<b>Understanding Indirect Costs: Part 1</b>
Understanding Indirect Costs: Part 1

Ever wonder how to classify expenses as “direct” or “indirect”? Curious about “overhead” and “administrative” costs? You’re not alone. There are myriad rules and regulations about the classification of “extra” costs that go beyond the basic, direct costs required to operate a program or project. We’ll try to break it down for you in this two-part series.

First, the terms “indirect,” “overhead” and “administration” basically mean the same thing, at least in most contexts. (Some organizations have distinct internal definitions.) Specific to federal grants, there is (finally) a consistent definition thanks to the  Uniform Guidance issued by the White House Office of Management and Budget (OMB) in 2015. Indirect costs are now formally referred to as “Facilities and Administration (F&A) Costs.” “Facilities” costs include: depreciation on buildings, equipment and capital improvement; interest on debt associated with certain buildings, equipment and capital improvements; and operations and maintenance expenses. “Administration” costs refer to general expenses such as the director’s office, accounting, personnel and all other types of expenditures not listed specifically under “Facilities.”

The Uniform Guidance also streamlined the process of recouping said costs. Specifically, the Guidance enables federal grantees to recoup indirect costs even without a federally negotiated indirect cost rate agreement (NICRA) in place. Under this reform, federal grant applicants may request indirect costs by using a default rate of 10 percent of the modified total direct costs of the project budget or through a post-award submission of a provisional rate proposal based on the organization’s most recently completed fiscal year. (The “modified” part of the default rate option means it excludes equipment, capital expenditures, charges for patient care, rental costs, tuition, remission, scholarships and fellowships, participant support costs, and the portion of each subaward and subcontract in excess of $25,000.) Applicants can only use the second option (a provisional rate—which is often higher than 10 percent)—if they had already submitted a formal NICRA request before notice of grant award.

Sounds nice, eh? Well, keep in mind that indirect cost recovery is rarely a windfall. Most funding mechanisms (with the exception of the National Institutes of Health’s research grants, for example) require indirect costs to be included within the total budget request. So, such costs typically have to come at the expense of the “direct” costs necessary to operate the proposed program/project. Also, some funding mechanisms limit indirect costs to a certain threshold regardless of NICRA. For example, the Health Resources and Services Administration (HRSA) has an 8 percent indirect cost limitation on training grants.

So is it worth pursuing indirect costs? Indeed. Do your homework now to be ready for grant opportunities that allow for indirects to exceed direct cost requests. Also, quantifying indirect costs demonstrates a clear understanding of all the costs associated with your organization and the back-end resources required to achieve specific program/project objectives. Pursuing a formal NICRA often holds even greater rewards, particularly for research grants that are often not subject to indirect cost limitations. Universities are notorious for generously high indirect rates (typically over 50 percent); hospitals and health care systems are typically in the 30 to 50 percent range, based on the extent of their research activity.

Stay tuned for Part 2 on this topic blog next month that will discuss:

  • What applicants should do if their organization does not have a federally negotiated indirect cost rate agreement and doesn’t plan to pursue one in the near future (recognizing that pursuing a formal rate agreement it is a very time-consuming, data-driven process);
  • What to do if you are ready to pursue a federally negotiated indirect cost rate agreement; and
  • How to use a provisional rate while your indirect cost proposal is under consideration.