Indirect Rates, Direct Impact

Why Understanding Indirect Rates is Crucial for Small Businesses

Whether you’re submitting your first proposal or are a seasoned veteran, preparing a cost proposal can feel overwhelming. While direct costs like salaries, materials, and project-specific expenses are often straightforward to calculate, indirect costs—those tied to overall business operations rather than specific programs—are frequently misunderstood and miscategorized. For small businesses, especially those navigating government contracts or grants, understanding and establishing indirect rates can mean the difference between building a sustainable enterprise and one that is rapidly burning through its runway.

What Are Indirect Rates?

Indirect rates are percentages used to allocate indirect costs (general and administrative as well as overhead expenses in some cases) across all programs. For example, the electricity bill for your office, HR costs, or the software tools your team uses that aren’t tied to any single contract or project but are essential for your business operations.

For companies working with government agencies through contracts and grants such as SBIR/STTR or other federally funded programs, indirect rates help ensure these costs are reimbursed appropriately. Without accurately established rates, small businesses often leave money on the table, absorbing expenses that could otherwise be recoverable.

Adding to the complexity, some indirect costs are unallowable and cannot be included in the indirect rate. What is allowable can vary across agencies and contracts or grants, making it essential to understand the specific guidelines for each funding source.

It is important to understand how federal indirect cost recovery rules and rates can differ, depending on the particular agency as well as with the details of the specific contract or grant.  Below are some examples of how various agencies treat indirect costs differently:

1. Independent Research and Development (IR&D) Costs

IR&D costs are expenses for research and development activities that are not sponsored by a grant or required by a contract but are necessary for a company's overall business objectives.

• Department of Defense (DoD): The DoD allows IR&D costs as indirect expenses, provided they are allocable and reasonable.

• National Science Foundation (NSF): NSF does not fund IR&D as part of an indirect cost rate under its grants.

• National Institutes of Health (NIH): NIH follows the federal cost principles outlined in 2 CFR Part 200, which generally do not allow IR&D costs unless they are directly associated with a specific project.

2. Patent and Intellectual Property Costs

Expenses related to filing and prosecuting patents and other intellectual property protections are also treated differently across agencies.

• DoD: Patent costs may be allowable if they are required for the performance of a contract or benefit the government. However, costs associated with acquiring patents primarily for commercial purposes are unallowable.

• NSF: Generally disallows patent costs unless they are directly related to the NSF-funded project and have been approved in the grant budget, such as in the Technical and Business Assistance (TABA) Supplement.

• NIH: Patent costs are typically unallowable unless they are directly tied to the funded research and have received prior approval.

3. Indirect Cost Caps

Each agency enforces unique cost limitations that reflect its priorities and policies. Here's a summary of how cost caps vary across agencies:

• NSF: For SBIR/STTR contracts, unless there is a previously negotiated rate with DCAA (Defense Contract Audit Agency), the total indirect costs plus fringe benefits are capped at 50% of total direct salaries and wages. Other NSF grants may have different caps.

• DoD: Typically negotiates the indirect rate with small businesses that do not have a previously negotiated DCAA rate. Permits indirect costs, including administrative expenses, as long as they are allocable, reasonable, and comply with FAR and DFARS provisions.

• USDA: Allows for the recovery of indirect costs through a negotiated indirect cost rate agreement. Depending on the program, organizations without such an agreement may request a de minimis rate of 10%.

When to Seek Help

For small businesses navigating the complexities of indirect rates and agency-specific guidelines, seeking professional assistance can save time and reduce costly errors. Consider seeking help if:

• You are preparing your first cost proposal and need guidance on allowable versus unallowable costs.

• You are working with multiple agencies and are unsure how to allocate indirect costs according to their unique requirements.

• You need to establish or negotiate an indirect cost rate agreement but lack the expertise or resources to do so.

• You want to ensure compliance with federal regulations such as FAR and agency-specific guidelines while maximizing cost recovery.

• You are planning to apply for SBIR/STTR grants or contracts and want to create a competitive, compliant cost proposal.

Firms like Abaci Accounting specialize in helping small businesses navigate these challenges, helping ensure compliance and financial success.

Conclusion

Indirect rates are not just an accounting exercise—they are a key component of building a financially sustainable business. By understanding allowable versus unallowable costs, tailoring indirect rates to agency-specific requirements, and recovering all eligible expenses, small businesses can strengthen their competitive edge and ensure long-term success.

For businesses looking to thrive in the complex world of government contracts, expert guidance can make all the difference. At Abaci Accounting, we empower small businesses to unlock their full potential by providing customized solutions for compliant cost proposals and financial management. Contact us today to take the next step in your journey toward success.