Construction is a highly competitive industry in the private sector. But when it comes to public projects, winning a job can be even more cutthroat. That’s because government jobs are often subject to prevailing wage laws, such as the federal Davis-Bacon Act or the “little Davis-Bacon acts” that have been adopted in many states.
Government contracts generally go to the lowest bidder. But, in an effort to level the playing field, prevailing wage laws require contractors to pay wages that are comparable to those for similar work in the same geographical area and to meet certain other requirements. The rules are complex, and it’s important for contractors to understand how they affect labor costs.
One area that deserves close attention is fringe benefits. Prevailing wage rates — which are established by the U.S. Department of Labor or relevant state agency — contain both a basic hourly rate (paid in cash) and a fringe benefit component. Savvy contractors can leverage fringe benefits to reduce their costs and make their bids more competitive.
Comparing cash with benefits
Government contractors generally 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.
Why? It’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 the state, these expenses can increase a contractor’s 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
- Vacation days, sick days or other paid time off.
Contributions to employee benefit plans avoid the payroll liabilities listed above, significantly reducing a contractor’s labor bid costs.
Crunching the numbers
Suppose, for example, that a particular worker is entitled to a prevailing wage of $50 per hour, which includes a $35 base wage and a $15 fringe benefit. If the contractor pays the entire $50 in cash (and assuming the payroll burden in the relevant state is 25%), its labor cost is $62.50 per hour [$50 + (0.25 × $50)].
On the other hand, if the contractor pays the fringe benefit component by funding one or more employee benefits, its labor cost is only $58.75 per hour [$50 + (0.25 × $35)]. Multiply the savings by hundreds of employees working 40 hours a week for several years, and the contractor’s bid costs are reduced by hundreds of thousands of dollars.
Contractors can even use existing benefit plans to meet their fringe benefit obligations. Let’s say, in the above example, that the contractor sponsors a group health plan and the contractor’s premium contribution is $500 per month, or $6,000 per year. Assuming the employee 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 example, the health plan covers only a portion of the contractor’s 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.
Designing a program
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, such as those listed above. It’s not available for use of company vehicles, tools, cell phones, travel expenses or benefits a contractor is legally required to provide. (Note, however, that health benefits are considered bona fide even if they’re mandated under the Affordable Care Act.)
Contrary to popular belief, contractors can even 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.
Getting the right help
Penalties for prevailing wage violations can be harsh. If you work on government projects — or plan to do so — work with your advisors to ensure that you understand the requirements, make the most of fringe benefits and prepare accurate bids.
In addition, be sure to keep timely, accurate records to establish your compliance. If you’re a general contractor or upper-tier subcontractor, you’re responsible for prevailing wage violations by lower-tier subcontractors, so it’s critical to document their compliance as well.
Ignore prevailing wage laws at your own peril
If you fail to comply with prevailing wage laws, the consequences can be severe. For example, penalties for Davis-Bacon Act violations may include:
- 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.
Contractors or subcontractors that falsify payroll records or solicit kickbacks of wages are subject to civil and criminal prosecution.