Developing an Indirect Cost Rate Proposal Under 2 CFR 200
Executive Overview
An indirect cost rate is the percentage (or dollar amount) that a non-Federal entity can add to direct costs when charging grants and federal awards. For a state or local government, a favorable indirect cost rate can mean recovering hundreds of thousands of dollars in costs that would otherwise be borne locally. For a nonprofit, it can determine financial viability.
Yet many organizations fail to develop and negotiate an indirect cost rate proposal (ICRP), instead using the de minimis 10% flat rate permitted under 2 CFR 200.414(a). This leaves millions on the table. For others, a poorly constructed ICRP triggers audit findings, Cognizant Agency rejection, or cost disallowances that effectively reduce grant revenue.
This guide walks through the entire ICRP process: the regulatory framework under 2 CFR 200, cost pool design and allocation methodologies, common cost categories and allowability determinations, calculation of indirect cost rates, documentation requirements, and the negotiation process with the Cognizant Agency for Indirect Costs.
By the end, finance professionals will understand how to build a defensible ICRP that maximizes cost recovery while maintaining compliance with federal regulations.
The Regulatory Framework: 2 CFR 200.414–200.419
What Is an Indirect Cost?
An indirect cost (also called overhead or administrative cost) is an expense that:
- Benefits more than one federal award or activity
- Cannot be directly charged to a single grant or project
- Must be allocated across multiple funding sources using a systematic methodology
Examples of Indirect Costs:
- Executive director / CEO salaries and benefits
- Finance and accounting staff
- Human resources and payroll
- Facilities costs (rent, utilities, maintenance for shared office space)
- Insurance (general liability, directors & officers)
- Legal and audit services
- Information technology and telecommunications
- Depreciation on shared assets (buildings, vehicles, equipment)
Examples of Direct Costs (Not Indirect):
- Project manager salary (if time tracked to specific grants)
- Equipment purchased for a particular project
- Supplies specifically purchased for a grant
- Subcontractor costs (typically charged directly)
- Travel for grant-specific meetings or training
The de Minimis 10% Rate: When It Applies
Under 2 CFR 200.414(f), any non-Federal entity that has never had a negotiated indirect cost rate can use a de minimis rate of 10% of Modified Total Direct Costs (MTDC), without obtaining a formal NICRA.
Eligibility:
- Entity has never received a negotiated indirect cost rate agreement
- Entity chooses not to develop a full cost allocation plan
- De minimis rate is a simplified alternative to a full rate proposal
Limitation:
- Once an entity negotiates a formal indirect cost rate, it must use that rate (cannot revert to de minimis)
- De minimis 10% applies to entities that cannot document their full costs; entities with documented costs should develop a formal rate
Example: A small nonprofit receives a $500,000 Department of Justice grant. Under de minimis:
- Direct costs: $500,000
- Indirect costs (10% of MTDC): $50,000
- Total federal award value: $550,000
However, if the organization's actual indirect cost rate is 25% (documented through a full cost allocation plan), the organization loses $75,000 in potential cost recovery by not developing a formal ICRP.
When Organizations Must Negotiate an Indirect Cost Rate
An organization must negotiate a formal indirect cost rate (Negotiated Indirect Cost Rate Agreement, NICRA) if:
- It received >$25 million in direct federal funding in the prior year, OR
- A federal agency requests that it develop a rate
Threshold Example:
- Year 1: Organization receives grants totaling $28M (exceeds $25M threshold)
- By Year 2: Must have negotiated a formal indirect cost rate
- Failure to do so results in questioned costs and compliance violations
Cost Allocation Methodologies
The core of an indirect cost rate proposal is the cost allocation methodology—the mechanism for systematically assigning shared costs to grants and operations.
Methodology 1: Modified Total Direct Costs (MTDC) Method
The MTDC method allocates indirect costs as a percentage of Modified Total Direct Costs. MTDC is defined as all direct costs except:
- Equipment (unit cost > $5,000, useful life > 1 year)
- Capital expenditures
- Charges for patient care services
- Rental costs of land and buildings (in healthcare)
- Tuition and related fees (in higher education)
MTDC Calculation Example:
A nonprofit receives a $1,000,000 federal grant with the following costs:
| Cost Category | Amount |
|---|---|
| Salaries and benefits | $600,000 |
| Contractual services | $150,000 |
| Supplies and materials | $75,000 |
| Travel (in-state) | $25,000 |
| Subtotal (Allowable MTDC) | $850,000 |
| Equipment ($6,000 unit cost) | $20,000 |
| Capital improvements | $105,000 |
| Total Direct Costs | $975,000 |
Modified Total Direct Costs = $850,000 (excludes equipment and capital)
If the organization's negotiated indirect cost rate is 35% of MTDC:
- Indirect costs = 35% × $850,000 = $297,500
Advantages:
- Simple to calculate and verify
- Aligns with how most organizations track costs
- Widely accepted by federal agencies
Disadvantages:
- May not perfectly reflect allocation of indirect costs
- Can result in same MTDC rate across widely different project types
Methodology 2: Direct Labor (or Direct Salary) Method
This method allocates indirect costs as a percentage of direct salaries and wages only.
Calculation Example:
| Cost Category | Amount |
|---|---|
| Direct salaries | $500,000 |
| Fringe benefits | $100,000 |
| Non-labor costs (supplies, travel) | $250,000 |
| Total Direct Costs | $850,000 |
Direct Salary Base = $500,000
If negotiated rate is 75% of direct salaries:
- Indirect costs = 75% × $500,000 = $375,000
Advantages:
- Simple and transparent
- Reflects actual labor-driven overhead
Disadvantages:
- May overcharge labor-intensive projects (high salary, low overhead)
- May undercharge capital/equipment-heavy projects
- Not recommended for organizations with mixed project types
Methodology 3: Total Direct Costs (TDC) Method
Allocates indirect costs as a percentage of all direct costs (including equipment and capital). This is the broadest base and typically results in the lowest rate percentage.
Calculation Example:
| Category | Amount |
|---|---|
| Direct costs (as above) | $850,000 |
| Equipment (included in TDC) | $20,000 |
| Capital | $105,000 |
| Total Direct Costs | $975,000 |
If negotiated rate is 30% of TDC:
- Indirect costs = 30% × $975,000 = $292,500
Advantages:
- Broad cost base results in lower rate percentage
- Captures full cost of service
- Appropriate for organizations with significant equipment/capital costs
Disadvantages:
- More complex to calculate (must track more cost categories)
- Lower rate percentage may not fully recover actual overhead
Choosing the Right Methodology
| Methodology | Best For | Examples |
|---|---|---|
| MTDC | Mixed project funding; typical nonprofits | Community service organizations, social services nonprofits |
| Direct Salary | Labor-intensive service providers | Legal aid, consulting, training organizations |
| TDC | Equipment/capital-intensive operations | Hospitals, research institutions, construction |
Best Practice: Compare all three methodologies during rate development. Use the methodology that most accurately reflects your cost structure and generates the most defensible rate.
Cost Pools and Allocation Bases
Designing Cost Pools
A cost pool is a grouping of indirect costs that are allocated together using a single allocation base.
Example Cost Pool Structure:
| Cost Pool | Costs Included | Allocation Base |
|---|---|---|
| Administrative | Executive director, finance, HR | MTDC (total direct costs) |
| Facilities | Rent, utilities, maintenance, depreciation | Square footage or headcount |
| IT/Communications | IT staff, software licenses, telecommunications | Headcount or MTDC |
| Audit/Compliance | External audit, internal controls, compliance monitoring | MTDC or number of awards |
Allocation Base Selection
The allocation base should reasonably reflect how the indirect cost is incurred.
| Cost Type | Recommended Allocation Base | Reason |
|---|---|---|
| Executive/management | MTDC or direct salary | Benefits all programs proportionally to size |
| Facilities (rent, utilities) | Square footage or headcount | Direct relationship to space/personnel |
| IT systems | Headcount or number of users | Usage drives cost |
| Audit costs | Number of awards or programs | Audit effort scales with complexity |
| Benefits/payroll processing | Direct salary or headcount | Cost proportional to number of employees |
| Depreciation on equipment | Direct usage or square footage | Asset use drives cost |
Example: Multi-Pool Allocation
A regional health department has:
- Administrative costs: $500,000 (executive director, CFO, HR)
- Facilities costs: $200,000 (rent, utilities, maintenance)
- IT costs: $150,000 (IT staff, software)
- Audit/compliance: $50,000
- Total Indirect Costs: $900,000
The organization's total modified direct costs are $3,000,000.
Step 1: Assign Costs to Pools
- Administrative Pool: $500,000
- Facilities Pool: $200,000
- IT Pool: $150,000
- Audit Pool: $50,000
Step 2: Choose Allocation Base for Each Pool
- Administrative: Allocate by MTDC (benefits all programs)
- Facilities: Allocate by square footage used by each program
- IT: Allocate by number of workstations used
- Audit: Allocate by number of grants managed
Step 3: Determine Rate for Each Pool
Assuming $3,000,000 MTDC across all programs:
- Administrative rate = $500,000 / $3,000,000 = 16.67% of MTDC
- Facilities rate = $200,000 / Square footage of facilities
- If 20,000 sq ft total, rate = $200,000 / 20,000 = $10/sq ft
- IT rate = $150,000 / 100 workstations = $1,500/workstation
- Audit rate = $50,000 / 25 grants = $2,000/grant
Step 4: Apply Rates to Individual Programs
For a program with:
MTDC of $400,000
Uses 2,000 sq ft
Has 8 workstations
Manages 3 grants
Administrative: $400,000 × 16.67% = $66,680
Facilities: 2,000 sq ft × $10/sq ft = $20,000
IT: 8 workstations × $1,500 = $12,000
Audit: 3 grants × $2,000 = $6,000
Total Indirect Costs for Program: $104,680
Combined Rate: $104,680 / $400,000 = 26.17% of MTDC
Unallowable Costs: 2 CFR 200.420–475
Federal regulations explicitly prohibit certain costs from being charged to federal awards. Any indirect costs attributable to these categories must be excluded from the cost allocation base.
Major Unallowable Cost Categories
| Category | Prohibition | Reference |
|---|---|---|
| Advertising | Except for recruitment or program-related advertising | 2 CFR 200.421 |
| Bad Debts | Losses due to noncollection of accounts | 2 CFR 200.424 |
| Contingencies | Set-asides for unknown future costs | 2 CFR 200.427 |
| Contributions | Donations made by the entity | 2 CFR 200.428 |
| Depreciation | On assets acquired with federal funds (with exceptions) | 2 CFR 200.436 |
| Entertainment | Costs of amusement, entertainment, recreation | 2 CFR 200.438 |
| Fines and Penalties | Costs of violations of law or regulation | 2 CFR 200.441 |
| Lobbying | Costs to influence legislation | 2 CFR 200.450 |
| Losses | Losses on asset disposition | 2 CFR 200.452 |
Specific Examples and Determinations
Example 1: Travel Meals
- Allowable: Conference meals for federal grant-related attendees, within federal per diem
- Unallowable: Meals at organizational retreats or celebrations
- Treatment in ICRP: Exclude entertainment/celebration meals from indirect cost base; include legitimate grant-related travel meals
Example 2: Depreciation on Facilities
- Allowable: Depreciation on buildings acquired with own funds (indirect cost)
- Unallowable: Depreciation on buildings wholly purchased with federal funds (entities should use rental rate instead)
- Treatment in ICRP: Calculate depreciation on non-federal buildings only; use federal rental rates for federal facilities
Example 3: Audit Costs
- Allowable: External audit costs related to federal compliance
- Unallowable: Special audits or litigation support unrelated to federal awards
- Treatment in ICRP: Include single audit costs in audit pool; exclude special/forensic audits
Example 4: Executive Compensation
- Allowable: Reasonable salary for CFO, controller, finance director (charged to indirect)
- Unallowable: Excessive compensation (amount determined by entity's own compensation policies, not excessive in practice)
- Treatment in ICRP: Document compensation policy; compare to peer organizations; charge reasonable portion to indirect
Developing the Indirect Cost Rate Proposal: Step-by-Step
Phase 1: Data Collection and Cost Identification (Weeks 1–4)
Step 1.1: Gather Financial Data
- Obtain audited financial statements for prior 2–3 years
- Obtain general ledger detail for the year being proposed
- Obtain grants accounting records (by program and grant)
Step 1.2: Classify Costs as Direct or Indirect For every cost in the general ledger, determine:
- Direct: Can it be specifically traced to a grant? (Yes = Direct)
- Indirect: Does it benefit multiple grants or operations? (Yes = Indirect)
| Cost | Classification | Reason |
|---|---|---|
| Salaries—Project Manager (time tracked to specific grant) | Direct | Traceable to specific grant |
| Salaries—Executive Director | Indirect | Benefits all programs |
| Rent—Shared office space | Indirect | Benefits all programs |
| Rent—Space dedicated to one program | Direct | Traceable to that program |
| Software license—Used by multiple programs | Indirect | Shared resource |
| Equipment—Purchased for specific project | Direct | Project-specific |
| General office supplies | Indirect | Shared |
| Travel—Conference (attendee from specific grant) | Direct | Grant-specific |
| Vehicle depreciation—Pool vehicle | Indirect | Shared |
Step 1.3: Compile Indirect Costs Create a schedule of all indirect costs by category:
| Cost Category | Amount | Notes |
|---|---|---|
| Personnel | ||
| Executive Director salary | $250,000 | Full-time; benefits all programs |
| Controller/CFO salary | $180,000 | Full-time finance; all programs |
| Accounting staff (2 FTE) | $160,000 | Processing, compliance |
| HR Director (0.5 FTE) | $45,000 | 50% shared |
| Facilities Manager | $70,000 | Shared facilities |
| Total Personnel | $705,000 | |
| Facilities | ||
| Rent—shared office space | $200,000 | 10,000 sq ft |
| Utilities—electric, water | $45,000 | All facilities |
| Maintenance—custodial, repairs | $30,000 | All facilities |
| Depreciation—leasehold improvements | $15,000 | Facility improvements |
| Insurance—building | $12,000 | All facilities |
| Total Facilities | $302,000 | |
| IT & Communications | ||
| IT Manager salary | $95,000 | All programs |
| IT Support staff | $65,000 | Help desk |
| Software licenses—shared | $40,000 | OS, office, etc. |
| Telecommunications | $28,000 | Phone, internet |
| Server depreciation | $22,000 | Shared servers |
| Total IT | $250,000 | |
| Audit & Compliance | ||
| External audit fees | $75,000 | Federal compliance |
| Internal controls / monitoring | $20,000 | Compliance function |
| Compliance staff (0.3 FTE) | $30,000 | Regulatory review |
| Total Audit | $125,000 | |
| Other General Expenses | ||
| General liability insurance | $18,000 | All operations |
| Professional development | $12,000 | Staff training |
| Dues & subscriptions | $8,000 | Professional memberships |
| Total Other | $38,000 | |
| TOTAL INDIRECT COSTS | $1,420,000 |
Phase 2: Define Cost Pools and Allocation Bases (Weeks 5–8)
Step 2.1: Create Cost Pools
For this organization, we'll use three pools:
| Pool | Costs Included | Amount |
|---|---|---|
| Administrative Pool | Executive, finance, HR, compliance, professional development | $655,000 |
| Facilities Pool | Rent, utilities, maintenance, depreciation, building insurance | $302,000 |
| IT Pool | IT staff, software, telecommunications, server depreciation | $250,000 |
| Audit Pool | External audit, internal controls | $95,000 |
(Alternative: Single pool = $1,420,000)
Step 2.2: Determine Allocation Base
For this exercise, we'll use MTDC as the allocation base (most common method).
| Pool | Allocation Base | Justification |
|---|---|---|
| Administrative | % of MTDC | Scales with program size |
| Facilities | Square footage OR % of MTDC | Actual sq ft more accurate, but MTDC acceptable |
| IT | % of MTDC or headcount | MTDC acceptable; headcount more precise |
| Audit | % of MTDC or # of grants | MTDC acceptable; # of grants more precise |
For simplicity, we'll use MTDC for all pools.
Phase 3: Calculate Direct Costs and MTDC (Weeks 9–12)
Step 3.1: Identify Total Direct Costs
From accounting records, total direct costs charged to grants:
| Program | Direct Costs |
|---|---|
| Workforce Development (DOL grant) | $1,200,000 |
| Youth Services (HHS grant) | $800,000 |
| Community Health (CDC grant) | $950,000 |
| Total Direct Costs | $2,950,000 |
Step 3.2: Remove Disallowable Items to Calculate MTDC
From the $2,950,000 direct costs:
- Equipment purchases (unit cost > $5,000): $120,000
- Capital improvements: $60,000
- Modified Total Direct Costs (MTDC) = $2,950,000 - $120,000 - $60,000 = $2,770,000
Phase 4: Calculate Indirect Cost Rates (Weeks 13–16)
Step 4.1: Single-Pool Approach (Simplest)
Total Indirect Cost Rate = Total Indirect Costs / MTDC = $1,420,000 / $2,770,000 = 51.3% of MTDC
Interpretation: For every dollar of modified direct costs charged to a grant, the organization can claim $0.513 in indirect costs.
Step 4.2: Multi-Pool Approach (More Precise)
| Pool | Indirect Costs | MTDC | Rate |
|---|---|---|---|
| Administrative | $655,000 | $2,770,000 | 23.6% |
| Facilities | $302,000 | $2,770,000 | 10.9% |
| IT | $250,000 | $2,770,000 | 9.0% |
| Audit | $95,000 | $2,770,000 | 3.4% |
| TOTAL | $1,420,000 | $2,770,000 | 47.0% |
(Note: The multi-pool rate is slightly lower because audit costs don't scale with MTDC; a per-grant or activity-based audit allocation might be more accurate.)
Phase 5: Documentation and ICRP Preparation (Weeks 17–20)
The ICRP must include:
Cost Allocation Plan or Cost Accounting Standards (CAS) Statement
- Narrative description of how indirect costs are identified and allocated
- Cost pools and allocation bases
- Treatment of special cost categories
- Period covered (typically fiscal year)
Detailed Cost Schedules
- Schedule of indirect costs by category and pool
- Schedule of direct costs by program
- Calculations of MTDC
- Supporting documentation (general ledger, cost allocation spreadsheets)
Reconciliation to Financial Statements
- Total indirect costs per ICRP must reconcile to audited financial statements
- Explanation of any differences
Compensation Analysis (if applicable)
- Comparison of executive and key personnel compensation to peer organizations
- Document that compensation is reasonable
Unallowable Cost Identification
- List of any unallowable costs excluded from the cost base
- Explanation of why they're excluded
Proposed Rates
- Clear statement of proposed rate(s)
- Effective date
- Requested period (typically one fiscal year, renewable)
Phase 6: Submission to Cognizant Agency (Weeks 21–24)
Step 6.1: Identify Cognizant Agency
The Cognizant Agency for Indirect Costs is designated based on:
- Which federal agency provides the most direct funding to the organization
- If tied, the agency with the most involvement in compliance
Examples:
- Organization funded primarily by HHS grants → HHS is Cognizant Agency
- Organization funded primarily by DOL grants → DOL is Cognizant Agency
Step 6.2: Identify Cognizant Agency Contact
Call or email the Cognizant Agency's indirect cost rate section (usually within the office of Inspector General or Finance Division). Provide:
- Organization name and EIN
- Funding history (major grants by agency)
- Request for guidance on ICRP submission
Step 6.3: Submit ICRP Package
Typically submitted to:
- Cognizant Agency audit/compliance office
- May also be submitted to federal funding agencies (listed in grant awards)
Package Contents:
- Cover letter (request for rate negotiation)
- Cost Allocation Plan narrative
- Detailed cost schedules and calculations
- Audited financial statements (most recent 2–3 years)
- General ledger (for proposed year)
- Any explanatory documentation (program descriptions, staffing plans)
Timeline:
- Submission to Cognizant Agency: 30–60 days before end of fiscal year (or as designated)
- Cognizant Agency review: 30–180 days (varies by agency and complexity)
- Provisional rate issued: Pending final review
- Final rate issued: After audit clearance
Negotiating with the Cognizant Agency
Common Cognizant Agency Requests and Challenges
Challenge 1: Cost Classification Disagreement
Cognizant Agency reviewer questions whether certain costs should be classified as direct or indirect.
Example: Organization charges executive director salary as 30% indirect (benefits all programs) and 70% shared direct (allocated to specific programs).
Reviewer may challenge: "If 70% is specifically attributable to program X, it should be direct, not allocated."
Resolution:
- Provide time and effort documentation showing how executive director's time is split
- Demonstrate that 30% qualifies as administrative overhead (board meetings, strategic planning, general management)
- Adjust allocation if not supported by time records
Challenge 2: Unallowable Costs Included
Reviewer identifies costs in the indirect pool that should be excluded under 2 CFR 200.420–475.
Example: Organization included $25,000 for executive director travel to non-programmatic conferences.
Resolution:
- Remove conference travel from indirect pool
- Revised pool = $1,420,000 - $25,000 = $1,395,000
- Revised rate = 50.4% (instead of 51.3%)
Challenge 3: Rate Reasonableness Challenge
Reviewer questions whether the proposed rate is reasonable compared to peer organizations or similar sectors.
Example: For nonprofits in the state, average indirect cost rate is 35%; this organization proposes 51%.
Resolution:
- Provide benchmarking data from similar organizations (peer survey, AICPA data, state nonprofit association data)
- Explain legitimate reasons for higher rate (e.g., higher personnel costs in geographic area, specialized compliance requirements)
- Offer compromise rate if rate is unreasonably high
- Document detailed cost justification for each major cost category
Dispute Resolution
If the Cognizant Agency proposes an indirect cost rate significantly lower than your proposal, you have the right to:
- Request Technical Review: Ask for detailed written explanation of each disallowed cost
- Provide Rebuttal: Submit written response with additional documentation
- Escalate: Request review by Cognizant Agency supervisor or cognizant regional office
- Appeal: In rare cases, request agency head review or involvement of OMB Memoranda contacts
Best Practice: Maintain professional, collaborative relationship with Cognizant Agency reviewer. Most disputes are resolved through clear documentation and professional communication.
Implementation: Using the Negotiated Rate
Once NICRA Is In Place
Apply Rate to All Federal Awards
- Every grant charged must include indirect costs at the negotiated rate
- Cannot selectively apply rate to some grants and not others
Update Budget Forms
- When submitting new grant applications, budget indirect costs at negotiated rate
- Include NICRA in application as evidence of federally-approved rate
Annual Certification
- At fiscal year-end, certify actual costs incurred
- If actual indirect costs differ from projections, reconciliation may be needed
- Cognizant Agency may request true-up payment
Document Everything
- Maintain cost allocation documentation for audit purposes
- Retain for 3 years post-closeout per 2 CFR 200.334
Sample ICRP Calculation in Practice
Grant Application (Fiscal Year 2026):
A nonprofit is applying for a $500,000 federal grant. With NICRA of 47% of MTDC:
| Cost Category | Amount |
|---|---|
| Direct Costs | |
| Project Manager salary | $120,000 |
| Program staff (2 FTE) | $180,000 |
| Contractual services | $80,000 |
| Supplies & materials | $45,000 |
| Travel (grant-related) | $25,000 |
| Total Direct (MTDC) | $450,000 |
| Equipment (>$5K) | $30,000 |
| Total Direct Costs | $480,000 |
| Indirect costs (47% × $450,000) | $211,500 |
| TOTAL PROJECT COST | $691,500 |
In the grant application, the nonprofit budgets $691,500 and references the NICRA as the basis for the indirect cost calculation. The grantor reviews and approves this budget.
Upon completion, the organization is reimbursed up to $691,500 (if all costs are actually incurred and allowable).
Conclusion
An indirect cost rate proposal is a technical but essential component of federal grant management. Organizations that invest in developing and negotiating a formal NICRA significantly increase cost recovery and financial sustainability.
The key steps are:
- Identify all indirect costs (shared across programs)
- Choose appropriate allocation methodology (MTDC most common)
- Design cost pools that reflect how overhead is incurred
- Calculate rates supported by documentation
- Submit to Cognizant Agency with detailed supporting schedules
- Negotiate professionally and be willing to provide additional documentation
- Implement and maintain documentation for audit purposes
An organization with $5 million in federal funding and a 35% indirect cost rate recovers $1.75 million in overhead costs annually—money that would otherwise come from reserves or local funding. This is the financial stakes of getting your ICRP right.
This article was prepared with AI-assisted research by DWU Consulting. It is provided for informational purposes only and does not constitute legal, financial, or investment advice. All data should be independently verified before use in any official capacity.