What Counts as an Indirect Cost?
Indirect costs, often called overhead, are the necessary expenses of running your business that support your SBIR project but aren’t tied to any specific task. They include everything that keeps your operations running—without being directly billable to the project.
Typical indirect costs include:
- Rent and utilities for your office or lab
- Administrative staff salaries
- General office supplies
- IT services and infrastructure
- Insurance and legal fees
- Depreciation of shared equipment
These costs are essential to your project, even if they aren’t tied to a specific experiment or engineering task. For example, your software engineer may be working full-time on your SBIR project (a direct cost), but the HR manager who handles their payroll is considered part of overhead (an indirect cost).
It’s equally important to understand what does not count. Expenses like marketing, lobbying, entertainment, or anything not aligned with federal cost principles are typically unallowable as indirect costs and must be excluded when calculating your rate.
Three Ways to Account for Indirect Costs
How you account for indirect costs in your SBIR budget depends on your business’s structure and history with federal funding. There are three accepted methods—each with its own rules and best-fit scenarios.
1. Use a Negotiated Indirect Cost Rate (NICRA)
If you’ve already secured a NICRA with a federal agency, this is your default method. The NICRA specifies an approved percentage that you can apply to eligible direct costs, such as direct labor or modified total direct costs (MTDC), depending on your agreement.
For example, if your NICRA allows 50% on direct labor and you plan $100,000 in direct labor costs, you can include $50,000 as indirect costs.
NICRA rates are agency-approved and typically reflect the actual costs of operating your business, which can make them the most precise—but also the most administratively complex—option.
2. Apply the De Minimis Rate
If you don’t have a NICRA, many agencies allow you to use a simplified “de minimis” rate. This is currently set at 15% of MTDC for most SBIR agencies, including NIH and NSF. MTDC includes direct labor, materials, travel, and the first $50,000 of subcontractor costs, but excludes equipment and capital expenses.
This method is easy to apply and requires no formal negotiation—making it a good option for first-time applicants or small teams without significant indirect overhead.
3. Propose a Custom Rate with Justification
Some businesses find that the de minimis rate is too low to cover actual operational overhead. In that case, you can propose your own indirect rate, often in the range of 20–40%, as long as you justify it with financial records.
To support a custom rate, you’ll need to submit a detailed breakdown of your indirect expenses and demonstrate how they support your SBIR work. Agencies like NOAA and NIST may allow proposed rates up to 40% without prior negotiation.
How to Calculate Your Indirect Rate
Whether you’re applying a NICRA, the de minimis rate, or proposing a custom rate, it helps to understand how indirect rates are actually calculated. Here’s a step-by-step guide to doing it correctly—and defensibly—for your SBIR proposal.
Step 1: List All Business Expenses
Start by listing all your annual business costs. This includes everything from salaries and software licenses to rent and professional services. Suppose your total costs for the year are $473,000.
Step 2: Categorize Each Expense
Next, divide these costs into three buckets:
- Direct costs: Costs tied directly to the SBIR project (e.g., lab supplies, project-specific labor)
- Indirect costs: General operating expenses that support the project (e.g., rent, admin staff)
- Unallowable costs: Expenses not permitted by federal cost principles (e.g., advertising, entertainment)
For example:
- Direct costs = $234,000
- Indirect costs = $228,000
- Unallowable = $11,000 (excluded from the calculation)
Step 3: Calculate the Rate
There are two common ways to express your indirect cost rate:
- Single-tier rate: Total indirect costs ÷ total direct costs
Example: $228,000 ÷ $234,000 = 97.4% - Labor-based rate: Total indirect costs ÷ total direct labor
Useful if your NICRA or proposal uses labor as the base.
Regardless of which method you use, your rate should reflect your actual operational structure and be supported by clear, well-organized documentation.
Agency-Specific Guidelines and Tips
While the overarching rules for indirect costs are similar across SBIR agencies, each agency may have unique guidelines, thresholds, or expectations. Understanding these differences is critical for compliance—and for maximizing your allowable budget.
Know the Variations
- NIH and NSF: These agencies use a 15% de minimis rate, not 10% as some older documents might suggest. If you’re not using a NICRA, this is your default.
- USDA and others: Some agencies still operate under the older 10% de minimis rule or may evaluate custom rates more conservatively.
- NIST and NOAA: These agencies may allow indirect cost rates up to 40% of total direct costs in Phase I without requiring prior negotiation—a major benefit for smaller firms with legitimate overhead needs.
Watch for Profit Caps
Some agencies cap total profit (including indirect costs and fee) at 7–10% of the total award. That means a high indirect cost rate could limit your room for other financial components if you’re not careful.
Always Review the Solicitation
Each agency—and sometimes each solicitation—may include specific instructions about what indirect cost rates are acceptable, how they must be calculated, and whether additional forms or justifications are needed.
Conclusion
Indirect costs are a necessary part of running your SBIR project—and budgeting for them properly ensures your business is both compliant and sustainable. Depending on your situation, you can:
- Apply a negotiated indirect cost rate if you have one
- Use a 15% de minimis rate if you’re just getting started
- Propose a custom rate with a clear justification if your overhead needs are more complex
Whichever route you choose, be sure to separate your expenses accurately, follow agency-specific guidelines, and provide detailed support for your calculations. This attention to detail not only strengthens your proposal but also lays the groundwork for efficient, transparent project execution.