Client Alert

House of Representatives Bill H.R. 1, Provider Tax and State Directed Payment Changes

H.R. 1 makes significant changes to Medicaid provider tax and State Directed Payment (SDP) requirements that may affect state Medicaid financing, provider payments, and program sustainability.

July 10, 2025

9 minutes

Key Takeaways

On July 4, 2025, the President signed the House of Representatives budget reconciliation bill H.R. 1 titled “An Act to provide for reconciliation pursuant to title II of H. Con. Res.14,” formerly known as the One Big Beautiful Bill. H.R. 1 includes many chapters with hundreds of sections covering a wide range of policy areas, such as health care, tax reform, education, agriculture, energy, defense and infrastructure. This overview focuses specifically on statutory changes related to provider taxes and state directed payments, within Subchapter C of the bill.

Provider tax hold harmless thresholds will change beginning October 1, 2026, with different requirements for Medicaid expansion and non-expansion states.
State Directed Payments will be subject to new payment limits based on published Medicare rates, with expansion states generally limited to 100% and non-expansion states to 110% of the applicable Medicare rate.
Certain existing SDPs may qualify for grandfathering protections, allowing states to maintain current payment levels temporarily before required annual reductions begin in 2028.
States should evaluate the combined fiscal impact of provider tax, SDP, and Disproportionate Share Hospital (DSH) changes and assess potential effects on Medicaid financing, provider payments, and beneficiary access.

What State Agencies Need to Know: At a Glance

The provider tax and SDP provisions in H.R. 1 could substantially affect Medicaid financing strategies and provider payment programs. States should begin evaluating their current provider tax structures, SDP arrangements, DSH programs, and related financing mechanisms to identify compliance risks and estimate potential fiscal impacts. Additional CMS guidance and rulemaking may provide further clarification regarding implementation and available flexibilities.

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Provider Tax Changes

H.R. 1 modifies the federal provider tax hold harmless threshold and establishes additional restrictions on provider tax structures. Beginning October 1, 2026, the applicable threshold will generally be reduced over time for Medicaid expansion states, while non-expansion states will generally maintain the percentage applicable to qualifying provider tax programs as of July 4, 2025.

State Directed Payment Changes

H.R. 1 establishes new limits on Medicaid State Directed Payments based on published Medicare payment rates. Certain existing SDPs may qualify for grandfathering provisions that temporarily allow higher payment levels before a phased reduction begins in 2028.

Provider Tax Changes

Hold Harmless Thresholds

Section 71115 modifies the federal hold harmless provisions governing health care-related taxes. The current hold harmless threshold is 6% of net patient revenue. The new provisions take effect beginning October 1, 2026.

The requirements differ depending on whether a state has expanded Medicaid:

Non-Expansion States

Provider tax programs enacted and imposed as of July 4, 2025, that meet the existing hold harmless requirements will generally have their threshold established at the program’s percentage of net patient revenue as of July 4, 2025.
For example, a qualifying provider tax imposed at 5.5% of net patient revenue as of July 4, 2025, would have a 5.5% hold harmless threshold beginning October 1, 2026.
Provider tax programs that were not enacted or imposed as of July 4, 2025, will have a 0% threshold.

Medicaid Expansion States

For provider tax programs enacted and imposed as of July 4, 2025, and meeting the applicable hold harmless requirements, the threshold will be the lesser of:

The individual tax program’s percentage of net patient revenue as of July 4, 2025; or
The following percentage of net patient revenue based on the applicable federal fiscal year (FY):

Federal Fiscal Year	Hold Harmless Threshold
2027	6.0%
2028	5.5%
2029	5.0%
2030	4.5%
2031	4.0%
2032 & after	3.5%

For Example, for FY 2028 if an individual provider tax program on July 4, 2025, was calculated at 4.0% of net patient revenue, the hold harmless threshold would be established at 4.0% of net patient revenue. Conversely, for FY 2028, if an individual provider tax program at July 4, 2025, was calculated at 5.8% of net patient revenue, the hold harmless threshold would be established at 5.5% of net patient revenue in accordance with the “lesser of” language.
Tax programs that were not enacted or not imposed as of July 4, 2025, will be set to 0% of net patient revenue.

Nursing Facility and ICF/IID Exception

Nursing facility and Intermediate Care Facilities for Individuals with Intellectual Disabilities (ICF/IID) provider tax programs are excluded from the reduction in hold harmless thresholds if the programs met applicable hold harmless requirements as of July 4, 2025. These programs may maintain their July 4, 2025, percentage of net patient revenue.

Additional Provider Tax Restrictions

Section 71117 establishes additional requirements related to the waiver of federal uniformity requirements for Medicaid provider taxes. These changes become effective upon enactment, subject to a transition period determined by the Secretary of Health and Human Services that may not exceed three fiscal years.

The legislation establishes additional criteria for determining whether a provider tax is considered generally redistributive. Under the new provisions:

A tax structure may be impermissible when taxpayers or tax rate groups with relatively lower volumes of Medicaid taxable units are subject to lower tax rates than groups with higher Medicaid taxable units.
A tax rate based on Medicaid taxable units may be impermissible when the rate is higher than a rate imposed on a group based on non-Medicaid units.
Tax structures that achieve similar results through characteristics other than an explicitly defined Medicaid measure may also be impermissible.

These provisions may affect tax programs even when the programs satisfy existing statistical tests. States should evaluate current tax structures and related waiver arrangements in light of these additional requirements.

State Directed Payment Changes

Section 71116 revises the requirements governing the maximum payment rates for State Directed Payments. The changes apply to SDPs for services furnished during rating periods beginning on or after July 4, 2025.

Payment limits differ based on Medicaid expansion status:

Non-expansion states: Payments generally are limited to 110% of the published Medicare payment rate or, if no Medicare rate exists, the applicable Medicaid state plan or waiver rate.
Expansion states: Payments generally are limited to 100% of the published Medicare payment rate or, if no Medicare rate exists, the applicable Medicaid state plan or waiver rate.

Additional CMS guidance may be necessary to clarify how states should calculate and apply the published Medicare rate. Myers & Stauffer will continue monitoring federal guidance and CMS implementation for additional information regarding available methodologies and flexibilities.

Grandfathering Provisions

Certain existing SDPs may qualify for grandfathering provisions under H.R. 1. Qualifying payments may continue at their current levels, up to the applicable average commercial rate, for rating periods beginning before January 1, 2028.

Beginning with rating periods on or after January 1, 2028:

The grandfathered payment amount must be reduced by 10% annually.
Reductions continue until the payment amount is equal to or below the applicable Medicare-based payment limit.
Eligibility for grandfathering generally depends on actions taken before July 4, 2025.

An SDP may qualify if it meets specified conditions, including:

Written CMS approval or a good faith effort to obtain approval before May 1, 2025.
Written approval before July 4, 2025, for certain rural hospital payments involving rating periods occurring within 180 days of July 4, 2025.
A good faith effort to obtain written approval before July 4, 2025, for certain rural hospital payments.
A completed preprint submitted to CMS before July 4, 2025, for a rating period occurring within 180 days of July 4, 2025.

The grandfathering provisions contain overlapping language regarding certain preprints and approval efforts. Additional federal guidance may be necessary to clarify congressional intent and the circumstances under which individual SDPs qualify.

Recommended State Actions

The changes under H.R. 1 may have significant financial and operational implications for state Medicaid programs. States should consider the following actions.

Provider Taxes

Review current provider tax programs, including taxes imposed on managed care organizations.
Identify potential compliance risks under the new hold harmless and generally redistributive requirements.
Review existing tax structures, waiver arrangements, tax definitions, and tax rate groups.
Evaluate the public policy rationale supporting existing tax rate groups and exclusions.
Calculate Medicaid utilization for each tax rate group and compare utilization with applicable tax rates.
Identify provider tax programs enacted as of July 4, 2025, and determine the percentage of net patient revenue currently subject to each tax.
Establish a reasonable methodology for calculating net patient revenue as of July 4, 2025, including consideration of both state and local provider taxes.
Perform fiscal impact analyses to estimate the effect of provider tax reductions, particularly for Medicaid expansion states.
Evaluate potential modifications to existing tax structures and perform applicable waiver tests.
Explore alternative Medicaid financing strategies when necessary.

State Directed Payments

Determine whether existing SDPs meet the H.R. 1 grandfathering requirements.
Calculate applicable payment limits based on published Medicare rates or Medicaid state plan rates.
Conduct fiscal impact analyses for grandfathered payments to estimate the effects of the required annual reductions beginning in 2028.
Evaluate the relationship between provider tax reductions and the state’s ability to finance SDPs.
Monitor CMS guidance regarding the interpretation and application of published Medicare rates.

DSH & Other Considerations

States should also evaluate the interaction between provider taxes, SDPs, and Disproportionate Share Hospital (DSH) payments.

Assess how reductions in SDPs could affect provider eligibility for DSH payments.
Evaluate how provider tax reductions could affect the financing available for DSH and SDP programs.
Account for the scheduled aggregate $8 billion annual DSH allotment reduction for each of FFYs 2026 through 2028, unless further legislative action extends or modifies the reduction.
Evaluate the combined impact of provider tax, SDP, and DSH changes on state Medicaid financing.
Assess potential downstream effects on provider payment rates and beneficiary access in both rural and urban communities.
Consider the Rural Health Transformation Program established under Section 71401 as a potential source of funding to mitigate some of the effects of these changes.

How Myers & Stauffer Can Help

Myers & Stauffer has extensive experience supporting state Medicaid agencies with provider tax programs, State Directed Payments, DSH programs, federal revenue enhancement, and provider payment strategies. Our team can help states evaluate the potential impact of H.R. 1 and develop strategies to address changing federal requirements.

As federal guidance continues to develop, Myers & Stauffer will continue monitoring CMS implementation of the provider tax and State Directed Payment provisions and is available to assist states with compliance assessments, financial modeling, program design, and implementation strategies.

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