Small businesses that win set-aside contracts while quietly handing most of the work to larger firms face a weak federal enforcement net, and the Small Business Administration’s watchdog now wants that net rebuilt. In Report 26-19, "Consolidated OIG Findings on Subcontracting Limitation Concerns for Set-Aside Awards", the SBA Office of Inspector General concluded that contracting personnel across several agencies misread, inconsistently apply and rarely verify the limitations on subcontracting (LOS) rule. The report carries a Sept. 30, 2026 date on SBA’s site, and it drew fresh attention this week when the law firm Koprince McCall Pottroff broke down its findings on its SmallGovCon blog.
The inspector general summarized the stakes bluntly: "As a result, confusion over roles and responsibilities, compliance gaps, and challenges contracting officers faced in performing key oversight tasks increased the risk that pass-through schemes, to include fraud, would go undetected."
What Report 26-19 Reviewed and Why SBA’s Fixes Fell Short
The evaluation had two jobs. First, it pulled together a body of oversight work from the inspectors general at SBA, the General Services Administration, the Department of Energy, the Department of the Interior and the Department of War to find ways to strengthen compliance government-wide. Second, it followed up on recommendations from two earlier SBA OIG reports, 22-10 and 23-11, to test whether SBA’s corrective actions on pre-award procedures and post-award monitoring worked as intended.
On the first question, the OIG wrote that "Our review of oversight reports across the government identified recurring deficiencies in the federal contracting community’s ability to interpret the rule’s requirements, apply them consistently, and monitor and enforce compliance throughout the life of a contract."
On the second, the answer was no. The OIG found that SBA’s corrective actions "did not effectively strengthen its compliance controls," and that SBA’s own internal review had turned up critical contract terms that were often missing or unenforced.
How the 50, 85 and 75 Percent Limits Are Supposed to Work
The LOS rule, found mainly in 13 C.F.R. § 125.6 and FAR 52.219-14, caps how much of a set-aside contract a small business prime can pay out to subcontractors that are not similarly situated. As the OIG report puts it, as quoted by SmallGovCon, payments to subcontractors that do not share the prime’s qualifying program status "may not exceed a specified percentage of the total contract value—50 percent for services and supplies; 85 percent for general construction; and 75 percent for specialty trade construction." Work sent to a similarly situated entity counts as the prime’s own performance.
Penalties can be heavy. Violators face fines of up to $500,000 or "the amount over the allowed subcontracting limit, whichever is higher," and noncompliance can lead to proposed debarment.
To show what a pass-through scheme looks like in practice, the report points to a $21.3 million False Claims Act settlement with a large contractor. The government alleged the company "used small businesses, including several service-disabled veteran-owned firms, as pass-through entities to obtain more than 90 set-aside contracts," while the small business prime "retained only 1-3 percent of the more than $200 million in aggregate government contract value."
Who Was Supposed to Check? The Oversight Gaps by Agency
The central problem the OIG describes is that nobody was sure whose job monitoring was. According to SmallGovCon’s account, the report found that "contracting personnel misunderstood the subcontracting limitations requirements, which led to confusion about roles and responsibilities, gaps in compliance, and assumptions that other officials were performing key monitoring tasks."
The specifics vary by agency:
- GSA "accepted the contractor’s self-reported assurance of compliance." In one GSA case, a contracting officer believed the contracting officer’s representative was responsible for monitoring, even though the delegation letter never assigned that task.
- Department of War staff in some cases "relied on the contractor’s proposal and planned work distribution as a form of verification." Some DoW contracting personnel did not believe they had to track what primes paid their subcontractors, and others were unaware that small business primes must report first-tier subcontract awards.
- Interior personnel "were unaware of the correct performance percentage applicable to their contracts and of how deductions for material costs affect compliance calculations."
The report also flagged a GSA case where contracting personnel did not evaluate the contractor’s past performance or its capability to comply with the subcontracting limits, and the contractor ultimately subcontracted at least 89 percent of the total project, well above the applicable limit. Contracting officers also often failed to document contractor performance ratings in CPARS within required timeframes, even though assessing LOS compliance and documenting it there is mandatory.
Another weak point is a 2019 rule change that lets service contractors deduct certain ancillary other direct costs from the LOS calculation. The OIG warned that "contractors can leverage this flexibility after the fact to meet LOS thresholds, effectively diluting the statutory requirement," citing a prime that claimed more than $13 million in data provider fees as excludable to stay within the 50 percent subcontracting threshold.
Four Recommendations and a Rewrite of 13 CFR 125.6 Due in 2027
The OIG made four recommendations: clarify regulations to improve monitoring and enforcement, strengthen compliance through training, reinforce use of available tools, and coordinate with GSA to assign oversight roles and responsibilities. SBA management agreed with the first three and partially agreed with the fourth. The OIG called the planned corrective actions sufficient to resolve all four.
SBA’s response goes further than tweaks. According to the report as quoted by SmallGovCon, "SBA plans to revise regulations to set new subcontracting thresholds, clarify oversight and tracking procedures, strengthen guidance, and remove unclear language that impedes enforceability of the limitations on subcontracting. Management plans to complete a draft revision to 13 CFR 125.6 by April 1, 2027."
SBA also wrote that current rules "allow for wasteful and abusive pass-through contracts, in part by requiring as little as 15 percent of a small business construction contract to be performed by small businesses." SmallGovCon editor Shane McCall read that as a signal that the percentages themselves, including for construction, may change in a proposed regulation in 2027.
What It Means for Contractors
For small business primes, the message is that the era of light-touch LOS oversight may be ending. The report describes agencies leaning on self-reported assurances and contractor proposals; the regulations make it optional for the contracting officer to obtain evidence to enforce compliance, and the OIG wants that clarified. Compliance is generally assessed at the end of the base period and each option period. Firms should keep invoice-level records of what they pay non-similarly situated subcontractors, track compliance order by order on multi-agency vehicles, and document up front which other direct costs they plan to exclude.
Construction firms should watch the 13 CFR 125.6 rewrite closely, since SBA has criticized the 15 percent performance floor. Large businesses that team as subcontractors on set-asides should also take note: the $21.3 million settlement shows the False Claims Act exposure that follows when a small prime is alleged to be a front.
