In general, government contracts are awarded to the lowest bidder. Yet prevailing wage laws require contractors to pay wages that are comparable to those for similar work in the same city or geographical area. Such laws can make it difficult for contractors to win public projects.
However, you may have an opportunity to reduce costs and make your bids more competitive by leveraging fringe benefits. Let's look at this strategy.
Cash Can Drive Up Costs
Prevailing wage rates — which are established by the U.S. Department of Labor or a relevant state agency — contain both a basic hourly rate (paid in cash) and a fringe benefit component. Government contractors typically can choose whether to pay the fringe benefit component of the prevailing wage in cash or to use those amounts to fund one or more "bona fide" employee benefit plans.
You may be tempted to pay fringe benefit amounts directly to employees in cash. After all, this option offers simplicity and administrative convenience. But it can also drive up your costs, making it more difficult to bid competitively. That's because cash wages are subject to a variety of payroll liabilities, including:
- Social Security and Medicare taxes (FICA),
- Federal unemployment taxes (FUTA),
- State unemployment taxes (SUTA),
- Workers' compensation insurance, and
- Public liability insurance.
Depending on your state, these expenses can increase your labor costs by 25% or more.
For most contractors, funding employee benefits is a far more cost-effective strategy. Eligible benefit programs include health and disability insurance; life insurance; retirement benefits, such as 401(k) or profit-sharing plans; and paid time off. Contributions to employee benefit plans avoid payroll liabilities, significantly reducing your labor bid costs.
Suppose that a worker is entitled to a prevailing wage of $50 per hour, which includes a $35 base wage and a $15 fringe benefit. If you pay the entire $50 in cash (and assuming the payroll burden in your state is 25%), your labor cost is $62.50 per hour [$50 + (0.25 × $50)].
On the other hand, if you pay the fringe benefit component by funding one or more employee benefits, your labor cost is only $58.75 per hour [$50 + (0.25 × $35)]. Multiply the savings by dozens or hundreds of employees working 40 hours a week for several years and your bid costs are reduced by thousands, even hundreds of thousands, of dollars.
You can even use existing benefit plans to meet fringe benefit obligations. Let's say, in the above example, that you sponsor a group health plan and your premium contribution is $500 per month or $6,000 per year. Assuming the worker in the example works 2,080 hours per year (40 hours per week × 52), the value of the health benefits is $2.88 per hour, which is credited toward the employee's $15 fringe benefit.
In this second example, the health plan covers only a portion of your fringe benefit obligation. If you wish to avoid paying fringe benefits in cash, consider other types of benefits — including employer contributions to retirement plans — to make up the difference.
Satisfy Wage Obligations
To ensure that fringe benefits satisfy your prevailing wage obligations, it's important to design your benefits program carefully. Remember, credit toward fringe benefit obligations is only available for "bona fide" benefits. It's not available for use of company vehicles, tools, mobile phones, travel expenses or benefits a contractor is legally required to provide.
Contrary to popular belief, contractors can use self-funded health plans to offset fringe benefit obligations. To be eligible, however, these plans must meet several requirements, including a funding arrangement that provides for irrevocable contributions.
Note that penalties for prevailing wage violations can be harsh. For example, under the Davis-Bacon Act they may include fines, contract termination, "debarment" (that is, exclusion from future federal contracts for up to three years) and withholding of contract payments to cover unpaid wages and other damages. What's more, contractors or subcontractors that falsify payroll records or solicit kickbacks of wages are subject to civil and criminal prosecution.
Rules Are Complex
If you regularly bid on government contracts, take a look at how you pay fringe benefits to learn whether cost-cutting opportunities exist. Because the rules governing prevailing wages are complex, be sure to talk with your CPA and other professional advisors before making major changes to the benefits you offer.