yourself short on showing your actual costs to do the work and adding confusion, as you note, to computing the subcontracting limitation.

This is a little different than Davis-Bacon payroll requirements. If you work on the site of work then you must be shown on the payroll. As owner (other than owner/operator when it comes to trucking) you are correct you do not show your salary etc. I do have to note that while I have never encountered it with regard to an “owner” the USDOL frowns on anything that is akin to volunteer labor on a project.

As a final thought remember, subcontracting limitation is determined on your bid/proposal for every SB category, except 8(a) where it should be monitored throughout a project as subcontracting limitation is a determination of compliance with not only a set aside but with continued participation in the 8(a) Program. For the other SB programs the subcontracting limitation is a determination that you are in fact a SB at the time of bib/proposal.

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Federalcontractor, while the statute has been amended, neither the SBA nor the FAR has issued implementing regulations. Because the statute is not self executing, until such regulations are issued, contractors should comply with existing regulations.

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Thank you all for some great insight. To follow-up:

  1. H2H-1, your suggestion to get a good accountant who understands cost accounting for gov contracts is probably the best advice yet. I've been stalling as long as I can from the conversion from a cash basis to an accrual basis. FYI, as an S Corp, the K-1 earnings pass through as personal taxable income. If I'm real good at the books, this will account for half of my income for the year to minimize my taxes.
  2. H2H-3, your interpretation was almost correct. I am not having a problem complying with Davis-Bacon reporting, compensation paid to an owner is not reported (but direct hours are). My problem is then how a contracting officer will figure (or assume) those wages when validating against any applicable subcontract limitations (wouldn't it be reasonable for them to assume the Co. has paid Davis-Bacon required wages for the applicable labor category).
  3. CC - very good insight, but I guess one thing wasn't clear that impacts all of this. Most of the contracts are low-bid FFP competitive, thus the gov does not have any cost or pricing data.
  4. Finally, to FedCon - The way I read the GAO ruling is "GO" for using the revised rule.

Thanks again to all. I'm not sure that I really have an answer other than "make sure you pay yourself" and "get an accountant", but those are both good.

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FederalContractor, in another discussion, I explained why I do not read the decision as applying the new criteria. Let me go a little deeper here.

First, the GAO stated that "Sealift argues that Schuyler’s proposal did not comply with the solicitation’s limitation on subcontracting clause." Thus, the issue presented was whether the proposal complied with 52.219-14, the limitation on subcontracting provision contained in the RFP. That clause does not incorporate the new measurement scheme from the NDAA, but includes the requirement that the contractor incur at least 50% of the labor cost using its own employees.

Later, GAO said "the agency during discussions inquired into Schuyler’s compliance with the RFP’s limitations on subcontracting. In its first discussion letter to Schuyler, the Navy contracting officer asked the firm to '[e]xplain how Schuyler will comply with FAR 52.219-14 Limitations [on] Subcontracting for this requirement.'" Later, the decision notes that " Schuyler 'demonstrat[ed] compliance with FAR § 52.219-14 with no outstanding issues'").

Based on the protest record, GAO concluded "that there was, and is, no indication that Schuyler took exception to the RFP’s limitation on subcontracting [FAR 52.219-14] or indicated an intent not to comply with the requirement. . . .

Accordingly, we disagree with the protester that the agency should have deemed Schuyler’s proposal technically unacceptable because it did not comply with the limitation on subcontracting clause [FAR 52.219-14]."

Any fair reading of the decision clearly evidences that the decision was based on compliance with the provisions of 52.219-14, not the NDAA.

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RetreadFed, I understand your points. The footnote may be nothing more than very misleading dicta. If that's the case, there was really no reason for GAO to reference the Defense Authorization law in its decision at all, it serves no purpose. That would be unfortunate if that's the case. I look forward to further clarification on this in the future.

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RetreadFed, I understand your points. The footnote may be nothing more than very misleading dicta. If that's the case, there was really no reason for GAO to reference the Defense Authorization law in its decision at all, it serves no purpose. That would be unfortunate if that's the case. I look forward to further clarification on this in the future.

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ohno - I appreciate your #3 comment but if anyone who is considered a interested party that wants to question your size status based on the subcontracting limitation challenged same I highly suspect (guarentee) that you would be asked for your cost or pricing data.

The world of Federal contracting demands, in my view, being ready to meet a very high standard of full disclosure on all kinds of fronts. If you are not prepared to do so I would suggest you might want to re-think about playing in the Federal contracting sand-box!

To add in re-reading all the posts I have to say this which I tried to say before but will re-phrase. Subcontracting limitation compliance and Davis Bacon compliance are two totally different things subject to different laws, statutes and regulations old or new. Do not confuse one with another.

Finally, I stated that this thread raised matters that could be very confusing. In support go here http://www.sba.gov/oha/3393 and put in the words "subcontracting limitation".

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Carl, I'm confused by your first sentence. What relationship do you see between a size protest and compliance with the limitation on subcontracting? Also, when you said "cost or pricing data," were you talking about cost or pricing data as used in TINA?

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ohnoyoudidnt 14,

I don't want to be overly technical but salary and income are two different things, especially for an S Corp. owner.

Just so other readers are clear, owners of "S" Corporations face double taxation. They must pay themselves a reasonable salary, from which taxes are withheld. The salary is an expense (one of many) to be deducted from sales to arrive at the Corporation's profit/loss. That Corporate profit or loss is reported to the S Corp owners on a Form K-1. The Form K-1 is reported as income on the owners' personal tax returns, which are of course subject to taxation.

The key issue for S Corp owners doing government contracting is that the salary they pay themselves must be allocated to the appropriate cost objectives, just like any other salary/wages. When an owner also performs direct contract work, that salary must be allocated both to G&A (running the business) and to the various contracts on which the owner works. That's a lot trickier than it looks, since most owners work quite a bit of overtime that looks uncompensated but is really compensated via the K-1.

Hope this helps.

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Retread - Correction accepted. It is a matter of repsonsibility and not size. Apologies for confusing the confusing.

With regard to "cost or pricing" I was simply using the same language as the original poster. I should of used quotes to indicate such. Thanks for keeping this discussion on the straight and narrow.

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Thank you all again for your insight on this topic. H2H, your info regarding the S-corp is 100% on the mark and may help a lot of readers of these discussions.

As a (very) small business owner, you pay your employees first, even if it means you go without. Referencing back to my original question, I'm sure you can all understand that it is frustrating as heck that if I decide to "go without" for a few weeks, it adversely effects my "limitations on subcontracting" calculation, even though my true effort on the contract is unchanged!

I'll be consulting with an experienced accountant very soon.

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Did anyone answer the original question?

"How would the contracting officer... allocate my compensation when it comes to calculating the labor portion as it relates the any applicable limitation on subcontracting? I often go without pay[.]"

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Did anyone answer the original question?

"How would the contracting officer... allocate my compensation when it comes to calculating the labor portion as it relates the any applicable limitation on subcontracting? I often go without pay[.]"

Vern, I didn't answer with respect to how a Contracting Officer would apportion the owner's compensation, but I attempted to suggest that it was incumbent on the contractor to do so.

H2H

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Looking at OHA decisions, it is clear that SBA will not get involved in this issue. OHA's positon is that compliance with the Limitation on Subcontracting provision is a question of responsibility that falls within the purview of the contracting officer.

As to how a contracting officer will view this, the answer is probably as varied as the number of contracting officers. I have not found any CDA decisions addressing this issue. Thus, contracting officers are left with little more than the language of the clause.

However, there is one thing that we can count on and that is how DCAA will look at this question. Because the clause uses the word cost, DCAA will examine a contractor's accounting records to determine the costs that have been allocated to a contract. If a contractor's cost records do not indicate compliance with the clause, it is almost a given that DCAA will cite the contractor for a contract non-compliance, particularly if the contract is a cost reimbursement contract. Any DCAA audit report on this topic is likely to substantially influence the contracting officer on the issue.

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Help:

The current subcontracting limitation clause, FAR 52.219-14, says that the prime's performance obligation, for construction, is either 15 or 25 percent of the "cost of the contract", excluding the cost of materials. Interpreting that language reasonably, it seems to me that the "cost of the contract" is the contractor's actual cost of contract performance, excluding materials, not the contract price or the estimated cost upon which the proposed price was based. Thus, the prime's performance obligation is a percentage of the proposed, estimated, or actual cost of contract performance, excluding materials. I have not fully checked the case law on this, but it seems pretty skimpy and does not seem to have addressed this issue.

Even assuming that the owner/laborer did not pay himself, his labor cost the company something measurable in terms of time, wages, and fringe benefits. The fact that he did not pay himself means only that he took a loss to that extent. Thus, the owner/laborer's share of the cost of the contract excluding materials would be hours worked x Davis-Bacon wages and fringes for the kind(s) of laborer that would have done the work that he did, plus allocable indirect cost. That amount should be used to compute the owner/laborer's contribution to the prime contractor's performance obligation.

What do you think?

Retread:

I don't think the SBA has any jurisdiction over the administration/enforcement of contract clauses. I think that disputes over compliance with the limitations on subcontracting clause are handled by the BCAs and the Court of Federal claims pursuant to the Contract Disputes Act.I also don't know what audit role DCAA would or could play with respect to a fixed-price construction contract.

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Help:

Even assuming that the owner/laborer did not pay himself, his labor cost the company something in terms of time, wages, and fringe benefits. The fact that he did not pay himself means only that he took a loss to that extent. Thus, the owner/laborer's share of the cost of the contract excluding materials would be hours worked x Davis-Bacon wages and fringes for the kind(s) of laborer that would have done the work that he did, plus allocable indirect cost. That amount should be used to compute the owner/laborer's contribution to the prime contractor's performance obligation.

What do you think?

I think you have found a reasonable approach that would definitely be rejected by DCAA because there were no "actual" costs incurred. In fact, I suspect that if any contractor tried this reasonable approach without footnoting the heck out of it to ensure absolute transparency, that same contractor might be setting itself up for a nice investigation regarding alleged violations of the False Statements Act and (perhaps) the False Claims Act.

Let me reiterate that I think your approach is sound and reasonable. I just do not think the government auditors will buy it and that might lead to a fraud referral.

I'm thinking of a related matter over at Quimba Software, whose blog details the company's long legal battles over deferred salary costs. Auditors tend to take a black-and-white approach to these sorts of things. Granted, the contractor is not claiming costs not actually paid in an invoice; but I think the situation sufficiently related to cause me to advise much caution.

As I stated several times the root cause of the poster's problem is a failure to establish a salary and then allocate it. Without that basic accounting taking place, in my opinion the owner would be skating on thin ice in following your approach. But -- hey! -- sometimes the sound and reasonable approach works. This might well be that rare time.

H2H

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Vern, I agree that SBA does not have jurisdiction to determine if a contractor complied with the Limitation on Subcontracting clause. By referncening OHA decisions, I was indicating that was not just my opinion, but the position of the SBA.

As for DCAA auditing a FFP construction contract, they certainly could do so if certified cost or pricing data was required for the contract. Also, they could attempt to do so at the special request of the contracting officer to verify compliance with the clause, although I do not know of any clause that permits this. However, lack of a specific clause giving the government audit rights has not stopped DCAA or contracting officers from trying to audit aspects of FFP contracts before.

All this raises the question of how contracting officers are to verify compliance with the clause.

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