When does FAR 31.205-6 apply?

Is the contractor charging employee compensation (salary, bonus, fringe) to a flexibly-priced government contract? If yes, 31.205-6 governs. The reasonableness test, the cap, and the written-plan requirements all apply on top of FAR 31.201-2. Does any single employee's charged compensation exceed the OFPP-published cap? If yes, the excess is unallowable on government work and must be excluded from indirect pools and direct charges. The cap applies to all contractor employees, not just executives. Are bonuses, severance, or stock-based compensation paid under a written plan that predates the payment? If not, the payment is at risk of being held unallowable as a discretionary distribution rather than compensation for services rendered.

What are the most common contractor pitfalls under FAR 31.205-6?

Failing to deduct the cap excess from indirect rate pools: The cap excess flows through compensation in fringe and indirect pools. Contractors who only adjust direct charges leave allocated cap excess in their pools, inflating rates and producing a downstream questioned cost. Discretionary bonuses with no written plan: A bonus paid at year-end at the owner's discretion, with no plan document defining the criteria, is routinely held unallowable. Establish written incentive plans before the performance period begins. Severance payments to terminated employees beyond normal practice: One-off severance to favored employees is treated as a discretionary payment, not allowable compensation. A consistent severance policy is the precondition for allowability. Pension funding patterns that violate CAS 412 / 413: Pension contributions that swing year to year to chase rate outcomes will be challenged. CAS 412/413 require funding to follow a measured assignment of cost, not contractor cash management. Using market data that supports rather than tests reasonableness: Compensation surveys are reasonable evidence, but cherry-picked surveys at the upper percentile do not satisfy reasonableness. DCAA looks at multiple sources and at the contractor's own historical levels.

What audit-flag patterns are associated with FAR 31.205-6?

Auditors and contracting officers commonly flag: Single-employee compensation in indirect pools that exceeds the OFPP cap with no exclusion; Year-end bonuses with no written plan documentation; Severance payments that do not match a published company policy; Stock-based compensation charges based on grant-date value rather than the cost recognition allowed by 31.205-6; Compensation survey citations limited to a single high-end source; Pension contribution variance year over year not explained by CAS-compliant funding logic.

FAR

FAR 31.205-6 — Compensation for personal services

Governs allowability of employee compensation charged to federal contracts. Sets the executive compensation cap, requires reasonableness, and addresses bonuses, severance, deferred compensation, pensions, and stock-based compensation.

Citation: 48 C.F.R. § 31.205-6 · Live text on acquisition.gov · eCFR

What this clause does

FAR 31.205-6 is one of the longest and most frequently litigated cost principles. It applies to all forms of compensation paid to employees and officers: salaries, wages, bonuses, deferred compensation, pensions, severance, fringe benefits, and stock-based compensation. The general rule is that compensation is allowable to the extent that it is reasonable for the work performed, conforms to a written compensation plan, and is not excluded by another provision.

The statutory executive compensation cap (often called the "Bowles cap" historically, now set under 41 U.S.C. 1127) limits the amount of any single employee's compensation that may be charged to a federal contract regardless of the employee's actual compensation. The cap applies to all employees, not just senior executives, and is updated annually by the Office of Federal Procurement Policy. Always check the current OFPP-published cap; do not memorize a number.

The section contains specific subsections on bonuses and incentive compensation (must be paid under a written plan), severance pay (allowable only when paid pursuant to a written plan and consistent with normal practice), pensions (subject to CAS 412 and 413 funding and assignment rules), post-retirement benefits other than pensions (CAS 415 / 416 territory), and stock-based compensation (specific allowability rules with the cost being limited to recognized stock values). Each of these subsections has been the basis of significant ASBCA and CBCA litigation.

Does this clause apply to my contract?

Three tests resolve applicability. Read each in order; the first "no" usually means the clause does not flow.

1.Is the contractor charging employee compensation (salary, bonus, fringe) to a flexibly-priced government contract?
If yes, 31.205-6 governs. The reasonableness test, the cap, and the written-plan requirements all apply on top of FAR 31.201-2.
2.Does any single employee's charged compensation exceed the OFPP-published cap?
If yes, the excess is unallowable on government work and must be excluded from indirect pools and direct charges. The cap applies to all contractor employees, not just executives.
3.Are bonuses, severance, or stock-based compensation paid under a written plan that predates the payment?
If not, the payment is at risk of being held unallowable as a discretionary distribution rather than compensation for services rendered.

Common contractor pitfalls

Patterns that produce questioned costs, back-wage liability, or False Claims Act exposure under this clause.

Failing to deduct the cap excess from indirect rate pools
The cap excess flows through compensation in fringe and indirect pools. Contractors who only adjust direct charges leave allocated cap excess in their pools, inflating rates and producing a downstream questioned cost.
Discretionary bonuses with no written plan
A bonus paid at year-end at the owner's discretion, with no plan document defining the criteria, is routinely held unallowable. Establish written incentive plans before the performance period begins.
Severance payments to terminated employees beyond normal practice
One-off severance to favored employees is treated as a discretionary payment, not allowable compensation. A consistent severance policy is the precondition for allowability.
Pension funding patterns that violate CAS 412 / 413
Pension contributions that swing year to year to chase rate outcomes will be challenged. CAS 412/413 require funding to follow a measured assignment of cost, not contractor cash management.
Using market data that supports rather than tests reasonableness
Compensation surveys are reasonable evidence, but cherry-picked surveys at the upper percentile do not satisfy reasonableness. DCAA looks at multiple sources and at the contractor's own historical levels.

Audit-flag patterns

Specific signals that contracting officers, DCAA, and agency IGs use to surface noncompliance.

Single-employee compensation in indirect pools that exceeds the OFPP cap with no exclusion
Year-end bonuses with no written plan documentation
Severance payments that do not match a published company policy
Stock-based compensation charges based on grant-date value rather than the cost recognition allowed by 31.205-6
Compensation survey citations limited to a single high-end source
Pension contribution variance year over year not explained by CAS-compliant funding logic

How FieldLedger helps

FieldLedger's Indirect Rate Engine applies the OFPP compensation cap at the employee level and excludes the excess from both direct charges and indirect pool allocations. Bonus, severance, and fringe components are tagged so the year-end Incurred Cost Submission already shows the cap-adjusted base.

DCAA compliance →Indirect Rate Engine →DCAA readiness check →

Related clauses

Clauses that flow alongside or interact with FAR 31.205-6.

Frequently asked

What does FAR 31.205-6 require?: Governs allowability of employee compensation charged to federal contracts. Sets the executive compensation cap, requires reasonableness, and addresses bonuses, severance, deferred compensation, pensions, and stock-based compensation.
When does FAR 31.205-6 apply?: Is the contractor charging employee compensation (salary, bonus, fringe) to a flexibly-priced government contract? If yes, 31.205-6 governs. The reasonableness test, the cap, and the written-plan requirements all apply on top of FAR 31.201-2. Does any single employee's charged compensation exceed the OFPP-published cap? If yes, the excess is unallowable on government work and must be excluded from indirect pools and direct charges. The cap applies to all contractor employees, not just executives. Are bonuses, severance, or stock-based compensation paid under a written plan that predates the payment? If not, the payment is at risk of being held unallowable as a discretionary distribution rather than compensation for services rendered.
What are the most common contractor pitfalls under FAR 31.205-6?: Failing to deduct the cap excess from indirect rate pools: The cap excess flows through compensation in fringe and indirect pools. Contractors who only adjust direct charges leave allocated cap excess in their pools, inflating rates and producing a downstream questioned cost. Discretionary bonuses with no written plan: A bonus paid at year-end at the owner's discretion, with no plan document defining the criteria, is routinely held unallowable. Establish written incentive plans before the performance period begins. Severance payments to terminated employees beyond normal practice: One-off severance to favored employees is treated as a discretionary payment, not allowable compensation. A consistent severance policy is the precondition for allowability. Pension funding patterns that violate CAS 412 / 413: Pension contributions that swing year to year to chase rate outcomes will be challenged. CAS 412/413 require funding to follow a measured assignment of cost, not contractor cash management. Using market data that supports rather than tests reasonableness: Compensation surveys are reasonable evidence, but cherry-picked surveys at the upper percentile do not satisfy reasonableness. DCAA looks at multiple sources and at the contractor's own historical levels.
What audit-flag patterns are associated with FAR 31.205-6?: Auditors and contracting officers commonly flag: Single-employee compensation in indirect pools that exceeds the OFPP cap with no exclusion; Year-end bonuses with no written plan documentation; Severance payments that do not match a published company policy; Stock-based compensation charges based on grant-date value rather than the cost recognition allowed by 31.205-6; Compensation survey citations limited to a single high-end source; Pension contribution variance year over year not explained by CAS-compliant funding logic.
How does FieldLedger help with FAR 31.205-6?: FieldLedger's Indirect Rate Engine applies the OFPP compensation cap at the employee level and excludes the excess from both direct charges and indirect pool allocations. Bonus, severance, and fringe components are tagged so the year-end Incurred Cost Submission already shows the cap-adjusted base.

Sources

FAR clause text — acquisition.gov/far/31.205-6
Live regulatory text — eCFR (Title 48)
DCAA Contract Audit Manual — dcaa.mil/Guidance/CAM
Plain-English methodology — FieldLedger methodology

Snapshot date: 2026-05-08. Clause text is binding only as of the version incorporated into your specific contract — check acquisition.gov for the live regulatory text.