Everyone understands the concept of sales tax. We pay it so our local governments can provide public services, infrastructure, transportation, and community development. These are the funds communities use to operate, grow, and improve. States collect sales tax automatically when we make purchases. Some items may be exempt, such as groceries in certain states. The F&A costs function the same for the institutions that host extramurally funded projects.
To establish an institution’s indirect cost rate, a negotiation is conducted to determine the maximum percentage an organization may charge for F&A costs. This legally binding agreement is made between the organization and the federal government through a cognizant agency, which is the federal agency that provides the majority of the organization’s direct federal funding. If an organization does not have a federally-negotiated indirect cost rate, it may apply the de minimis rate. One of these rates will be used unless the sponsor limits F&A recovery through its policies or within the RFP.
When certain expenses are excluded from indirect cost calculations, the resulting base is referred to as modified total direct cost (MTDC). A project with a total direct cost (TDC) base would typically have a low indirect cost rate that applies to all expenses. A project with an MTDC base typically refers to an indirect cost rate that complies with its federally-negotiated indirect cost rate agreement. This agreement will specify which expenses incur indirect costs and which are excluded from indirect cost allocation. Keep in mind that specific sponsors and/or requests for proposals (RFPs) may indicate other exempt categories. If an organization does not have a federally-negotiated rate agreement, it may apply the de minimis rate outlined in the Uniform Guidance.
Indirect costs support the same types of expenditures as our taxes. These are costs that cannot be directly attributed to a sponsored project but are essential for the organization to function. They help fund day-to-day operations and fund essential infrastructure, including building costs, rent, utilities, equipment, furniture, central administrative staff, IT services, facility maintenance, office supplies, compliance, libraries, etc. Like sales tax exemptions, some items generate indirect costs while others, such as tuition, may not.
It may be helpful to explain why indirect costs must be included within the overall budget. If someone goes to the store with $100 to spend, they will not walk out with $100 worth of goods. The $100 must also cover the applicable sales tax. Failing to account for those taxes means the shoppers would need to return items or pay for them with other funds. This is what occurs when a principal investigator (PI) does not properly account for the required indirect costs in their budget or reconciliation.
Without indirect costs, institutions would not be able to function effectively or sustainably. These costs support the infrastructure, services, and administrative systems that enable research, from maintaining buildings and laboratories to providing critical services such as IT, compliance oversight, and financial administration. Just as everyone contributes taxes to support the essential functions of a community, sponsored projects must contribute their fair share to ensure the institution can operate, maintain its facilities, and continue to grow its research enterprise. When investigators understand that indirect costs are not arbitrary fees but necessary contributions that keep resources available, it becomes clear why they are both vital and required for doing business. By framing indirect costs as a shared investment in the organization’s ability to support high-quality research, we can help PIs see how these expenses ultimately benefit their own work, their departments, and the broader campus community.