SUBJECT: East Missouri Action Agency, Inc.

DECISION

East Missouri Action Agency, Inc. (EMAA) appealed a disallowance of $31,619 charged to its Head Start grant for the year ended September 30, 1997. The disallowance represented the amount by which the Administration for Children and Families (ACF) determined EMAA overcharged the Head Start program for State unemployment insurance taxes. ACF found that, although the amount of taxes paid by EMAA to the State was based on EMAA's total payroll, EMAA charged the cost of the taxes to Head Start on a basis other than Head Start's payroll. ACF concluded that the methodology used by EMAA violated the applicable cost principles at OMB Circular A-122. On appeal, EMAA stated that it had revised its methodology for allocating the taxes to Head Start and its other programs and argued that the disallowance should be reduced to $9,661.33. ACF took the position that no reduction in the disallowance was warranted because the revised methodology also violated OMB Circular A-122.

For the reasons explained below, we conclude that ACF's methodology is consistent with the applicable cost principles while EMAA's revised methodology is not. Accordingly, we sustain the disallowance in its entirety.

Applicable Cost Principles

The allowability of charges to federal funds by nonprofit organizations such as EMAA is governed by Office of Management and Budget Circular A-122, made applicable to HHS grants by federal regulations at 45 C.F.R. � 74.27(a) (1994). OMB Circular A-122 provides a uniform set of cost principles for determining costs of grants, contracts, and other agreements and is designed to promote efficiency and understanding between nonprofit grantees and the federal government. Home Education Livelihood Program, Inc., DAB No. 1598 (1996). It provides general principles on allowable costs, as well as guidance on specific cost items. Id.

ACF's disallowance letter cited as authority for the disallowance Attachment (Att.) B, � 7.f(2), of OMB Circular A-122, which provides:

Fringe benefits in the form of employer contributions or expenses for social security, employee insurance, workmen's compensation insurance, pension plan costs (see subparagraph h), and the like are allowable, provided such benefits are granted in accordance with established written organization policies. Such benefits whether treated as indirect costs or as direct costs, shall be distributed to particular awards and other activities in a manner consistent with the pattern of benefits accruing to the individuals or group of employees whose salaries and wages are chargeable to such awards and other activities.⁽¹⁾

ACF later cited OMB Circular A-122, Att. A, � 2.a, which requires that, to be allowable under an award, costs must "[b]e reasonable for the performance of the award and be allocable thereto under these principles." Paragraph 4.a in turn provides:

A cost is allocable to a particular cost objective, such as a grant, project, service, or other activity, in accordance with the relative benefits received. A cost is allocable to a Government award if it is treated consistently with other costs incurred for the same purpose in like circumstances and if it:

(1) Is incurred specifically for the award.

(2) Benefits both the award and other work and can be distributed in reasonable proportion to the benefits received.

(3) Is necessary to the overall operation of the organization, although a direct relationship to any particular cost objective cannot be shown.

Also relevant here is � 2.d., which requires that, to be allowable under an award, costs must "[b]e accorded consistent treatment."⁽²⁾

Factual Background

EMAA is a not-for-profit corporation located in Park Hills, Missouri. It provides housing assistance, nutrition services, early childhood education and other related services to low-income individuals. The majority of its program funding is provided through federal and state grants. ACF Ex. 3, at 15.

Each year, the Division of Employment Security in the Missouri Department of Labor and Industrial Relations sets an employer's contribution rate for unemployment insurance that is determined by the claims history of its employees. Specifically, the employer's contribution rate is calculated based on its account balance, which is a cumulative total of contributions paid by the employer less unemployment insurance payments by the State to that employer's terminated employees. EMAA notice of appeal dated 5/29/01, attached letter dated 5/22/01, at 1. EMAA's contribution rate for the period at issue here was 7.8%, the State's maximum rate for that period. Id. at 2; ACF Ex. 2. EMAA's high rate was attributable to the fact that many of EMAA's Head Start employees received unemployment insurance payments during the months between the ending of classes in May and the beginning of classes in August. At EMAA's request, the State waived the normal job search requirement for these employees so that they would return to work for EMAA in August instead of finding new jobs. ACF Ex. 3, at 40. According to EMAA, 98% of the unemployment insurance benefits charged to its account by the State in 1997 were for Head Start employees. EMAA Br. dated 9/24/01, at 1-2; ACF Br. dated 9/24/01, Ex. 4, at 2.

An employer's State unemployment insurance taxes are determined by multiplying its total payroll by its contribution rate. EMAA paid $130,012.32 in such taxes for the year ended September 30, 1997 based on its total payroll for the period of $1,666,824.60 and the 7.8% contribution rate set by the State. EMAA Br. dated 9/24/01, at 1.⁽³⁾

Based on the report of EMAA's independent auditors for the year ended September 30, 1997, ACF determined that EMAA overcharged its Head Start program $31,619 for State unemployment insurance taxes for that year. The auditors found that EMAA allocated the cost of the taxes among its programs using a different base from the base on which the taxes were paid. The auditors stated, and ACF agreed, that the taxes should be allocated among all of EMAA's programs-including Head Start-using the same base as used to calculate the taxes payable by EMAA. ACF Ex. 3, at 2; ACF letter dated 2/9/01, at 2-3.⁽⁴⁾

On appeal, EMAA recalculated the cost of unemployment insurance taxes using a different methodology from the methodology that resulted in the disallowance.⁽⁵⁾ EMAA first multiplied the taxable wages (payroll) for its programs other than Head Start for the year at issue ($511,839.86) by 3.51%, which it identified as the "base" State contribution rate. According to EMAA, the product ($17,965.58) was the amount of State unemployment insurance taxes that was allocable to EMAA's programs other than Head Start. EMAA then subtracted this amount from the total amount of unemployment insurance taxes it paid ($130,012.32). According to EMAA, the difference ($112,046.74) represented the amount of the tax cost that was allocable to Head Start. This amount was less than the amount EMAA originally charged to the Head Start program and, if accepted, would reduce the amount of the overcharge to $9,661.33. EMAA notice of appeal dated 5/29/01, attached letter dated 5/22/01, at 2.

This case presents the issue of the proper methodology for allocating State unemployment insurance taxes to EMAA's Head Start and other programs. Both the cost principle regarding fringe benefits and the general cost principle regarding the allocation of costs require that costs be allocated in accordance with the "benefits" accruing to or received by the activities to which the costs are allocated. ACF took the position that the cost of the taxes should be allocated to EMAA's programs by applying EMAA's contribution rate to the payroll costs for each program. As explained below, we conclude that this methodology correctly reflects the manner in which the taxes benefit EMAA's programs, results in a charge to the Head Start program that is reasonable in amount, and treats the cost of the taxes in a consistent manner. Accordingly, we sustain the disallowance in its entirety.

In determining the nature of the benefits received, the nature of the cost being allocated is paramount. When, as here, an employer pays mandatory state unemployment insurance taxes, the employer is in effect purchasing an insurance policy for its employees. This insurance policy entitles an eligible employee who has been terminated to receive periodic payments for some length of time following termination. The policy benefits an employee regardless of whether the employee ever receives unemployment insurance payments because every eligible employee is protected against a total loss of income in the event of termination. Indeed, EMAA did not dispute that the taxes were properly considered fringe benefits, which the cost principles treat as part of an employee's compensation.

ACF's methodology allocates the cost of the taxes by distributing it to EMAA's various programs in direct proportion to EMAA's payroll for those programs. This methodology thus allocates the cost among EMAA's activities in accordance with the benefit accruing to those activities, i.e., the unemployment insurance protection that is afforded to each employee. In addition, since the cost of the taxes is allocated to EMAA's programs on precisely the same basis that the State uses to assess the taxes on EMAA, there can be no question that the amount allocated is reasonable. Moreover, since the State assessed the taxes on EMAA on a uniform basis, use of the same methodology to allocate the cost of the taxes results in the consistent treatment of the cost across all of EMAA's programs. Indeed, it is difficult to see how the cost of the taxes could reasonably be allocated without reference to the State law that established the taxes and determined how they would be computed.

EMAA nevertheless argued that ACF's methodology failed to recognize the impact that the Head Start employees had in the computation of EMAA's contribution rate for the year in question. The extensive claiming history of the Head Start employees (even when combined with the very low claiming history of the non-Head Start employees) caused EMAA's contribution rate to be set at the maximum rate permitted under State law of 7.8%. Thus, according to EMAA, Head Start would be subsidizing EMAA's other programs if the cost of the taxes were allocated to all of EMAA's programs at the same rate. EMAA argued that it was therefore entitled to calculate a separate rate that would be applicable solely to EMAA's non-Head Start employees as a basis for allocating the cost of the taxes to those employees.

EMAA's methodology views the benefit accruing to EMAA's employees in terms of the unemployment payments received by the employees rather than in terms of the unemployment insurance protection afforded by the mandatory unemployment insurance taxes. Even if we were to accept this concept of benefit, however, EMAA's methodology does not meet the requirements of the applicable cost principles. Under State law, an employer pays unemployment insurance taxes based on a uniform annual contribution rate applicable to its total payroll. State law does not permit separate contribution rates for subgroups of employees based on their differing claims histories. Although State law does not directly govern the allocation of the cost of the taxes among the employer's programs, EMAA's departure from State law by creating customized contribution rates for subgroups of employees raises questions about the reasonableness of the amounts allocated and consistency of treatment of the cost among programs.

Even if the State had established EMAA's contribution rate based solely on Head Start's claims history, that rate could not have exceeded the maximum rate of 7.8% authorized under State law. However, when EMAA subtracted its hypothetical tax for non-Head Start employees from EMAA's total tax bill, it created a tax rate by default for Head Start employees of "approximately 12.3%." EMAA Br. dated 9/24/01, at 2. Thus, under EMAA's methodology, the Head Start program is charged for the cost of the taxes at a rate that significantly exceeds the amount that EMAA as a whole could be assessed under State law.

To the extent the amount allocated to Head Start exceeds the amount of taxes paid by EMAA based on its Head Start payroll, it represents a cost not actually incurred by Head Start. EMAA's contention that the unemployment payments made by the State to Head Start employees were "actual costs of the Head Start Program" (EMAA Br. dated 9/24/01, at 3) confuses the State payments that benefitted the Head Start program with the cost that EMAA incurred to provide those benefits. The cost to be allocated is the cost of the unemployment insurance taxes, and it is simply unreasonable to allocate that cost to Head Start in an amount that exceeds that which it actually incurred.

Moreover, EMAA's methodology results in the inconsistent treatment of the cost of the taxes since the amount allocated to EMAA's non-Head Start programs is based on a rate authorized by State law and the amount charged to EMAA's Head Start program is based on an unauthorized rate exceeding the ceiling under State law. Thus, contrary to EMAA's contention, this methodology, and not ACF's, shifts costs to a program that did not incur them.

Conclusion

For the foregoing reasons, we conclude that EMAA did not allocate the cost of State unemployment insurance taxes to its Head Start program in accordance with the applicable cost principles, overcharging that program by $31,619 for the year ended September 30, 1997. Accordingly, we sustain the disallowance in that amount.

Marc R. Hillson

M. Terry Johnson

Donald F. Garrett
Presiding Board Member

1. Prior to a revision of OMB Circular A-122 on June 1, 1998, the same language appeared at � 6.f(2). We cite the earlier version of the Circular elsewhere in this decision.

2. EMAA cited language in OMB Circular A-122 that "[c]ertain conditions require special consideration and possible limitations in determining costs under Federal awards where amounts or types of compensation appear unreasonable." EMAA Br. dated 9/24/01, at 3, quoting OMB Circular A-122, Att. B, � 6.d. This does not appear to refer to circumstances affecting how costs should be allocated, however, but rather to circumstances that may limit or render unallowable personal services costs that might otherwise be allowable under the cost principles.

3. An employer's contribution rate is established on a calendar year basis; thus, it appears that EMAA had the same 7.8% rate in 1996 and 1997.

4. EMAA asserted that the audits since 1997 did not question the amount allocated by EMAA to the Head Start program for the cost of unemployment insurance taxes. However, ACF stated that it had not yet received those audits for resolution and that it would wait until the issue was resolved for 1997 before proceeding to address subsequent years. Tape recording of 10/10/01 telephone conference. The mere fact that EMAA's independent auditor failed to question the costs does not establish that the costs were allowable.

5. The parties agreed that for purposes of this case it is not necessary to understand how EMAA calculated the amount originally charged to Head Start. Tape recording of 10/10/01 telephone conference.