Disallowed costs in federal grants are expenses the awarding agency refuses to pay because they violate the spending rules in 2 CFR Part 200, the Uniform Guidance. When a cost is disallowed, the recipient has to return the money, and the trouble often does not stop there. Interest accrues, penalties can be added, future funding can be withheld, and in the worst cases the organization can be barred from federal awards or prosecuted. Most disallowances come not from outright fraud but from missing documentation, skipped approvals, and honest misreadings of what the grant allows.
What Gets a Cost Disallowed
Every charge to a federal grant has to survive a short list of tests set out in 2 CFR 200.403 and the sections that follow it.1eCFR. 2 CFR 200.403 – Factors Affecting Allowability of Costs Fail any one, and the cost gets disallowed.
The cost must be necessary and reasonable: it serves the grant’s objectives, and the price is what a careful spender would pay under similar circumstances.2eCFR. 2 CFR 200.404 – Reasonable Costs It must be allocable to the grant being charged; if the expense benefits three projects, you split it proportionally, and you cannot drop the whole bill on one grant because that grant has money left.3eCFR. 2 CFR 200.405 – Allocable Costs It must be consistently treated, meaning your accounting rules apply the same way to federal and non-federal work. It must be adequately documented. And it must fall within the grant period, with a narrow exception for closeout costs incurred up to the due date of the final report.
The consistent-treatment rule catches organizations more often than you might expect. An employee who splits time between a federal project and other activities has to have their salary split accordingly. Charging 100 percent of that salary to the grant because it is easier is a textbook disallowance. The documentation rule catches even more people. If you cannot show what was bought, why it was needed, and how it ties to the grant, the cost is presumed disallowable no matter how legitimate it actually was.
Spending That Is Always Prohibited
Some categories of cost are flatly barred under Subpart E of the Uniform Guidance, regardless of how tightly connected they are to your project.4eCFR. 2 CFR Part 200 Subpart E – Cost Principles No amount of paperwork saves them.
- Alcoholic beverages, even at a working dinner with grant partners.
- Lobbying, including staff time spent contacting legislators about pending bills.
- Fundraising, capital campaigns, and donor solicitation.
- Entertainment: event tickets, social outings, and associated gratuities, unless the activity has a programmatic purpose written into the grant itself.
- Fines and penalties from violating any law, except in narrow situations where the penalty resulted from complying with specific grant terms.
- Bad debts and the legal costs of trying to collect them.
- The commuting and personal-use portion of employer-provided vehicle costs.5eCFR. 2 CFR 200.431 – Compensation – Fringe Benefits
The entertainment prohibition trips organizations up more than it should. A networking reception at a conference feels work-related, but unless the grant specifically authorizes that activity and the cost serves a documented programmatic purpose, it is disallowed. When in doubt, treat social events as personal.
Costs That Require Prior Written Approval
Some expenses are allowable in principle but become disallowed if you did not get written permission from the awarding agency before spending the money. Skipping this step is one of the fastest ways to lose funding on an otherwise reasonable purchase.6eCFR. 2 CFR 200.407 – Prior Written Approval
Common triggers include special-purpose equipment with a per-unit cost of $10,000 or more,7eCFR. 2 CFR 200.439 – Equipment and Other Capital Expenditures foreign travel charged to the grant, budget revisions beyond what the award terms allow, pre-award costs incurred before the official start date, and abnormal severance pay such as mass-layoff packages that exceed your standard policy. Lacking prior approval does not automatically mean the cost was unreasonable or unrelated to the grant. But when the rules specifically require approval for allowability, spending without it is enough on its own.
Where Documentation Fails
Most disallowances are not inherently unreasonable purchases. They are reasonable purchases with missing paperwork. Auditors cannot give you the benefit of the doubt when the records are not there. A few areas produce the bulk of the problems.
Travel
Travel is allowable but heavily regulated. Costs must follow your organization’s written travel policy, and that policy must apply the same way to federally funded trips as to everything else.8eCFR. 2 CFR 200.475 – Travel Costs Without a written policy, the Federal Travel Regulation controls, setting per diem and mileage by location.
Airfare above basic economy is disallowed unless you can document a specific justification: cheaper routing was unreasonably circuitous, required travel at unreasonable hours, or would have cost more overall after extra lodging. Convenience is not an exception. The Fly America Act requires federally funded air travel on U.S.-flag carriers; a code-shared flight has to be booked through the U.S. carrier’s flight number. Exceptions are narrow: no U.S. carrier is available, using one would add 24 or more hours of travel, or an Open Skies Agreement applies. Ticket price alone is never an exception.9U.S. General Services Administration. Fly America Act
Salary Caps and Fringe Benefits
Federal grants often limit how much of a person’s salary you can charge. The most prominent cap applies to NIH and other agencies that tie compensation to Executive Level II. For fiscal year 2026, that cap is $228,000.10National Institutes of Health. Guidance on Salary Limitation for Grants and Cooperative Agreements FY 2026 If an employee earns $280,000 and works half-time on a capped grant, you can charge only half of $228,000, which is $114,000. The rest comes from non-federal funds.
Fringe benefits are allowable when required by law, by an employment agreement, or by established organizational policy, and they must be allocated proportionally across an employee’s activities. Pension contributions get extra scrutiny: costs assigned to a fiscal year must be funded within six months after that year ends, and funding delays beyond 30 days after each quarter make the increase unallowable.5eCFR. 2 CFR 200.431 – Compensation – Fringe Benefits
Personnel costs require time-and-effort reporting that reflects the actual hours worked on grant activities, signed by the employee or a supervisor who directly observed the work. A blanket estimate that someone spent “about 50 percent” of their time on the grant, created after the fact, collapses under audit.
Indirect Costs
Indirect costs are the shared expenses that keep the organization running but cannot be tied to a single project: rent, utilities, general administration. The government reimburses these through an indirect cost rate applied to your direct costs, and getting the rate wrong is a common source of disallowances.
Organizations that have never negotiated a rate with a federal agency can elect a de minimis rate of up to 15 percent of modified total direct costs. That rate needs no supporting documentation and can be used indefinitely, but once elected it must be applied to all federal awards until a formal rate is negotiated. Agencies and pass-through entities cannot force you to accept less than either your negotiated rate or the de minimis rate you elected.11eCFR. 2 CFR 200.414 – Indirect Costs
The most frequent indirect-cost mistake is double-charging. When you classify rent as a direct cost on one grant and also include it in your indirect cost pool spread across all grants, you have billed the government twice for the same expense. Each cost has to be charged consistently as either direct or indirect. Never both.
Subrecipients
If you pass federal funds to another organization through a subaward, you inherit responsibility for how that money gets spent. Pass-through entities must monitor subrecipients, review their financial and performance reports, and resolve audit findings tied to the subaward.12eCFR. 2 CFR 200.332 – Requirements for Pass-Through Entities When a subrecipient spends grant money on disallowed costs, you are on the hook. You can pursue repayment from them, but from the federal agency’s view, you signed the award and took on the compliance obligation. Weak monitoring is itself an audit finding.
How Auditors Find Disallowed Costs
Organizations that spend $1,000,000 or more in federal funds during a fiscal year must undergo a Single Audit. That threshold rose from $750,000 under a 2024 revision to the Uniform Guidance, effective for fiscal years beginning on or after October 1, 2024.13eCFR. 2 CFR 200.501 – Audit Requirements Falling below the threshold does not exempt you from the cost rules; the awarding agency can still review expenditures directly.
An independent auditor tests compliance against the grant agreement and the Uniform Guidance, looking for missing documentation, prohibited expenditures, and costs that fail the allowability tests. Problems are logged as “questioned costs.” Known questioned costs exceeding $25,000 for a compliance requirement in a major program must be reported as an audit finding.14eCFR. 2 CFR 200.516 – Audit Findings The report goes to the Federal Audit Clearinghouse, where the awarding agency reviews it.15Federal Audit Clearinghouse. About This Guide and the Federal Audit Clearinghouse The agency then makes a management decision on each questioned cost. Sustaining a questioned cost turns it into a formal disallowance.
What Happens After a Disallowance
Once a cost is disallowed, the awarding agency has a toolkit of remedies that escalates with the severity of the problem. The Uniform Guidance authorizes any of the following:16eCFR. 2 CFR 200.339 – Remedies for Noncompliance
- Withholding payments until the problem is fixed.
- Formally rejecting the expenditures and demanding repayment.
- Reducing the remaining award to offset the disallowed amount.
- Suspending or terminating the award entirely in serious cases.
- Blocking new or continuation funding for the same program.
- Initiating debarment proceedings to exclude the organization from all federal awards.
Typically the agency issues a written notice specifying the disallowed amount and the reason, and you are asked to return the money by check, wire transfer, or offset against future payments. Straightforward documentation failures usually draw simple repayment demands; patterns of noncompliance trigger the more aggressive responses.
Interest, Penalties, and Administrative Costs
Disallowed costs that go unpaid become federal debts, and federal debts accumulate interest. The Treasury sets the Current Value of Funds Rate annually; for 2026, that rate is 4.00 percent.17Bureau of the Fiscal Service. Current Value of Funds Rate Once the debt is more than 90 days overdue, an additional penalty of up to 6 percent per year begins accruing on top of the interest.18eCFR. 31 CFR 901.9 – Interest, Penalties, and Administrative Costs Administrative costs for processing the delinquent debt get added too. Partial payments are applied to penalties and administrative costs first, then interest, and finally the original principal. A $50,000 disallowance sitting unpaid for a year can easily grow past $55,000 before any payment touches the principal.
Appealing a Disallowance
You have the right to challenge a disallowance through the awarding agency’s administrative appeal process.19eCFR. 45 CFR 98.66 – Disallowance Procedures The specific procedures and deadlines vary by agency. For agencies within the Department of Health and Human Services, recipients can appeal to the Departmental Appeals Board within 30 days of receiving the final decision.20eCFR. 45 CFR Part 16 – Procedures of the Departmental Grant Appeals Board Other agencies set their own timelines, so the first step after a disallowance notice is finding the appeal deadline.
Appeals are typically decided on a written record: both sides submit documents and statements, and a board or administrative law judge reviews them. HHS offers expedited procedures for disputes of $25,000 or less. Informal conferences and mediation are available in some cases; formal hearings with witness testimony happen only when material facts are genuinely disputed. Missing the filing deadline almost always makes the disallowance final, and extensions are rarely granted.
When Disallowance Becomes Fraud
When disallowed costs cross the line from noncompliance into deliberate fraud, the consequences are no longer limited to repayment. Federal law makes it a crime to steal, embezzle, or fraudulently obtain property valued at $5,000 or more from an organization receiving more than $10,000 in federal benefits during any one-year period, and conviction carries up to 10 years in prison.21Office of the Law Revision Counsel. 18 USC 666 – Theft or Bribery Concerning Programs Receiving Federal Funds
The False Claims Act adds civil exposure. Knowingly submitting a false claim to the government triggers liability for three times the government’s actual damages plus a per-violation civil penalty that adjusts annually for inflation.22Office of the Law Revision Counsel. 31 USC 3729 – False Claims The “knowingly” standard reaches deliberate ignorance and reckless disregard for the truth. Not reading the grant terms is not a defense.
Organizations found to have committed fraud or serious noncompliance also face debarment, which bars them from receiving any federal awards. Debarment generally lasts up to three years but can run longer depending on the conduct. During that time the organization sits on the System for Award Management exclusion list, effectively shut out of federal funding.23eCFR. 2 CFR 180.865 – How Long May My Debarment Last
How Long Records Must Be Kept
The Uniform Guidance requires recipients to retain all financial records for three years after the final expenditure report is submitted. For awards that renew quarterly or annually, the three-year clock restarts with each periodic report.24eCFR. 2 CFR 200.334 – Record Retention Requirements If an audit, litigation, or claim is pending when the three-year period would end, records must be kept until the matter is resolved.
The government’s side runs longer. The statute of limitations for recovering diverted grant funds is six years from when the right of action accrues,25Office of the Law Revision Counsel. 28 USC 2415 – Time for Commencing Actions Brought by the United States and that clock can reset if you make a partial payment or acknowledge the debt in writing. A disallowance from years back can still generate a legal action if the six-year window is open, which is why destroying records the moment the three-year retention period expires is risky whenever a compliance issue is unresolved.