FAR 31.205-6(a)(6)(ii) states compensation to owners must be reasonable for the personal services rendered, and not be a distribution of profits.  Therefore, it appears that distribution of profits is not an allowable contract cost.

However, payments made to owners are Not Automatically Unallowable if the payments are a distribution of profits on the accounting records of the enterprise.  How is that for confusion! 

The DCAA understands that some smaller firms, including sole owners and partnerships, regularly compensate owners through distribution of profits.  The DCAM 6-414.4(e.) directs the auditors that these amounts (distribution of profits) should be questioned Only if the total compensation paid (including the distribution of profits) to an individual exceeds an amount reasonable for the services performed.

For closely held corporations, compensation, including bonuses, will not be recognized in excess of the costs that are deductible as compensation under the IRC 26 U.S.C. and regulations under it.   Two issues appear important here:

  1. Is the total compensation recognized under the Internal Revenue Code?
  2. Is the total compensation reasonable for personal services rendered?

If I show a distribution of profits in my accounting records to owner(s), and it is considered compensation by the IRC, and it is reasonable, then I interpret the guidance as indicating I can include the compensation (distribution of profit) as an Allowable Cost when charging to contracts (either Direct or Indirect).
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Remember to have support as to the reasonableness of your claimed total compensation (including any distribution of profit).  What's reasonable?  In general, reasonable compensation under the IRC and regulations is the amount that would be paid for Like Services by Like Enterprises under Like Circumstances. 

It appears that in smaller firms that are LLC or Partnership, where all profits may be distributed, there must be a determination of how much of the distribution is considered reasonable compensation for personal services rendered.  In most cases, during the initial years of smaller firms, distribution of profits is much less than the reasonableness indicator.  This reasonable amount determined could be included in your costs and indirect rate calculations.

I recommend that owners, partners, etc., maintain good timekeeping records that will support the level of effort for the firm.

Any feedback, input, or comments are welcomed and appreciated from those members who have experienced this issue.