Federal contracting officers have been assuming someone else is checking whether small-business primes actually do the work on set-aside contracts, and the Small Business Administration's own watchdog says that confusion leaves room for pass-through deals to go undetected. In a consolidated review covered by SmallGovCon on October 27, 2026, the SBA Office of Inspector General pulled together oversight findings from five agencies and identified recurring deficiencies in how the limitations on subcontracting rule is interpreted, applied, monitored and enforced. SBA management has agreed to revise the rule, with a draft revision of 13 CFR 125.6 due by April 1, 2027.
The document, SBA OIG Report 26-19, carries a September 30, 2026 date on SBA's site. It draws on oversight work from the SBA, General Services Administration, Department of Energy, Department of the Interior and Department of War, and it follows up on select 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 are working.
Who Is Supposed to Police the 50 Percent Cap?
The rule itself is not new. Payments to subcontractors that do not share the prime's small-business program status may not exceed a set percentage of the total contract value: 50 percent for services and supplies, 85 percent for general construction and 75 percent for specialty trade construction. Penalties include fines of up to $500,000 or the amount over the allowed subcontracting limit, whichever is higher, and failure to comply can also lead to proposed debarment.
The problem the OIG identified is about who checks. 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 verification methods varied widely. At GSA, personnel accepted the contractor's self-reported assurance of compliance. At the Department of War, some personnel relied on the contractor's proposal and planned work distribution as a form of verification, treating a bid's intended split as proof of what actually happened. DoW contracting staff also reportedly did not believe they were required to track what prime contractors paid their subcontractors. Interior personnel were unaware of the correct performance percentage applicable to their contracts and of how deductions for material costs affect the compliance calculation.
In one GSA case, a contracting officer believed the contracting officer's representative was responsible for monitoring compliance, even though that task was not delegated in the representative's delegation letter. The report also notes that the regulations make it optional for the contracting officer to obtain evidence to enforce compliance, even though assessing compliance and documenting it in CPARS is mandatory.
A Prime That Subcontracted 89 Percent of the Work
The consequences show up in the case examples. GSA OIG found that contracting personnel did not evaluate one contractor's past performance or prior experience, or its capability to perform the work and comply with the subcontracting limits, before award. That contractor ultimately subcontracted at least 89 percent of the total project, well above the applicable limit.
The report also takes aim at a 2019 revision that lets service contracts deduct certain other direct costs ancillary to the contract's main purpose from the payment base used to calculate compliance. Because compliance is generally assessed at the end of the base period and each subsequent option period, the OIG warned that "contractors can leverage this flexibility after the fact to meet LOS thresholds, effectively diluting the statutory requirement." In one example, a small-business prime contractor claimed that more than $13 million in certain data provider fees were excludable other direct costs, allowing it to stay within the 50 percent subcontracting threshold.
How the $21.3 Million Pass-Through Settlement Fits In
The OIG pointed to a False Claims Act case as an example of how the gaps get exploited. A large contractor agreed to a $21.3 million settlement over allegations that it used small businesses, including several service-disabled veteran-owned firms, as pass-through entities to obtain more than 90 set-aside contracts. According to the allegations the report summarizes, the large firm managed the contracts, performed the vital and primary requirements, assigned the work and received the majority of the payments, while the small-business prime retained only 1-3 percent of more than $200 million in aggregate government contract value.
SBA's written response to the OIG goes further than the watchdog's own language. As quoted by SmallGovCon, management wrote that "Current regulations on Limitations on Subcontracting 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."
What SBA Promised to Change by April 2027
The OIG made four recommendations: to clarify regulations to improve monitoring and enforcement, to strengthen compliance through training, to reinforce use of available tools, and to coordinate with the General Services Administration to assign oversight roles and responsibilities. SBA management agreed with the first three and partially agreed with the fourth. The OIG said management's planned corrective actions are sufficient to resolve all four recommendations.
On the regulation, SBA said it "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," with a draft revision to 13 CFR 125.6 planned by April 1, 2027. A draft revision is not a final rule, and any new thresholds would still need to go through rulemaking before they bind contractors.
What It Means for Contractors
Small-business primes should be ready for contracting officers to ask for payment records, not assurances. The report points to reliance on self-reported assurances and proposal work splits as weak verification, and the push to clarify the regulations is aimed at the optional language on collecting evidence. Because compliance is based on amounts paid and is generally assessed at the end of the base period and each option period, and separately for each order on a multi-agency contract, primes that track subcontractor payments on that same schedule will be in a better position when requests arrive.
Service contractors that lean on the other-direct-costs exclusion to stay under 50 percent should document those deductions as they go, since the OIG flagged after-the-fact use of that flexibility as a way to dilute the requirement.
Construction firms should watch the thresholds most closely. SBA's own response criticizes the rule for requiring as little as 15 percent of a small-business construction contract to be performed by small businesses, and SBA says new thresholds are coming, so the construction limits may be in play for the 2027 draft. That is an inference, not something the agency has stated.
Large firms teaming as subcontractors on set-asides should take note of the $21.3 million settlement. The OIG cited it as an example of how pass-through arrangements can play out, and SBA says it is preparing to tighten the rules those arrangements exploited.
