Government Contractor Compensation Cap for Calendar Year (CY) 2026

For the last few years, our friends at the Defense Contract Audit Agency (DCAA) have been very helpful by publishing the Contractor Compensation Cap in the December timeframe. This year, I am guessing that the Government shutdown has diverted their attention. To help our clients, we have calculated the 2026 amount of the cap.

Per Section 702 of the Bipartisan Budget Act of 2013 (BBA; Pub. L. 113-67), dated December 26, 2013, the compensation costs of contractor and subcontractor employees for a fiscal year is limited to an amount set by Congress which is “adjusted annually to reflect the change in the Employment Cost Index for all workers, as calculated by the Bureau of Labor Statistics” with narrowly targeted exceptions.

Calculation

The Current Calendar Year Cap Amount equals the Prior Calendar Year Cap Amount times the Change in Employment Cost Index for all workers from the Bureau of Labor Statistics [BLS Table 4. Compensation (Not Seasonally Adjusted) Employment Cost Index for total compensation, for civilian workers, by occupational group and industry. (Twelve Months Ended September 30)].

CY 2025 Cap = $671,000

BLS Index for All Workers – September 2024 = 167.0

BLS Index for All Workers – September 2025 = 172.905

CY 2026 Cap = $695,000 ($671,000 x (172.905/167.0), rounded to the nearest thousand)

Yearly Compensation Caps

Who the Compensation Cap Applies To

It is important to remember that the compensation cap does not limit what a company can pay its employees. Instead, it limits how much of that compensation can be recovered on government contracts.

The cap applies to compensation costs for both contractor and subcontractor employees, including executives and other highly compensated individuals, when those costs are charged to covered government contracts. This includes cost reimbursement contracts, time and materials contracts, and certain fixed price contracts that incorporate cost principles. In limited circumstances, an agency head may approve narrowly targeted exceptions for scientists, engineers, or other specialists when it is determined that higher compensation is necessary to maintain access to critical skills. These exceptions are evaluated based on the level of taxpayer funded compensation involved and the duties performed by the employee.

Because the cap affects allowability rather than payroll, its impact shows up in areas such as billing, indirect rates, and incurred cost submissions, rather than in how compensation is set or paid.

What Counts as Compensation Under the Cap

When thinking about the compensation cap, many contractors focus only on base salary. In reality, the government looks at total compensation, which includes several elements beyond wages.

Compensation subject to the cap generally includes:

• Salary and wages
• Bonuses and incentive pay
• Deferred compensation arrangements
• Certain fringe benefits tied to compensation plans

Items such as executive bonuses, long term incentives, and deferred compensation are often where questions arise. These areas tend to receive closer attention during audits, especially when policies are unclear or treatment is inconsistent.

It is also important to remember that staying under the compensation cap does not automatically make a cost allowable. Compensation must still meet the Federal Acquisition Regulation standards for reasonableness. Even when pay falls below the cap, auditors will look at whether the amount is appropriate based on the employee’s role, experience, market conditions, and the work being performed. The cap limits the maximum amount that may be recovered, but it does not replace the requirement to support compensation as reasonable.

Taking time to clearly define what your organization considers compensation and how it is tracked can help avoid unnecessary issues later.

What to Do When Compensation Exceeds the Cap

If an employee’s compensation exceeds the annual cap, the excess amount does not disappear. It simply becomes unallowable for government contract purposes.

From a government contractor’s perspective, this means making sure that:

• Amounts above the cap are identified and tracked separately
• Unallowable compensation is excluded from indirect cost pools and rates
• The treatment of capped compensation is clearly reflected in incurred cost submissions

When this is not handled consistently, it can lead to questioned costs, rate adjustments, and additional audit follow-up. Aligning payroll, accounting, and billing practices around the cap helps keep these issues from becoming larger problems later.

Why the Cap Matters for Proposals and Budgeting

The compensation cap is not just a year-end accounting issue. It also affects how government contractors think about pricing, budgeting, and long-term compensation planning.

The cap should be considered when:

• Developing forward pricing rates
• Preparing cost proposals that include executive or highly compensated positions
• Designing compensation and incentive programs
• Planning for the recruitment and retention of key leaders

When the cap is ignored during the proposal stage, government contractors can find themselves absorbing costs they expected to recover. Building the cap into pricing and planning discussions helps align business decisions with how costs will ultimately be treated under government contracts.

Support for Compensation Compliance and Audit Readiness

Redstone GCI works with government contractors to help them understand federal compensation requirements and apply those rules in a compliant and consistent way across their organizations. Our team supports clients with compensation system assessments, policy and procedure development, audit preparation, indirect rate support, and guidance on how compensation costs should be recorded and reported for government contract purposes. By supporting government contractors in these areas, Redstone GCI helps strengthen internal controls, improve documentation practices, and maintain alignment between payroll, accounting, and contract compliance requirements so organizations are better prepared for audits and long-term contract performance.