Annualization is one of the most commonly misunderstood concepts in the Davis Bacon Act (DBA), Service Contract Act (SCA) and state laws. However, knowledge about how annualization works, and how it affects contractors’ financial obligations for bona fide benefit plans, is critical for all businesses engaged in public work.
As stated in the U.S. Department of Labor Prevailing Wage Resource book, “Annualization is a computational method used to determine the hourly rate of benefit plan contributions that are creditable towards a contractors’ prevailing wage fringe benefit obligation on covered projects.”
Because the fringe benefit portion of the prevailing wage is expressed as an hourly amount, the first step in calculating fringe benefit credit under annualization is to translate benefit costs from an annual to an hourly rate. This step is somewhat complicated for merit shop contractors because benefits are seldom purchased at an hourly rate. However, calculating benefit costs on an hourly basis mirrors how union contractors configure benefits, and since the DBA, SCA and state laws are designed to level the playing field for union and merit shop contractors, hourly calculations permit easy analysis and are favored by regulators.
To compute the contractor’s allowable hourly credit towards meeting the prevailing wage obligation for covered workers on a prevailing wage project, the total annual cost of the fringe benefits must be divided by the total number of hours individual employees work in a year (including work on both covered (public) and non-covered (private) work). The annualization computation must be done for each individual worker.
Annualization calculations for contractors that are subject to a collective bargaining agreement are simple because they are required to pay an hourly amount for benefits to the union benefit fund for all hours worked, regardless if they are public or private work. Annualization is a non-issue for union contractors.
However, annualization can become a tangled web for merit shop contractors that work on both public work and private work because annualization requires the cost of benefits to be divided by all hours worked. Therefore, contractors must provide benefits that cost a sufficient amount to cover the prevailing wage fringe benefit rate across all hours even though hours on private projects worked are not covered by prevailing wage benefit rules.
Example of a laborer employed by a merit shop contractor:
Total hours worked for the year: 1,500
Total hours worked on public work: 500
Prevailing fringe benefit rate: $20 per hour
The total annual cost of benefits: $15,000 (Medical, dental, pension, etc )
Annualized hourly credit for benefits: $10 per hour ($15,000 benefit cost/1,500 total hours)
In this example, the contractor has a $10 per hour underpayment of fringe benefits: $20 per hour prevailing fringe benefit rate — $10 per hour annualized credit. The total underpayment for the contractor is $5,000 ($10 per hour underpayment x 500 public work hours).
How can the contractor remedy the $5,000 underpayment? Essentially there are two options.
- Pay the $5,000 as additional cash wages.
- Provide additional benefits.
But how much would a contractor need to pay in additional benefits to make up the $5,000 underpayment? Logic would tell you the contractor would need to provide another $5,000 of benefits to make up for the underpayment. However, providing additional payments for benefits accelerates the underpayment problem rather than solves it because the annualized credit needs to be updated by the additional $5,000 contribution.
Total annual costs of benefits: $20,000 ($15,000 + additional $5000 contribution for annualization)
Updated hourly credit for benefits: $13.33 per hour ($20,000 benefit cost/$1500 total hours)
Revised underpayment: $6.67/hour ($20 per hour fringe benefit rate- $13.33 annualized credit)
Total revised underpayment: $3335 ($6.67 per hour underpayment x 500 public work hours)
As you can see in this example, even though the contractor computed the underpayment correctly as $5,000 and provided additional benefits in that amount, the contractor still has a substantial underpayment because the $5,000 contribution is divided by all of the hours worked (not just those covered by prevailing wage rate). A subsequent iteration of annualization calculations perpetuates the underpayment obligation rather than fix it.
So how much will the contractor need to fund in benefits to meet its obligation under the law? The answer is $30,000 (1,500 hours x $20 per hour). The effect of annualization levels the playing field between union contractors and merit shop contractors by requiring benefits to be provided across all hours worked at a cost sufficient to at least equal the hourly prevailing wage rate.
A contractor always has the option of making up the underpayment of benefits by providing the worker with additional wages equal to the underpayment. In our example, the obvious choice would be to pay the $5,000 underpayment as additional cash wages, which is substantially less than the additional $15,000 that would have been needed to get the annualized credit up to the $20 per hour prevailing rate obligation.