Leaving Unallowable Costs in Your Incurred Cost Proposal Can Trigger a Penalty

1FAR 31.205-22 and 31.205-27The costs were always unallowable; only the amount was in dispute

Raytheon Company and Raytheon Missile Systems removed lobbying costs only for time worked in normal business hours, and merger and acquisition costs only from the point of an indicative offer or a decision to go to market. The United States Court of Appeals for the Federal Circuit held in 2023 that both practices left expressly unallowable costs in the proposals. Lobbying is unallowable under FAR 31.205-22, and planning mergers and acquisitions under FAR 31.205-27. It sent the case back for a "determination of costs Raytheon must repay and, if necessary and appropriate, an assessment of penalties". The parties settled the amount, which left the penalty.

Raytheon argued that costs it had treated as allowable could not draw a penalty. The Board answered that "there is no allowable level of lobbying and merger and acquisition costs", and drew the line this way:

"this appeal presents a question regarding the amount of expressly unallowable costs, rather than a question as to whether a category of claimed cost is expressly unallowable"

That set aside the decisions Raytheon relied on. In Ology Bioservices, the government had published the executive compensation cap long after contractors had to file. In Luna Innovations and General Dynamics, the question was whether a type of cost was expressly unallowable at all.

Why it matters: a good faith method for splitting a named unallowable cost is not a defense to the penalty. The Board agreed the calculation was complex and the disagreement reasonable, and still found the costs expressly unallowable.

2FAR 42.709-2 and 42.709-4The penalty is the cost again, plus interest, and the next one doubles

The Board held the government entitled to level 1 penalties. Under FAR 42.709-2, that is the penalty for a cost a cost principle makes expressly unallowable: the disallowed amount allocated to covered contracts, plus interest on any part already paid. The section's other penalty, for a cost already determined unallowable for that contractor before the proposal, is twice the amount. For 2007 alone, DCAA identified $13,072,523 of expressly unallowable costs subject to penalty, and the contracting officer sustained $6,486,337 of it.

Why it matters: a lost appeal does more than settle one year. FAR 42.709-4 counts this as evidence of a prior determination: "A prior executive agency Board of Contract Appeals or court decision involving the contractor, which upheld the cost disallowance". A cost you litigate and lose is the cost that draws the double penalty if it appears in a later proposal.

3FAR 42.709-6A waiver is the contracting officer's call, and it takes both prongs

FAR 42.709-6 requires the contracting officer to waive the penalty when the proposal is withdrawn before the audit begins, when the amount is $10,000 or less, or when the contractor shows both adequate controls and that the costs were included inadvertently. Raytheon withdrew nothing and was, the Board noted, still litigating nearly 20 years later, so only the controls prong was left.

The Board's review of that call "is narrow and we are not to substitute our judgment for his". It allowed that "the CO could have crafted a better explanation for his decision", and upheld it anyway: the officer found a pattern of unallowable costs, supported by DCAA audits and by earlier decisions of the Board and the Federal Circuit, with questioned and sustained costs in every year from 2002 through 2007.

Two of Raytheon's arguments failed in ways that reach every contractor. The earlier costs did not have to be the same kind: "We see nothing in the language of the FAR penalty waiver provision providing that waiver is appropriate if a contractor's previous unallowable costs submissions were for different types of costs". And the second prong could not be met in any case, because "Raytheon testified that it intentionally included the expressly unallowable costs in its proposals".

Why it matters: controls are judged on your record. A history of questioned costs of any kind, in audits or in decisions, can support a denial. And a cost left in on purpose under your own policy is not an inadvertent error.

4FAR Overhaul 42.508Under the FAR Overhaul, the same waiver test has lost its examples

Since March 16, 2026, Department of War contracting officers use the FAR Overhaul's revised Part 42 in place of the codified text, under Class Deviation 2026-O0050. The penalties move to 42.508, with the same two levels.

The waiver at 42.508-6 keeps both prongs. Its controls prong, though, no longer carries the list of examples that follows it in 42.709-6. That list ends with "Government audits which have not disclosed recurring instances of expressly unallowable costs". That is the example this contracting officer relied on: his letter found that "Government audits have, in some instances, disclosed recurring instances of expressly unallowable costs".

Why it matters: the test is the same, so the result here would not change. What changes is the text you can point to. Our reading, not a statement by the FAR Council: without the examples, a waiver request rests on the bare standard and on what satisfies the contracting officer.

5CAS 405What the government did not appeal stayed decided

The Board's 2021 decision had denied the government's claim under CAS 405 (48 CFR 9904.405-40), the standard that requires expressly unallowable costs to be identified and excluded from any proposal. The government never asked the Federal Circuit to reverse that denial. On remand, the Board held that "the Board's 2021 denial is undisturbed and remains law of the case", even though, as it put it, "the government could have raised the issue in one sentence in its appellate brief".

Why it matters: the result split. Raytheon lost on the FAR penalty and won on the CAS 405 claim, because a claim left out of an appellate brief is gone.

Disclaimer. This piece is commentary on a published decision. It is not legal advice, and it is not a determination about any contractor, cost or contract. Confirm how the decision applies to you with counsel or a government contracts professional. Read the Board's opinion and the Federal Circuit's in full.

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