How do NAICS Codes Impact Limitation on Subcontracting?

Not to pull the curtain back too far, but here at GovConBrief we have a little contest going. The author of the post with the most readers at the end of the month gets the best parking spot. Something tells me this post—discussing a system of six digit codes that identify discrete industries—is not going to win it for me.

Nevertheless, it’s an important question. NAICS codes have a lot to say and savvy businesses learn to listen. If you know them well, you can use them to your advantage.

North American Industry Classification System codes—“NAICS” codes—are an industrial categorization system published by the United States Census Bureau. They describe various industrial sectors across North American and assign six-digit codes to each for record keeping purposes.

The SBA utilizes NAICS codes as the backbone of its small business size program. Each NAICS code is assigned a revenue or employee size standard by the SBA. For set-aside procurements, the awardee cannot exceed the threshold of the NAICS code assigned to the solicitation.

NAICS codes are critical to small business set-aside procurements, but this isn’t exactly news. What is more interesting is the role NAICS codes play with respect to limitation on subcontracting compliance.

The limitation on subcontracting applies to all contracts set-aside for small business participation, including set-asides for any of the SBA’s socioeconomic programs. It restricts how much money may be paid by the prime contractor to entities that do not share small business or socioeconomic status of the prime contract.

The limitation on subcontracting is always expressed as a percentage and is measured in dollars paid by the federal government to the prime. The SBA’s regulations identify three general brackets of subcontracting limitation: 50 percent for services, supplies, and manufacturing contracts; 75 percent for specialty trade contracts; and 85 percent for general construction contracts. Thus, for a $1 million services contract set-aside for 8(a) participation, the prime contractor could subcontract no more than $500,000 to non-8(a) firms.

This begs an important question: How does a contractor know which limitation applies?

The answer is in the NAICS code assigned to the Solicitation. The SBA’s regulations explain that “[t]he contracting officer’s selection of the applicable NAICS code is determinative as to which limitation on subcontracting and performance requirement applies.”

Individual NAICS codes are grouped with common industries to form business sectors. Many of these business sectors match the limitation on subcontracting categories. The business sector is denoted by the first two digits in any NAICS code. Subsectors are identified by the third digit of the code. The SBA’s size regulation groups NAICS codes by sector and subsector, so it’s easy(-ish) to see visually.

For example, construction NAICS codes are grouped within business sector 23. Thus, NAICS 236118, Residential Remodelers, is a construction NAICS code and would be subject to the 85 percent limitation on subcontracting. Specialty trade construction contractors also fall under business sector 23 but are specifically grouped under subsector 8. Thus, NAICS 238220, Plumbing, Heating, and Air-Conditioning Contractors, is a specialty trade construction code and subject to a 75 percent limitation on subcontracting.

Tying the limitation on subcontracting to the NAICS selection can have significant compliance impacts. Imagine a contract for refreshing the landscaping at a federal building. The scope of work anticipates design effort, as well as the associated earthwork. If this contract was competed under NAICS 541320, Landscape Architectural Services, it would be subject to the 50 percent limitation on subcontracting assigned to services contracts. On the other hand, if the contract is assigned NAICS 238910, Site Preparation Contractors, a 75 percent limitation on subcontracting would apply.

Interesting, right?! Maybe not. But the discussion above does highlight the important compliance information conveyed by NAICS codes. For small business federal contractors, complying with these requirements can be the difference between successful contract performance and a lost contract or the SBA taking enforcement actions.