CMS gives new guidance on upcoming restrictions to Medicaid provider taxes

CMS issued preliminary guidance about how it will implement new restrictions on Medicaid provider taxes as required by the budget reconciliation law known as the One Big Beautiful Bill Act (OBBBA).

OBBBA language will curb provider taxes as a Medicaid funding mechanism through which states can increase their allotment of federal matching dollars that, in turn, are disbursed to providers as supplementary funding.

In a research organization’s analysis issued shortly before the OBBBA became law, the decline in federal Medicaid funding among 18 expansion states was projected to total $11.9 billion per year once the new caps are fully implemented. States such as Arizona, Iowa, New Hampshire, Nevada and Vermont would each lose more than 7.5% of current funding.

In a news release on the guidance, CMS says its own analysis has found that “improper use of these financing mechanisms inappropriately generates billions of dollars annually, weakening fiscal accountability and shifting costs away from states and their shared responsibility required under the law” (note that in the news release and elsewhere, the Trump administration has rebranded the OBBBA as the Working Families Tax Cuts legislation, or WFTC).

Slashing allowable Medicaid tax rates

The new guidance refers to the indirect hold harmless threshold, which allows participants to be exempt from a general prohibition on hold-harmless arrangements. Through prior regulations, CMS has implicitly established that a hold-harmless approach is allowed if the Medicaid tax does not exceed 6% of net patient revenues at participating providers.

Under the OBBBA, implementation of new or increased provider taxes is effectively prohibited in all states. Whereas a Medicaid non-expansion state can maintain the applicable tax percentage it had for ongoing arrangements when the legislation was signed, expansion states are subject to a reduction. The drop from the currently allowed percentage of 6% to a new 3.5% cap will be phased in over a five-year period starting in FY28.

In the guidance, CMS clarified that tax percentages are frozen for all states effective Oct. 1, 2026, based on taxes in place as of July 4, 2025. A higher rate can be implemented in the meantime but would be rolled back next October.

A point of emphasis in the new guidance is that the October 2026 freeze on new or increased taxes is based on thresholds for taxes that were fully authorized and being imposed as of this past July 4.

“Revenues associated with tax waiver proposals that were pending on or submitted after July 4, 2025, will not be included in the new indirect hold harmless threshold,” the guidance states. “CMS will calculate thresholds associated with the tax structure in effect with the most recent waiver approval for the tax, and for which the state is actively collecting revenue.”

Notably, the guidance also states, “The enacted tax structure as of July 4, 2025, does not include administrative or legislative adjustments to a tax structure after July 4, 2025, even if retroactively applicable.”

Closing a Medicaid tax loophole

The OBBBA also tightens the definition of generally redistributive with respect to provider taxes. Tax arrangements must be generally redistributive, meaning they redistribute resulting funds across providers instead of guaranteeing repayment of tax cost.

Per criteria in the new legislation, a tax arrangement effectively will be prohibited if providers with lower Medicaid volumes are taxed at lower rates than those with higher volumes, or if tax rates vary based on Medicaid vs. non-Medicaid units (e.g., a per-member-per-month metric). Any such arrangement that does not explicitly mention Medicaid can be forbidden as well.

CMS says the biggest concern in this area applies to Medicaid managed care organizations (MCOs) rather than providers. In one arrangement, an insurer’s Medicaid business has been levied at a rate 117 times higher than that of commercial plans, according to CMS. Such arrangements have been approved due to a statistical loophole in the formula for determining whether a tax is generally redistributive, the agency said.

CMS asserts that MCO tax arrangements must close the loophole by the end of state FY26, while taxes applying to hospitals and other providers have until the end of state FY28. The agency may choose to provide additional time in some instances.

“CMS recommends that affected states carefully consider how to avoid or mitigate any possible budgetary and/or program challenges in this interim period and take appropriate action,” the guidance states.

The legislation and the new guidance echo a 2025 proposed rule that is undergoing review before being published as a final rule. Those regulations would bar non-uniform tax rates on MCOs and providers, along with prohibiting “the use of vague language to disguise taxes that target Medicaid,” according to a fact sheet.

Watching for potential complications

CMS advises that additional rulemaking will formalize different parts of the new guidance and the associated compliance timelines.

Stakeholders have expressed concern that closing loopholes as required to meet the definition of generally redistributive could be difficult for states given the potentially lower hold-harmless thresholds. While stating that it does not foresee such an issue, CMS says it will provide technical assistance to states as needed.