Indirect Cost Rates and Cost Allocation Plans for Nonprofits and Grant-Funded Programs

Most grant-funded organizations do not run into cost allocation as a theoretical question. It shows up when a second or third award arrives, an employee starts splitting time across programs, and the finance director has to decide how much of the rent, the accounting fee, and the executive director's salary belongs to each grant. This article explains the mechanics: what indirect costs are, how an indirect cost rate works, what a cost allocation plan contains, how shared payroll gets distributed, and how the federal de minimis rate fits in.

What Are Indirect Costs?

Indirect costs are expenses incurred for a common or joint purpose that benefit more than one program, grant, or function, and that cannot be readily assigned to a single one of them without an allocation method. Direct costs, by contrast, can be identified specifically with a particular program, award, or activity.

Expenses that are frequently treated as indirect include:

• Administrative and executive salaries and related fringe benefits
• Accounting, bookkeeping, payroll processing, and audit-support functions
• Occupancy — rent, utilities, maintenance, and building costs for shared space
• Technology — shared software licenses, IT support, phone and internet service
• General liability, property, and directors and officers insurance
• Human resources, general management, and board governance support
• General office supplies and equipment used across the organization

Whether a particular cost is direct or indirect is not fixed by the expense category. It depends on how the organization is structured, how it consistently treats similar costs, what the award documents say, and what guidance applies to the funding source. Under the federal cost principles, the same cost cannot be charged as both a direct and an indirect cost to a federal award, and an organization is expected to treat like costs consistently in like circumstances.

What Is an Indirect Cost Rate?

An indirect cost rate is a ratio that converts a pool of shared costs into a percentage that can be applied to program spending. Instead of deciding line by line how much of the electric bill belongs to each grant, the organization groups shared costs into a pool, picks a base that reasonably measures the benefit each program receives, and divides.

Indirect cost pool ÷ allocation base = indirect cost rate

An illustrative example

The following figures are hypothetical and are used only to show the arithmetic. They are not a benchmark, a recommended rate, or a suggestion that these amounts are typical.

• Indirect cost pool for the year: $180,000 (administration, accounting, occupancy, insurance, shared technology)
• Allocation base for the year: $1,200,000 of direct salaries, wages, and applicable fringe benefits
• $180,000 ÷ $1,200,000 = 15% indirect cost rate

If a program in that example incurred $200,000 of costs within the same base, applying the rate would assign $30,000 of indirect costs to it. Change the base — total direct costs, modified total direct costs, direct labor hours, full-time equivalents — and the resulting rate and the amount charged to each program change with it. There is no single base that is correct for every organization; the base should have a defensible relationship to how the shared costs are actually consumed, and federally negotiated rates are established with a cognizant agency rather than chosen unilaterally.

What Is a Cost Allocation Plan?

A cost allocation plan is the written document that explains how an organization assigns shared costs. Where an indirect cost rate produces one percentage, a cost allocation plan can describe several methods — different pools with different bases, and direct allocation of certain costs using a measurable driver such as square footage, headcount, or documented staff time.

Organizations commonly allocate shared costs across grants, individual programs, departments or cost centers, funding sources, and functional categories such as program services, management and general, and fundraising. A plan typically identifies each cost pool, the base used for it, the reason that base is reasonable, who performs the calculation, how often it is recalculated, and where the supporting data comes from.

Two qualities matter more than sophistication: the methodology should be reasonable in relation to the benefit received, and it should be applied consistently rather than adjusted award by award or month by month to fit remaining budget. Whether a specific plan or rate must be submitted for approval depends on the funder, the award terms, and any negotiated rate agreement in place.

Direct Costs vs. Indirect Costs

How Are Shared Payroll Costs Allocated Across Grants?

Payroll is where cost allocation usually becomes real. One case manager covers two grants. A program director splits time between a funded program and general management. A payroll clerk supports everything. The accounting question is how much of each person's compensation and fringe belongs to each grant, program, or function — and what records support that answer.

Common situations include an employee working across multiple federal or state awards, an employee splitting time between program delivery and administration, staff moving between restricted and unrestricted activities during the year, and short-term reassignment when a new award starts mid-period.

For federal awards, the cost principles require that charges for salaries and wages be based on records that accurately reflect the work performed, supported by the organization's system of internal control, and incorporated into its official records. Budget estimates alone are not a substitute for support reflecting actual activity. Requirements for state, local, and private funders vary, so award documents govern.

Practically, this means the payroll process and the general ledger need to carry the same allocation the activity records support: pay periods coded by program and funding source, fringe following the same distribution as the underlying wages, and a periodic reconciliation between what was charged and what those records show.

See how ESBS handles payroll processing and allocation →

What Is the De Minimis Indirect Cost Rate?

Under the federal Uniform Guidance at 2 CFR 200.414(f), recipients and subrecipients that do not have a current federally negotiated indirect cost rate — including a provisional rate — may elect to charge a de minimis rate of up to 15 percent of modified total direct costs. The 2024 revision to 2 CFR Part 200, which generally applies to federal awards issued on or after October 1, 2024, raised this ceiling from the prior 10 percent. The organization determines the appropriate rate up to that limit; it is a ceiling, not a mandated percentage.

• Who may use it: recipients and subrecipients without a current federal negotiated rate, including a provisional rate. Use is optional.
• What base it applies to: modified total direct costs (MTDC), which under 2 CFR 200.1 includes direct salaries and wages, applicable fringe benefits, materials and supplies, services, travel, and up to the first $50,000 of each subaward, and excludes items such as equipment, capital expenditures, rental costs, tuition remission, scholarships and fellowships, participant support costs, and the portion of any subaward above $50,000.
• Why organizations use it: it avoids the time and cost of negotiating a rate, does not require documentation to justify its use, and may be used indefinitely.
• Consistency condition: when the de minimis rate is applied, costs must be charged consistently as either direct or indirect and may not be double charged or inconsistently charged as both. Once elected, it applies to the organization's federal awards until it chooses to receive a negotiated rate.
• When a negotiated rate may be more relevant: organizations whose actual indirect cost structure exceeds the de minimis ceiling, or whose funders or programs expect a negotiated agreement, may recover more through a rate negotiated with their cognizant agency.

Two cautions. The de minimis rate does not apply to cost reimbursement contracts issued directly by the federal government under the FAR. And non-federal funders — state agencies, counties, foundations — set their own administrative cost policies, which may cap or define indirect costs differently. Award terms and any negotiated rate agreement control what an organization can actually charge.

Why Does Cost Allocation Matter?

Allocation is not only a compliance exercise. It determines whether management can read its own numbers. When shared costs are assigned inconsistently, several things tend to follow:

• Program profitability is distorted — programs carrying too little overhead look self-sustaining, and others look like losses.
• Similar costs get charged differently across grants, which is difficult to explain to a funder later.
• Reimbursement claims are delayed or reduced when the basis for a charge cannot be shown.
• Budget-to-actual reports move for reasons unrelated to program activity.
• Decisions about which programs to expand rest on numbers that do not reflect true cost.
• Questions from funders and auditors take significant staff time to answer after the fact.

What Should a Cost Allocation System Document?

• The cost pools — which specific accounts feed each pool of shared costs.
• The allocation base for each pool and the rationale for choosing it.
• The written methodology, including who prepares it and who approves it.
• Evidence of consistent application across programs and periods.
• Supporting calculations retained for each period, not just the current one.
• The program and cost center structure in the chart of accounts that the methodology relies on.
• Payroll distribution records tying compensation charges to the work performed.
• A periodic review — typically at least annually, or when programs, space, or staffing change materially.

Example: A Workforce Development Organization

This example is hypothetical and is used for illustration only.

Assume an organization operates four things at once: a federally funded skilled-trades training grant, a state apprenticeship program, an unrestricted community program funded by donations, and central administration. Instructors and participant supplies are clearly direct to the two funded programs. The apprenticeship coordinator splits time between the apprenticeship program and the training grant. The finance manager, the shared office, insurance, and the accounting platform serve all four.

The accounting system in that scenario needs to do three distinct things: record direct program expenses against the right award, distribute the coordinator's compensation based on records reflecting work actually performed, and apply a documented method — a rate or an allocation plan — so that the training grant, the apprenticeship program, and the unrestricted program each carry an appropriate share of the shared pool. Reporting then has to present that same information two ways: by funding source for the funders, and by program for the board.

Financial administration for workforce development programs →

What Should a Nonprofit Do Before Choosing an Allocation Method?

• Read the award documents and any pass-through agreement for indirect cost and administrative cost provisions.
• Identify funding restrictions and any funder-specific caps or definitions.
• Inventory expenses and separate those clearly direct from those genuinely shared.
• Establish cost centers and program tracking in the chart of accounts before the methodology is applied.
• Decide between the de minimis rate, a negotiated rate, or an allocation plan based on the organization's actual cost structure and funder mix.
• Document the methodology in writing and have it approved internally.
• Build payroll and accounting processes that produce the data the methodology depends on, rather than reconstructing it at report time.
• Confirm the reporting formats each funder expects and make sure the system can produce them.

These are practical planning considerations, not legal or audit guidance. Organizations with complex or high-value federal funding often work through them with their auditor, legal counsel, or cognizant agency as well.

When Cost Allocation Becomes an Accounting-System Problem

For most organizations the difficulty is not defining a cost allocation plan. It is operating one every month, across a growing number of awards and employees, without the bookkeeping falling behind. At that point the constraint is the accounting infrastructure: whether the chart of accounts supports program-level bookkeeping, whether grant activity can be tracked separately from inception to close, whether payroll actually posts allocated, whether budget-to-actual reporting can be produced per award, whether reimbursement claims can be documented from the ledger, and whether management reporting arrives soon enough to be useful.

Nonprofit Accounting & Grant Management →

Workforce Development Financial Support →

Managing Multiple Grants or Programs?

If your organization is managing increasingly complex grants, programs, payroll allocations, or financial reporting requirements, Evening Star can help evaluate and operate the accounting infrastructure behind them.

The information provided is for general educational purposes and should not be considered individualized tax, accounting, legal, or financial advice. Tax rules and reporting requirements depend upon individual circumstances. Please consult with an appropriate professional regarding your specific situation.