Cash Fringe Benefits  -- Pros and Cons Under Prevailing Wage Laws

I think everything has its own pros and cons.

—Anushka Sharma

 

A client recently called me  with a question which bears on the pros and cons of government contractors paying cash in lieu of fringe benefits rather than incurring the cost and hassles of administrating a fringe benefit plan with all the Employer Retirement Income Security Act(“ERISA”)  burdensome rules. Indeed, over the years,  Government contractors have frequently asked whether it is better to pay fringe benefits in cash or to contribute those amounts to bona fide benefit plans. And most contractors do both, since there are usually workers who opt out of the health plans due to existing insurance of their own or spouse, and other workers who refuse to participate in matching 401K plans. Both approaches are permissible under the Service Contract Act (“SCA”) and Davis-Bacon Act (“DBA”), but each carries distinct financial and administrative consequences.

This blog breaks down the real costs, compliance requirements, and strategic considerations so you can make an informed business decision.

A.     Three Options for Meeting Fringe Obligations

Under prevailing wage laws, contractors must provide a base hourly wage plus a mandatory fringe benefit rate. You can satisfy the fringe requirement in one of two ways:

1. Pay the Fringe Amount as Cash

This is the simplest administratively, but also usually the most expensive. If you pay in cash you must pay it each pay period. And the cash is taxable income to the workers. Because cash in lieu of benefits is treated as wages, it triggers all payroll-related taxes and premiums, including:

  • Federal and state income tax withholding

  • FICA (Social Security and Medicare)

  • FUTA and SUTA

  • Workers’ compensation premiums

  • Unemployment insurance

For the employer, this means a fringe rate of $5.55/hour costs more than $5.55/hour once taxes and premiums are added. FICA

2. Contribute the Fringe Amount to a Bona Fide Benefit Plan

This is the default program for most mid and large sized employers. The kinds of benefit plans include health insurance, retirement plans, disability, extra paid leave, childcare, or other bona fide fringe benefits. Since the Initiation of tax penalties during the early Obama Care era, most sizable Government contractors moved to put in place bona fide fringe benefit plans., so this is the de facto default option for most contractors.

And of all the variability in cost  of many bona fide benefits, the use of 401K retirement plans with “pour over” contribution features offer the most flexibility to prevailing wage covered employers. And any underpayments, after audit, are paid into the 401K plan. They thus use the 401K contribution to satisfy their prevailing fringe benefit requirements. Of course, to do so requires the employer to make an employer contribution to the 401K plan. If the plan is a so-called “matching” benefit plan and the employee chooses not to participate, then the employer contributes no monies to the plan and gets no credit towards satisfying the SCA or DBA fringe benefit requirements. As a result, most prevailing wage covered employers make mandatory payments into the plan regardless of the employees own contributions. And any annual benefits payable into a fringe benefit plan, like into the 401K plan, while permissible, are still problematic. Under the DOL rules,  the fringe benefit is supposed to be  furnished periodically, like every month, and not less often than quarterly. So the annual contribution only counts towards compliance in the quarter year at most in which the benefit is furnished.

Key advantages of in-kind benefit plans:

  • Employer contributions are not subject to payroll taxes, typically saving around 15%.

  • Contributions can be made monthly or quarterly (depending on the plan), offering administrative flexibility.

  • Employees receive tax-deferred benefits, paying taxes only when funds are withdrawn, usually many years later.

3. Go Double Breasted and Offer Both Cash and Fringe Benefit Plans

As a practical reality, most employers are forced to pay some cash fringes even if they have bona fide plans in place. Not every employee is always eligible to participate in the plans. New employees may have short periods of time at the start of the employment where they are ineligible. Other workers may refuse to make co-payments for insurance premiums say for health plans, because they have existing coverage (like Tricare for former military employees or the FEHB for US Government retirees) or because they are covered under spousal insurance policies. Other workers  need cash now and refuse to make matching contributions into 401K plans. And still other workers just want the money and not the benefits, which they may perceive to be of little value to their individual situation. And of course, there may be temporary or part-time workers who are ineligible for the fringe benefit plan contributions.

Accordingly, hybrid plans are fairly common where some workers get all or some part of their benefits in cash, while other workers are covered by a bona fide plan.

B. Overtime Rules: Cash vs. Benefits

Some recent judicial decisions have sought  to add cash fringe benefits to the employees’ regular rate of pay and use them to boost up the amount of overtime pay due. See Must Cash Payments in Lieu of SCA Mandated Fringe Benefits be included in FLSA Overtime Rates? — Abrahams Wolf-Rodda, LLC . The rationale is the Fair Labor Standards Act (“FLSA”) statute strictly defines what payment can be excludes from the regular rate of pay overtime calculation. That statute excludes monies paid into bona fide fringe benefit plans but has no explicit exclusion for cash in lieu thereof. DOL has formal notice and comment rulemaking to exclude the cash from the regular rate, but the courts have said that rule is contrary to the statute and only Congress can fix the problem. The DOL SCA and DBA regulations provide that the cash fringe may be excluded from the regular rate of pay, but some courts have reasoned that regulation was in excess of the Department of Labor’s (“DOL”) authority, so they claim the DOL rules improperly expand the statutory exception.

Thus, although some courts have suggested that cash fringes may increase the regular rate, DOL guidance maintains that fringe cash is excluded from overtime calculations where paid in lieu of a prevailing benefit requirement, so don’t expect DOL to make these kinds of overtime claims. They should only arise in in the context of FLSA private disputes.

C. Timing Requirements for Cash Payments

Under SCA regulations (29 CFR 4.175) cash payments in lieu of fringe benefits must be paid in the same pay period in which the fringes were earned and accrued. Employers cannot

  • Accumulate and hold  the cash fringe payment; or

  • Pay it monthly or quarterly; or

  • Delay payment for administrative convenience.

On the other hand, benefit plan contributions (unlike cash fringes) can be made periodically, and can be trued up for compliance purposes often monthly or even on a quarterly periodic basis.

D. Certified Payroll Reporting Requirements

The SCA has no certified payroll requirement so there are no reporting requirements for SCA cash or other fringe benefits. Employers just must maintain records and make them available to DOL if and when requested. If you just pay additional monies to the workers, however, under the SCA that is just added wages, and it does not satisfy the SCA fringe benefit requirements. The SCA requires that wages and fringe benefits be separately identified and  made payable and not simply commingled in a lump sum cash payment. So, if you are paying cash fringes, you need to tell your workers and make some kind of notation on your payroll records to show that the cash was in lieu of the SCA fringe benefit requirements. For example, put a notation on the payroll stub like “Cash FBs”, “Cash FBs in lieu of H&W”  or “Cash H&W”.

For DBA projects, however, pursuant to the Copeland Act requirements, weekly certified payroll  (e.g., WH‑347) must clearly show:

  • The base hourly wage; and

  • The fringe amount including any cash payments; and

  • Whether fringes are paid in cash or through bona fide benefit plans.

Indeed, DOL recently expanded the payroll reporting form to require the employer to furnish more information about its fringe benefit compliance. See The Last Goodbye “Gift” from the Biden DOL to Davis-Bacon Covered Construction Contractors — Abrahams Wolf-Rodda, LLC. Misreporting of the fringe allocations is a common DOL finding.

E. The Bottom Line

Paying cash in lieu of fringe benefits may feel simpler, but it:

  • Increases payroll tax liability;

  • May raise workers’ compensation and unemployment insurance premiums;

  • Offers no tax advantage to the employer and in fact penalizes the employer;

  • Requires periodic payroll administration and reporting; and

  • May complicate  the computation of overtime premium pay and boost up the sums due.

By contrast, provision of  bona fide benefit plans:

  • Will reduce employer tax burden;

  • Provide predictable cost control;

  • Provide tax free or deferred benefits to workers; and

  • Help with recruitment since  they offer employees long-term financial advantages in retirement accounts or other benefit plans

For many contractors, benefit plans are the more cost‑effective, employee friendly, and compliant solution. But the ultimate decision is a business judgment, and there are circumstances where it is easier to pay the cash fringes.

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Note: This blog was written with assistance from Google AI.

By Daniel Abrahams, Davis-Bacon Act, Government Contracts, Service Contract Act, Wage & HourDaniel Abrahams