SBA Targets the Limitations on Subcontracting | Schwabe, Williamson & Wyatt PC

SBA has told its Inspector General it will draft revisions to the limitations on subcontracting (LOS) rule, 13 CFR 125.6, by April 1, 2027, including “new subcontracting thresholds.” The Small Business Act limits how far that rewrite can go. But several of the provisions SBA criticized most sharply are regulatory, not statutory, and sit squarely within SBA’s reach.

The trigger. SBA OIG Report 26-19 (September 30, 2026) found widespread failures to verify and enforce LOS compliance and recommended that SBA rewrite 13 CFR 125.6 in mandatory terms.
SBA went further than OIG asked. Its response describes the current rules as a regime that “legalizes and incentivizes” pass-throughs to large firms, and commits to new thresholds that close “pass-through loopholes.”
Likely direction: more self-performance. SBA’s language points toward stricter thresholds, not just clearer ones. It promises new thresholds that close “pass-through loopholes” and ensure small businesses “perform small business contracts,” and it objects that construction primes may self-perform as little as 15%. Together, this suggests SBA intends to lower the caps on subcontracting to non-similarly situated firms, requiring small businesses to self-perform more of the work.
Locked in by statute. The 50% caps on subcontracting in services and supplies contracts, the materials exclusion for supplies, the requirement to measure compliance with limitations on subcontracting based on revenue and amounts paid, and the self-performance credit for subcontracts with similarly situated subcontractors are all mandated by statute and can only be modified by Congressional action. SBA may move the 50% figures only by making a finding about conventional industry practice.
Within SBA’s reach by rule. The 85% and 75% construction caps, the construction materials deduction, the other-direct-cost (ODC) exclusion from services contracts, the mechanics of applying the similarly situated entity rules, the period of measurement for complying with limitations on subcontracting, reporting obligations, and the ostensible subcontractor rule are all regulatory creations and can be modified by the SBA by regulation.
The SBA proposed April 2027 as its deadline for action, but that is not guaranteed. To implement regulatory changes, the SBA would need to propose a rule, open public comment, issue a final rule, and update the FAR with conforming clauses.
Enforcement is not waiting. The SBA’s commitment to contracting officer training, CPARS ratings, sub-award scrutiny, and the ongoing 8(a) audit needs no new rule.

OIG reviewed eight oversight reports issued over five years by the SBA, GSA, DOE, DOI, and Department of War inspectors general. The same failures recurred: contracting officers accepted contractors’ assurances of compliance, did not track amounts paid to subcontractors, and did not use the monitoring tools already available.

Recurring findings. Five reports found reliance on the contractor’s intent to comply, and five found no real monitoring or enforcement. Others flagged ostensible subcontractor indicators, unassigned monitoring duties, missing CPARS ratings, and unreported FFATA sub-awards. In one GSA project, the prime subcontracted at least 89% of the work.
Root causes. OIG blamed ambiguous regulatory text and thin training. It singled out 13 CFR 125.6(f)(4), which reads as if collecting evidence of compliance is optional, and contracting officers’ discretion over whether to refer suspected violations.
SBA’s own contracts. An SBA internal review in December 2024 found the LOS clause missing or unenforced in 34 of 35 sampled contract files.
Other direct costs. OIG criticized the 2019 ODC exclusion as lacking safeguards. It cited a prime that claimed more than $13 million in data provider fees as excludable, identified only after the contract ended.
Enforcement backdrop. OIG cited a June 2026 False Claims Act settlement of $21.3 million, in which small business primes kept 1–3% of more than $200 million in set-aside work. It also noted that SBA’s audit of all 8(a) participants is screening for pass-through arrangements.

OIG made four recommendations: revise 13 CFR 125.6 with unambiguous, mandatory language; train procurement stakeholders government-wide; train SBA’s own acquisition staff; and formalize LOS oversight roles with GSA. SBA agreed with the first three and partially agreed with the fourth.

What SBA Said

SBA’s response, dated September 28, 2026 and signed by the Associate Administrator for Industrial Base Resilience and Contracting and by the Chief Financial Officer, reads less like an audit reply than a policy statement. SBA states that the current regulation “does not provide for the best interest of small businesses” and commits to rewriting the thresholds themselves.

How SBA characterized the current rules

It calls them a “meticulously crafted regulatory regime” that legalizes and incentivizes pass-throughs to non-similarly situated firms, including large corporations.
It says as little as 15% of a small business construction contract must be performed by small businesses.
It says materials deductions and “other ambiguous rules” further shrink the share of award value that reaches small businesses.
It describes the prime’s retained share as a “pass-through fee” of at least 15% that raises taxpayer costs and denies small firms real past performance.

SBA’s two examples (from usaspending.gov)

A 2024 8(a) construction award of $95.3 million, of which $73.6 million (77%) went to a large corporation with nearly $20 billion in 2025 revenue. SBA says this passed through “legally.”
A 2024 8(a) management consulting award of about $8.8 million, of which $8.5 million (over 96%) went to a large consulting firm.

The second example, on its face, exceeds the 50% services cap. It points to an enforcement failure or to heavy use of exclusions, not to a threshold the rules permit. Both examples are 8(a) awards.

What SBA states it will do

SBA also wants “greater visibility and publication” of subcontracts made under small business contracts.

What SBA Cannot Change by Regulation

The Small Business Act fixes the core of the LOS regime, principally 15 U.S.C. § 657s and the penalty provisions of 15 U.S.C. § 645. SBA cannot rewrite these elements by rule. Only Congress can.

The one statutory valve. Section 657s(c) of the Small Business Act lets SBA change the services and supplies percentages by notice-and-comment rule, but only if the change is “necessary to reflect conventional industry practices” among small businesses in that industry. SBA’s own procedure for such changes, 13 CFR 125.6(g), calls for industry-wide economic data, market data, and a specific justification.

SBA’s stated rationale, closing pass-through loopholes, is a different test. Tightening the 50% services cap would require a record that small firms in a given industry conventionally self-perform more than half the work. That record would differ by NAICS code, which points toward industry-specific changes rather than a single new services number.

What SBA Can Change by Regulation

Much of what SBA criticized is regulatory. The most exposed provisions are the construction caps, the construction materials deduction, and the services ODC exclusion. None of the three appears in the statute, and all three map directly onto SBA’s stated complaints.

Other regulatory treatments are also within SBA’s reach, though SBA has not signaled changes. These include the exclusions for overseas Foreign Assistance Act work and required local-contractor work, and the treatment of leased employees as self-performance on non-staffing contracts.

Limits on SBA’s Latitude and Likely Timing

Even where SBA has authority, it must build a record and complete a full rulemaking.

Construction percentages. The current statute sets no standard for the construction percentages. But the pre-2013 provision, 15 U.S.C. § 644(o)(3), required construction percentages to rest on the same industry-practice standard that governs services and supplies.
Reversing the ODC exclusion. SBA adopted the exclusion in 2019 to reflect how services contracts are actually performed. An agency changing position must acknowledge the change, explain it, and account for reliance on the prior rule.
Small business impacts. SBA must analyze the rule’s effect on small entities under the Regulatory Flexibility Act. Tighter thresholds could reduce the pool of small firms able to bid on large construction and services requirements.

The path from SBA’s draft to contract clauses runs in sequence:

SBA completes draft revisions to 13 CFR 125.6 (target April 1, 2027).
OMB’s Office of Information and Regulatory Affairs reviews the rule if it is deemed significant.
SBA publishes a proposed rule and opens a public comment period.
SBA considers comments and publishes a final rule with an effective date.
The FAR Council conforms FAR 52.219-14, now being rewritten under the Revolutionary FAR Overhaul. OIG urged SBA to act before those FAR revisions are finalized.

New percentages would generally apply to solicitations issued after the effective date. The verification and documentation push does not wait for any of this. Training, CPARS ratings, FFATA scrutiny, and SBA’s 8(a) audit can tighten enforcement under the current rules now.

Takeaways and Issues to Consider

The near-term risk is enforcement under the current rules; the longer-term risk is a narrower rule, most likely for construction and services ODCs. Issues contractors may want to consider:

Records of amounts paid. Does LOS tracking capture amounts actually paid, by base and option period and by order? Would the supporting invoices, subcontracts, and task values satisfy a contracting officer’s request today?
Sister-company and teaming arrangements. How would current 8(a) work-sharing structures fare under lower construction caps or a narrower materials deduction?
Mentor-protégé joint ventures. Higher self-performance requirements may push more contractors toward joint ventures with mentors under SBA-approved mentor-protégé agreements. A JV can meet the applicable LOS based on the combined work of both partners, so the mentor’s own work counts as self-performance rather than subcontracting. But the protégé must perform at least 40% of the work the JV performs, and that work must be more than administrative or ministerial. Because the 40% is measured against the JV’s self-performed work, a higher self-performance requirement raises the protégé’s required share as well. Work by similarly situated entities, such as 8(a) sister companies, does not count toward the protégé’s 40%, while all work by the mentor’s affiliates counts as the mentor’s.
ODC documentation. Are the ODCs being excluded documented, and was agreement on their treatment captured at award rather than reconstructed later?
FFATA sub-award reporting. Are first-tier sub-award reports being filed? OIG found small business primes unaware of the obligation, and SBA is already using this data to build its case.
Ostensible subcontractor indicators. How do current performance models look against the indicators OIG cited? These include reliance on a subcontractor’s systems or experience, little direct labor by the prime, and a subcontractor leading negotiations.
Participation in the rulemaking. Industry-practice data showing what small firms in a given NAICS code conventionally self-perform will likely carry the most weight, especially for construction. Contractors may also want to consider coordinating comments through industry associations.

Milestones to watch

SBA’s draft revisions to 13 CFR 125.6, targeted for Apr 1, 2027
SBA’s government-wide LOS training and new agency reporting structure, targeted for Aug 20, 2027
Publication of a proposed rule and opening of the comment period
Revisions to FAR 52.219-14 under the Revolutionary FAR Overhaul
Document requests arising from SBA’s 8(a) audit