(Editor’s Note. We receive numerous questions about relocation costs. The cost principle, which is more detailed than most, sometimes makes costs unallowable that are normally part of relocation packages offered to employees. Contractors need to understand these provisions so they can identify those relocation expenses provided by the company that need to be screened. Also, some companies choose to align their relocation reimbursement policies with the cost principles. Questions sometimes arise because there are occasional proposals to significantly change the cost principle which up till now have not been passed. For example, in 1998 the government proposed to remove the ceilings on specific relocation costs, provide for a lump-sum payment rather than actual costs and make tax gross-ups and assistance for employee spouses allowable. There are also both allowability and allocability questions. When preparing company written procedures these rules should be taken into account (though not necessarily followed to the letter where, for example, companies may want to provide "tax gross-ups" to employees even though they are unallowable). We have relied on a careful reading of the cost principle, our experience as former government auditors, contractor employees and consultants,, Mathew Bender’s "Accounting for Government Contracts" and the DCAA Contract Audit Guidance.)
General Rules
FAR 31.205-35 addresses relocation costs. Relocation costs are incurred when a current employee is reassigned or when a new employee is recruited. A permanent reassignment must be for an indefinite time or if a definite time, no less than 12 months. If an employee who is paid otherwise allowable costs resigns within 12 months for reasons under the employee’s control, the relocation costs must either be refunded to the government or credited to the account. Costs for mass relocation of personnel are allowable but the costs should be allocated based on the contracts or time periods benefiting from the costs. So, for example, when a facility is closed and employees are transferred to another site, the costs are to be allocated to the cost objectives at the new location.
Relocation costs that are generally allowable include travel costs of the employee and their immediate family and costs of transporting household and personal effects to the new location. Also, the costs of finding a new home are allowable which includes house-hunting trips by employees and their spouses and temporary lodging which cannot exceed 60 days for the employee and 45 days for spouses and dependents.
Unless relocations costs meet the following three criteria they are unallowable:
the move must be for the benefit of the employer;
reimbursement must be in accordance either with an established policy or with a practice that is consistently followed and designed to motivate employees to relocate promptly and economically; and
employee reimbursement may not exceed actual costs, except that a policy may be established to reimburse employees up to $1,000 for certain miscellaneous expenses (discussed below).
Slightly different requirements exist for relocation of employees who are hired for specific contracts or long term field projects. First, the employment agreement must specifically limit the duration of the employment to the time spent on the specific contract or project. Second, the agreement must provide for the return of the employee to their location before the employment covered by this agreement or to a location of equal or lesser cost.
Specific Requirements
Within certain limits, costs related to disposing of a residence the employee owns at the time of notice of transfer are allowable. Closing costs include (1) brokerage fees (2) legal fees (3) appraisal fees (4) points and (5) finance charges.
Costs of ownership of a vacant former residence that is sold after the employee purchases or leases a new residence are also allowable within limits. These costs include building and grounds maintenance, utilities, taxes, property insurance, mortgage interest and related items. The combined closing and ownership costs cannot exceed 14 percent of the sales price of the property sold.
Other miscellaneous relocation costs usually considered necessary and reasonable expenses are (1) costs of disconnecting and connecting household appliances (2) automobile registration fees (3) new driver’s licenses and use taxes (4) cost of cutting and fitting rugs, draperies and curtains (5) forfeited utility fees and deposits and (6) property insurance for items in transit.
Costs of acquiring a home at a new location are allowable subject to the following and are not expressly unallowable as discussed below. First, the employee must have been a homeowner before relocation. Second, the total costs cannot exceed 5 percent of the purchase price of the new home. Mortgage interest differential payments are also allowable for up to three years provided payments are limited to the difference in the interest rates between the two residences times the current balance of the old mortgage. If the employee transfers again before the three years have passed, the allowable costs are reduced in proportion to the actual relocation period.
Rental differential payments are also allowable. These payments usually arise when a relocated employee retains ownership of a vacated home and rents at the new location. The rented quarters must be comparable to the vacated home. The allowable payment is limited to the actual rental costs less the fair market rental value of the vacated home for three years. The costs of canceling an unexpired lease on vacated premises are also allowable.
Expressly Unallowable Costs
Certain relocation costs are expressly unallowable. These include:
a loss on the sale of a residence
mortgage principle payments on the old residence
payments for employee income or social security taxes incident to reimbursed relocation costs (so-called tax gross-ups)
payments for job counseling and placement assistance for spouses and dependents who were not contractor employees at the old location
costs incident to furnishing loans to employees or arranging for below-market mortgage loans.
Also unallowable are brokers’ fees and commissions, litigation costs, real and personal property insurance, mortgage life insurance, owner’s title policy insurance when such insurance was not carried by the employee on the former residence and property taxes and operating or maintenance costs related to acquiring a home in a new location.
DCAA Audit Guidance
Chapter 7-1004 of the Defense Contract Audit Manual (DCAM) addresses employee relocations costs. In addition to merely reflecting the FAR, one can reasonably assert the points emphasized in DCAM actually adds elements to the cost principle. We recommend your human resources and project manager personnel become familiar with this section when considering policies, employee agreements and relocation plans. The guidance contains seven sections summarized below:
7-1004.1. General. This section states FAR 31.205-35 addresses relocation costs and applies to costs incident to permanent changes of duty assignments of not less than 12 months. It identifies eight type of costs that are usually associated with relocation costs – (1) travel and transportation of household goods (2) advanced trips to find a permanent residence (3) closing costs incidental to sale of prior residence (4) miscellaneous expenses such as cancelling a lease or disconnecting and reinstalling appliances (5) acquiring a new house (6) continuing mortgage interest at the old residence (7) interest differential between the old and new mortgage and rental differential where relocated employee retains ownership of a vacated house in the old locations and rents at the new location and (8) other miscellaneous expenses. Travel costs associated with relocation should be considered allowable per diem costs in accordance with FAR 31.205-46, travel costs.
This section stresses that the auditor should evaluate the contractor’s policies and procedures and employment agreements to assure they are reasonable and in compliance with FAR requirements. In addition to ensuring they are allowable, the auditor should assure the contractor’s allocation methods provide the costs are properly allocated to benefiting contracts with special attention to whether they are charged to the appropriate business segment. The auditor should test whether these policies and procedures are adhered to and if the contractor’s policies and procedures are inadequate, additional tests of individual vouchers should be conducted.
7-1004.2. Conditions for allowability. This section focuses on the meaning of the 12 month threshold period. Relocation must involve a permanent change of duty assignment or for an indefinite period as long as more than 12 months are expected. The auditor should question relocation costs "in excess of constructive temporary duty assignment costs" if the contractor should have known at the time of assignment it would not have continued for a period of 12 months or more.
Failure to fulfill a permanent change of duty requires the contractor to refund or credit the cost charged to the government. The auditor is told to encourage contractors to include recapture provisions in their relocation agreements with employees and that this provision should be monitored by the auditor to assure the contractor adequately collects refunds from employees and these refunds are credited to the government.
The guidance states the recapture rule is not applicable to new employees who are (1) hired specifically for long term (at least 12 months) field projects or contract assignments (2) entitled to a return relocation under the terms of their employment contract and (3) not permanent employees and are released from employment upon completion of their assignment. All three conditions are required to meet the recapture waiver so, for example, existing employees reassigned to field projects do not apply.
7-1004.3. Applicability of Joint Travel Regulations (JTR). JTR per diem rates for lodging, meals and incidentals are to apply to employees traveling on official business which includes house-hunting trips and travel to new duty stations. JTR per diem rates do not apply to temporary quarters allowances because employees are not considered to be on official business travel while in temporary quarters.
7-1004.4. Employee assignments not considered relocations. Certain duty assignments, principally overseas locations, often include "location allowances." These "location advances" are considered inducements to work at these locations and should be considered additions to normal wages and salaries covered by FAR 31.205-6, "compensation for personal services" and not relocation costs. Also, costs of travel to overseas locations should be considered travel not relocation if dependents are not permitted and the expenses do not include costs of transporting household goods. Under these circumstances, the move is considered a temporary rather than permanent change of duty station.
7-1004.5. Unallowable relocation costs. The guidance reflects the type of costs in FAR 31.205-35(c) identified above. The section does state the contractors should not be compelled to refund or credit relocation costs for less than 12 months of relocation when the termination of employment was due to illness, disabling injury or death.
7-1004.6. Mass relocations. The guidance alludes to FAR 31.205-35(e) that states both reasonableness and allocation questions may arise over large scale or mass relocations and stresses that when an advanced agreement is not in place FAR 31.2 should be used by the auditor to determine reasonableness and allocation of costs. When the auditor learns of impending mass relocation costs they are told to report the matter to the cognizant ACO and recommend an advanced agreement be prepared for allowability of costs that addresses (1) the appropriate segment where the costs should be allocated (2) length of time over which the costs are to be amortized and (3) eligible employees.
7-1004.7. State and local transfer tax. When a state or local government imposes a tax on the sale of a home by law, the guidance in FAR 31.205-35(a)(3) allows the costs. However, if an agreement to pay the tax is not imposed on the seller (i.e. employee) by law but is agreed to in order to help make the sell or other reasons, the tax is not considered a legitimate closing cost and is to be questioned by the auditor.
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