Independent Contractors and the FAR’s Subcontracting Limits

Recently, the U.S. Small Business Administration made headlines by announcing that it was investigating an 8(a) Program contractor for potentially violating the limitations on subcontracting imposed by the Federal Acquisition Regulation and the SBA’s regulations. The SBA’s investigation serves as a strong reminder that small business prime contractors must strictly follow subcontracting limits and fully understand how independent contractors are treated under the FAR and SBA rules to avoid compliance issues.

Small businesses often use independent contractors, or “1099s,” to supplement their W-2 workforce. Although independent contractors are not employees, it is not uncommon for small businesses to begin thinking of their 1099s as functionally equivalent to employees. For this reason, when it comes to the limitations on subcontracting, many prime contractors assume that work performed by their 1099s counts toward the prime contractor’s workshare. Not so.

FAR 52.219-14(d) specifies that “[a]n independent contractor shall be considered a subcontractor.” Similarly, 13 C.F.R. 125.6(d)(3) says that “[w]ork performed by an independent contractor shall be considered a subcontract.” This means that, ordinarily, an independent contractor’s work counts against the prime contractor’s self-performance for purposes of the limitations on subcontracting, not toward it.

For example, consider a case in which a service-disabled veteran-owned small business is awarded a $150,000 services contract. The applicable limitations on subcontracting specify that the prime contractor cannot subcontract more than 50% of the amount paid by the government to subcontractors that are not similarly situated entities. The SDVOSB pays a 1099 independent contractor $100,000 to perform a portion of the work. Unless the 1099 is a certified SDVOSB, that $100,000 counts against the limitations on subcontracting, and the SDVOSB has violated the rule by subcontracting more than 50% of the amount paid by the government.

As suggested by the example, the only exception is when the 1099 is a “similarly situated entity,” that is, an entity with the same small business status needed to qualify for the prime contract. Because SBA’s four major socioeconomic contracting programs–8(a), SDVOSB, HUBZone, and woman-owned small business–all require formal SBA certifications, it may be difficult to find similarly situated 1099s. On the other hand, when the prime contract is set-aside for small businesses, it may be significantly easier to find 1099 independent contractors who qualify as similarly situated entities.

Prime contractors looking to use the similarly situated entity rule to help meet the limitations on subcontracting are strongly advised to consult experienced legal counsel to ensure that their 1099 independent contractor agreements provide adequate assurances that the 1099 is, in fact, a similarly situated entity