SBA Plans Stricter Limitations-on-Subcontracting For Set-Aside Contracts - Construction Contractors Should Take Particular Note

The U.S. Small Business Administration (“SBA”) has announced plans to revise the limitations-on-subcontracting rules governing covered small-business set-aside and sole-source awards in response to a September 30, 2026, SBA Office of Inspector General (“OIG”) report. This report looked into federal-wide compliance with the limitations on subcontracting for set-aside awards, including those for construction contracts. SBA’s September 28, 2026, management response proposes compliance, oversight, reporting, tracking, data-collection, and enforcement reforms that are broader than construction, but the scope of any changes to subcontracting percentage limits remains unspecified.

SBA expects to complete draft revisions to 13 C.F.R. § 125.6, by April 1, 2027. The announced revisions would set new subcontracting thresholds and strengthen oversight, reporting, tracking, data collection, interpretation, and enforcement. SBA has not yet published a proposed rule, and the current limitations remain in effect.

Governing Framework

Limitations on subcontracting arise under the Small Business Act, 15 U.S.C. § 657s, and are implemented through 13 C.F.R. § 125.6 and FAR 52.219-14. Subcontracting limitation rules apply to set-aside contracts for covered services, supply, general construction, and specialty trade construction awards. To preserved the objective of set-aside contracts, these rules limit the amount a small-business prime may pay to subcontractors that are not “similarly situated.” A similarly situated subcontractor must share the prime contractor’s applicable small-business program status and be small under the NAICS code assigned to the subcontract. Payments to a similarly situated subcontractor generally are excluded from the limitation, but amounts that an entity pays to a non-similarly situated lower-tier subcontractor count against the prime contractor’s permitted percentage.

The current caps are:

• Services: 50%
• Supplies: 50%, excluding the cost of materials
• General construction: 85%, excluding the cost of materials
• Specialty trade construction: 75%, excluding the cost of materials

For services, the prime generally may not pay more than 50% of the amount paid by the Government to non-similarly situated subcontractors. For supplies, the corresponding 50% calculation excludes the cost of materials. For general construction, the current cap is 85% of the amount paid by the Government, excluding the cost of materials, and for specialty trade construction the current cap is 75% on the same basis. The limitations generally apply to total small-business set-asides above the simplified acquisition threshold and to set-aside or sole-source awards under the 8(a), HUBZone, SDVOSB, and WOSB programs regardless of dollar value, subject to the regulation’s stated exceptions.

Compliance generally is measured over the base term and then separately over each option period, unless the contracting officer requires order-level application for an indefinite-delivery contract. A violation may result in a fine equal to the greater of $500,000 or the amount spent in excess of the applicable limitation. SBA’s regulation also addresses the effect of compliance on past-performance evaluations and recognizes specified extenuating circumstances.

OIG Findings

SBA OIG Report 26-19 examined limitations-on-subcontracting compliance for set-aside awards across the federal government. OIG reviewed eight oversight reports involving five agencies and identified recurring deficiencies in interpretation, application, monitoring, reporting, and enforcement. Recommendation 1 directs SBA to revise 13 C.F.R. § 125.6 using unambiguous, mandatory language to promote consistent interpretation, application, and enforceability. Recommendations 2 through 4 address training, reinforcement of pre-award and post-award controls, and clearer allocation of federal oversight roles. The report therefore supports an alert directed to contractors across the covered set-aside programs.

SBA’s Planned Changes

SBA agreed with Recommendations 1, 2, and 3 and partially agreed with Recommendation 4. Its planned revisions to oversight, reporting, tracking, agency guidance, data collection, and enforceability are framed generally. SBA’s numerical-threshold discussion, however, focuses most directly on construction, criticizing the rule for permitting a general-construction prime to perform as little as 15% of the contract amount after excluding materials. SBA cited a 2024 $95.3 million 8(a) construction award in which $73.6 million, or 77%, was subcontracted to a large corporation. SBA also cited a 2024 management-and-general-consulting-services 8(a) award of nearly $8.8 million in which approximately $8.5 million, or more than 96%, allegedly was subcontracted to a large consulting firm.

SBA’s announced draft revisions will:

• Set new subcontracting thresholds intended to close pass-through loopholes and ensure small businesses perform small business contracts
• Clarify oversight, reporting, and tracking requirements
• Guide agencies on tracking and reporting and develop collection mechanisms for SBA to use limitations-on-subcontracting data to identify waste, fraud, and abuse
• Replace ambiguous or nonmandatory language that impedes consistent interpretation, application, and enforcement

SBA has not specified the proposed numerical thresholds or identified every contract category whose threshold may change. The Small Business Act establishes the 50% limitations for services and supplies and provides a process for SBA to revise those percentages based on conventional industry practices. For other contract categories, including construction, SBA may establish a specified percentage through notice-and-comment rulemaking. Accordingly, the announced compliance and enforcement revisions are broader than construction, but the management response provides its clearest threshold-specific rationale for changing the 85% general-construction cap. Any resulting regulatory amendment also may require conforming action to FAR 52.219-14.

Application to Existing Contracts

SBA’s management response does not state whether revised thresholds or compliance mechanisms would apply to existing contracts, later-exercised options, or new orders under existing indefinite-delivery vehicles. Contractors should review the applicability and effective-date provisions of any proposed rule when issued, with construction contractors paying particular attention to any proposed change to the current 85% and 75% caps.

Interplay with the Proposed New Size Standards

These plans arrive while SBA’s proposed size standards overhaul remains open for comment. SBA estimates that proposal would add approximately 114,541 firms to the pool of qualifying small businesses. Comments are due November 20, 2026. (Please review the October 5, 2026,  October 12, 2026, and October 14, 2026, articles published by our government contracts team attorneys to learn more about the pending SBA Size Standards issues.)

The two rulemakings intersect at the definition of “similarly situated.” While increased size standards would place more subcontractors inside that group, a stricter cap would limit what a prime may pay to firms outside it. The net effect on any contract will depend on the final numbers in both rules. Firms that gain small status under the proposed standards may find a stricter cap easier to meet as primes because they have more capacity to self-perform.

Recommended Actions

Before SBA publishes a proposed rule, affected parties should:

1. Review the share of each set-aside contract paid to subcontractors that are not similarly situated.
2. Track subcontractor payments by size and certification for each base and option period.
3. Model construction bids and future opportunities against potentially lower construction subcontracting caps and model service and supply contracts for more prescriptive documentation, monitoring, and enforcement requirements.
4. Identify subcontractors that qualify as similarly situated today and those that may qualify under the proposed size standards.
5. Review teaming, joint venture, and mentor-protégé workshare provisions built around the current limits.
6. Tighten subcontract flow-down and certification terms—require similarly situated subcontractors to self-perform with their own employees and to notify the prime if they lose their size or socioeconomic status during performance.
7. Preserve contemporaneous evidence of compliance—invoices, subcontracts, and task-level value records—which a contracting officer may demand during or after performance.
8. Identify cure and mitigation options in advance; § 125.6(e) recognizes extenuating circumstances, such as labor shortages, government-directed scope changes, and a subcontractor’s loss of similarly situated status, that can preserve a satisfactory past-performance rating.

Bottom Line

This SBA initiative is broader than construction in its compliance, oversight, reporting, training, and enforcement dimensions because it responds to federal-wide concerns involving § 125.6 and set-aside awards. The most concrete indication of a numerical threshold change remains construction, particularly the current 85% cap for general construction. The alert should therefore address all contractors performing covered set-aside and sole-source awards while retaining construction thresholds as the principal identified numerical-rulemaking risk. Current limitations remain in effect unless and until SBA completes rulemaking and establishes an effective date.

Clark Hill’s Government Contracting team can assist companies in reviewing subcontracting compliance, structuring teaming and workshare arrangements, and preparing comments on both rulemaking processes.

Contact Clark Hill Attorneys

If you have questions regarding this report or its implications for federal contractors, please contact the authors of this article.

• Bret S. Wacker (bwacker@clarkhill.com; 202.772.0906)
• Jeffrey M. Gallant (jgallant@clarkhill.com; 313.967.4071)
• Ronald D. Sullivan (rsullivan@clarkhill.com; 202.809.2235)
• Chris White (jcwhite@clarkhill.com; 517.318.3011)
• Colleen Jarrott (cjarrott@clarkhill.com; 202.640.6668)
• Contributor: Max Sarkissian, Law Clerk

Click here to find our Clark Hill Government Contracts Law Attorneys.

Click here to find our Clark Hill Construction Law Attorneys.

Subscribe here to receive future Clark Hill alerts directly in your inbox.

This publication is intended for general informational purposes only and does not constitute legal advice or a solicitation to provide legal services. The information in this publication is not intended to create, and receipt of it does not constitute, a lawyer-client relationship. Readers should not act upon this information without seeking professional legal counsel. The views and opinions expressed herein represent those of the individual authors only and are not necessarily the views of Clark Hill PLC. Although we attempt to ensure that postings on our website are complete, accurate, and up to date, we assume no responsibility for their completeness, accuracy, or timeliness.