On May 15, 2025, the Centers for Medicare & Medicaid Services (CMS) published a proposed rule titled “Medicaid Program; Preserving Medicaid Funding for Vulnerable Populations-Closing a Health Care-Related Tax Loophole Proposed Rule.” As indicated in the proposed rule, CMS is trying to ensure that provider tax programs that utilize a waiver of broad-based or uniformity rules remain generally redistributive. CMS defines generally redistributive to mean “the tendency of a State’s tax and payment program to derive revenues from taxes imposed on non-Medicaid services in a class and to use these revenues as the State’s share of Medicaid payments.” 

CMS is concerned that certain tax programs utilize what they perceive is a loophole to pass the mathematical waiver tests, yet are not generally redistributive in nature. This “loophole” currently allows some health care-related taxes to be imposed at higher tax rates on Medicaid taxable units than non-Medicaid taxable units, contrary to statutory and regulatory intent for health care-related taxes to be generally redistributive. CMS notes these arrangements have a similar effect as a hold harmless arrangement, through the imposition of taxes using variable rates or provider exclusions to increase the tax burden on the Medicaid program. CMS believes these types of tax structures serve to mitigate or eliminate the tax burden on entities with relatively lower Medicaid business that may not be able to receive the amount of the tax they paid through increased Medicaid payments funded by the tax.

The following are key highlights of the proposed rule:

• CMS noted the majority of waivers they find unacceptable are for managed care organization (MCO) taxes (and one hospital tax).
• Before Federal Fiscal Year (FFY) 2024, CMS was aware of 5 states with 6 taxes that are not in compliance with the proposed rule standards and in 2025 approved 2 additional states that would not comply.
  • CMS indicated they have sent companion letters to 4 of the states with problematic taxes for their most recent tax waiver approvals and 3 states have not received letters but have received technical assistance (TA).
• New definitions have been added to clarify taxable units and tax rate groups.
• In addition to the current statistical tests, a new paragraph is being added to help ensure the generally redistributive requirement is met:
  • Taxes imposed on a tax rate group based upon its Medicaid taxable units that are higher than any tax rate imposed on a group based upon its non-Medicaid units will not be permissible (with exceptions for excluding Medicare/Medicaid revenue).
    • Example: An MCO tax where Medicaid member months are taxed $200 per member month whereas the non-Medicaid member months are taxed $20 per member month.
  • Taxes imposed on a tax rate group explicitly defined by its relatively lower volume of Medicaid taxable units that are lower rates than the tax imposed on any other tax rate group defined by its higher volume of Medicaid units will not be permissible.
    • Example: A tax on nursing facilities with more than 40 Medicaid-paid bed days of $200 per bed day while nursing facilities with 40 or fewer Medicaid-paid bed days are taxed $20 per bed day.
    • Example: A tax on hospitals with less than 5 percent Medicaid utilization at 2 percent of net patient service revenue for inpatient hospital services, while all other hospitals are taxed at 4 percent of net patient service revenue for inpatient hospital services.
  • Taxes that exclude or impose lower taxes on a tax rate group defined by or based on any characteristic that results in the same effects as the two items above but may not explicitly use the term Medicaid to define the unit, will not be permissible.
• States may continue to exclude or apply lower tax rates to tax groups established to meet public policy goals that are not defined by a specific Medicaid unit, but that may happen to include providers with low Medicaid utilization.
  
  • Examples: Sole community hospitals, continuing care retirement communities, rural providers, and psychiatric hospitals.
• Regarding rule implementation, states that received their most recent waiver approval two years or less from the final rule date will not be granted a transition period and would need to update immediately upon the effective date of the rule. Failure to do so could result in a disallowance of federal financial participation for the amount of state expenditures financed with collected funds. States that received their most recent waiver approval more than two years prior to the final rule date will be granted a transition period (at least one fiscal year, maybe slightly longer).

Please note: The proposed rule is open for comments until July 14, 2025. Comments can be submitted here.